The rise of the phoenix company

The collapse of Maclean Computing Ltd, and the reported purchase of its assets by Maclean Technology Ltd, has led to some discussion on whether the new company may be a phoenix company (see here for the New Zealand definition). While many of the issues being discussed are moral rather than legal issues, here are my quick comments on some aspects of the phoenix rules generally:

Liability for debts

Under the phoenix rules (sections 386A-386F of the Companies Act 1993), a director of a phoenix company is not automatically liable for the debts of the original company. The director of a phoenix company will only be automatically liable (under the phoenix rules) for the relevant debts of the new company (i.e. the phoenix company). For example:

  • Company A Ltd collapses and goes into liquidation owing $1m.
  • Either before or within 5 years of the collapse, a director of Company A Ltd starts up a new company with a similar name, “Company A Technology Ltd”, and starts doing business out of the new company, apparently leaving unsecured creditors of the old company up the river.
  • Company A Technology Ltd will likely be a phoenix company.
  • The director will be personally liable for relevant debts (which has a particular meaning) of the Company A Technology Ltd (i.e. the phoenix company) if it fails.
  • But the director will not be liable for the $1m of debts of Company A Ltd (i.e. the original, failed company).

So the phoenix rules effectively give directors of “failed companies” (note there is a particular definition of that term) what some may consider a free pass on debts of their first company (although they may be liable to fines – see below – and there are also numerous other company law liabilities that may arise and result in personal liability; these are very selective thoughts only). That is the nature of limited liability companies, which are essential for modern commerce. The new rules are aimed at creditors who may be deceived by the phoenix company, rather than creditors of the original company. So a director can rack up large debts in your first company, have that company fail, launch a phoenix, and not be personally liable (under the phoenix rules) for the first company’s debts. But if the phoenix company “fails”, or any second, third or later phoenix company, then the director will likely be liable for those companies’ relevant debts (which should itself act as a deterrent, because it undermines the protection of limited liability).

The very simple way to avoid the phoenix rules is to avoid using a similar name to the failed company.

Capturing the debts of the original company

It may still be possible to make a director of a phoenix company liable for at least some debts of the original company as follows:

  • Put the original company into liquidation (if not already).
  • Apply for and obtain a “pooling order” under s 271 of the Companies Act 1993, in respect of the original and phoenix companies. This is not easy, but if granted has the effect of allowing the debts of the original company to be treated as debts of the phoenix company.
  • Then use the phoenix rules to make the director personally liable for the debts of the phoenix company, which, because of the pooling order, may include the obligation to pay the debts of the original company.

Note that pooling orders are not commonly obtained and have strict requirements, including that the two companies were “related” (as defined), hopelessly intermingled and effectively indistinguishable. This generally requires a period of overlap of existence between the two companies; a phoenix company formed after the collapse of the original company would be unlikely to qualify.

Penalties under the Companies Act

A person convicted of breaching the phoenix rules can face a fine of up to $200,000, or up to 5 years imprisonment. The fine gets paid to the Government, not go to creditors. These punishments will hopefully deter phoenix directors but will likely provide cold comfort to a stiffed creditor.

Other thoughts

There can be other potential remedies for creditors either directly under the Companies Act or, more likely, via the liquidation / receivership process. Remember that the phoenix rules are not intended to protect creditors of the original company.

In any case, at the end of the day it is usually a case of what is economic to pursue.

To end on a positive note, prevention is always better than cure. A key step that creditors can take (if available) to improve their chances in the event of a debtor’s insolvency is to become a secured creditor over appropriate collateral supported by a registered security interest protecting their position.

Company admin reforms

New Zealand is lucky to have one of the best (if not the best) Companies Office websites in the world. We also have a very liberal company law regime – which is generally a good thing. It is little surprise therefore that New Zealand ranks #1 in the world for ease of setting up a business – the process is almost ridiculously easy and often only takes a few minutes. The proportionally large number of registered companies confirms that setting up and maintaining a company is an easy thing to do.

Two changes will affect this slightly.

First, from 1 August a $45 charge has been introduced for filing of annual returns (previously this was free). As the process is fully automated and does not involve filing accounts, it is difficult to see what this charge is actually for. But it should be a nice little earner: the Companies Office says there were 563,856 active companies at June 2011, and assuming each one files annual returns this will bring in over $25 million.

This will also sting those people who, for whatever reason, sit on numerous shelf companies. Someone with say ten shelf companies will now have an annual holding cost of at least $450 per year, or face having them struck off.

The second, more substantive change (which has not yet occured) are reforms requiring, among other things, companies to have at least one director or agent resident in New Zealand (or an “enforcement country” with whom we have reciprocal arrangements). As Stuff reports:

The Government is fast-tracking reforms to prevent New Zealand companies being used as tools by international criminals.

The move comes after criticism from opposition parties that the Government was dragging its feet on the issue and as the Sunday Star-Times uncovers New Zealand links to a rort of the Ukraine health system, where publicly purchased vaccines were subjected to 300 per cent mark-ups.

As in previous cases of shell company abuse, the vaccine scam relied on New Zealand-registered companies using foreign directors – in this case a Panamanian mother – to obscure transactions.

This is a sensible and probably overdue change. It will not affect the vast majority of New Zealand companies. But there have been numerous instances of New Zealand companies having no local directors, being involved in international money laundering. The requirement for a local director / agent will address this by:

  1. Making it harder to register a company without a New Zealand resident being involved; and
  2. Ensuring (or at least making more likely) that there is at least one person in the jurisdiction (or one with enforcement arrangements in place) who can be investigated or potentially prosecuted if the company becomes involved in suspicious activities.

Electronic shareholder communications

The Government is set to update the Companies Act 1993 to allow the use of electronic communications for certain formal notices and procedures.

Currently, the law permits shareholder meetings to be held via the following methods (Schedule 1, section 3 of the Companies Act 1993):

(a) by a number of shareholders, who constitute a quorum, being assembled together at the place, date, and time appointed for the meeting; or

(b) subject to the constitution of the company, by means of audio, or audio and visual, communication by which all shareholders participating and constituting a quorum, can simultaneously hear each other throughout the meeting.

There is no formal provision for electronic communication (although certain electronic means do meet the existing requirements). The Regulatory Reform Bill, which received its first reading recently, will improve that by allowing meetings by shareholders to be held by:

(a) being assembled together at the time and place appointed for the meeting; or

(b) participating in the meeting by means of audio, audio and visual, or electronic communication; or

(c) by [sic] a combination of both of the methods described in paragraphs (a) and (b).

Currently, notices to individual shareholders may be sent via the following means:

(a) delivered to that person; or

(b) posted to that person’s address or delivered to a box at a document exchange which that person is using at the time; or

(c) sent by facsimile machine to a telephone number used by that person for the transmission of documents by facsimile.

Again, there is no express provision for modern electronic communication such as email. It is reasonably arguable (and in practice does happen) that delivery by email falls under (a), however companies (especially those with large shareholder bases) may be reluctant to take such chances.

The option to receive notices electronically is not so much for the company’s benefit, but for the shareholders’. Accordingly, the new law does not force shareholders to accept electronic communications, but gives them the option (binding on the company):

(3A) … a shareholder or creditor may notify the company—

(a) that the shareholder or creditor wishes to receive the document by electronic means; and

(b) of the electronic address to which the document is to be delivered.

(3B) Notification in accordance with subsection (3A) may be made in respect of a particular document or documents, or in respect of all documents to be served.

(3C) The company must comply with a notification made under subsection (3A).

Note that the company must comply with the shareholder’s specified mode of electronic communication. The new law does not limit what the modes are, so in theory a shareholder could request to be sent documents via Facebook or Twitter.

This is a sensible reform, as many modern business people are far more likely to have ready access to their electronic communications, than to a document posted to a physical address.

The Electronic Transactions Act 2002 will apply to any questions over the time of dispatch and receipt.

Privacy for company director addresses

From October, the UK will be restricting access to the residential addresses of company directors on new registrations (and optionally for existing registrations).

At present – as in NZ – directors must disclose their residential addresses, although – unlike in NZ – a director may apply to have that information restricted on the grounds of possible attack. Soon, residential addresses will become “protected information” by default – only disclosable to credit reference agencies and certified authorities. There will also be an option to hide the residential address from even those authorities.

The change is apparently in response to increased privacy concerns and threats of violence against directors.

In New Zealand, the law requires that company directors disclose their residential address (e.g. section 215 of the Companies Act 1993 among other sections). There is no provision for withholding an address. Interestingly, our Companies Act also requires that founding shareholders provide a residential address (section 12(2)(c)), but not subsequent shareholders (section 87 only refers to “the latest known address” which, in the case of a person, could be a non-residential postal or even electronic address. Many companies I have dealt with and managed use a non-residential person-shareholder address).

It is probable that New Zealand will eventually go the way of the UK, although there has not been any call for it yet. Australia has a provision for suppressing directors’ residential addresses which would also be a possible model to adopt.

Is this a good idea? It depends on the purpose of showing a director’s residential address. Why do we really need to know that information? If the answer is to serve documents on a director, that can be easily achieved by allowing directors to be served:

  1. At an alternative “address for service” specified by the director (the new UK model); or
  2. At the company’s “address for service” which all companies must have anyway.

Provided we have one of the above options, the residential address isn’t really needed and should be able to be suppressed. This would be consistent with the UK and Australia, and also the approach under the Electoral Act 1993. The electoral roll is open for public inspection (though not electronically) and can be used to find a residential address, but with the ability for individuals to request suppression under section 115.

The Privacy Commissioner has guidelines suggesting a model similar to Australia’s, allowing suppression on request, although for some reason its report does not mention the Companies Act at all.

In the meantime, all company records including director addresses are open to full public inspection. Is there some other reason why it should stay? Openness and transparency are always good things, but if it is not necessary to disclose this personal information, should we?