The High Court was faced with a case regarding the re-use of a company name and whether the relevant company was indeed dormant within 12 months of liquidation.
Background:
Maxima takes assignments of debts due to creditors from insolvent companies. The defendants, Mr. Fealy and Mr. Barrett, were directors of two companies, namely McFee Interiors Ltd., incorporated in April 2009, which entered into voluntary liquidation in November 2013, and McFee Ltd., incorporated in November 2012 which entered into voluntary liquidation in February 2017.
When McFee Ltd. went into liquidation it owed one creditor £226,991 and another £11,924. Maxima sued both defendants on the basis that McFee Ltd. Had used a prohibited name which is against Section 216 of the Insolvency Act 1989. The defendants argued that the third exception to the use of a prohibited name was found under Section 216(3). The central question for the High Court to resolve was whether McFee Ltd. was dormant throughout the 12-month period prior to McFee Interiors Ltd.’s liquidation.
Decision:
The High Court dismissed the claim against the defendants for failure to satisfy the non-dormancy requirement. In doing so, the Court provided a detailed analysis of the law and the case law surrounding the relevant sections and summarised important points. First, the statutory restrictions were aimed at avoiding the ‘phoenix’ problem which His Honour Judge Hodge KC described as “the continuance of the activities of a failed company by those responsible for that failure using the vehicle of a new company. The new company, often trading under the same or a similar name, uses the old company's assets, often acquired at an undervalue, and exploits its goodwill and business opportunities. Meanwhile, the creditors of the old company are left to prove their debts against a valueless shell, and the management conceals their previous failure from the public. The phoenix company thus rises out of the ashes of the defunct company.” The phoenix problem is not the only target of the provisions, but the provisions also “encompass factual situations that cannot be described in those terms.” The Judge went on to note that “the statutory provisions should not be construed so as to include transactions which do not fall within their scope on a fair interpretation.”
The Court warned against any potential ‘doubtful penalisation’ and that a person should not be penalised except under clear law. As a result, the courts should “strive to avoid adopting a construction which penalises someone where the legislator’s intention to do so was doubtful, or penalises him in a way which is not clear.”
The third excepted case has been included to exclude the operation of Sections 216 and 217 when the second company is not a ‘phoenix’ company. This exception applies only if a company has been established and trading under a prohibited name for a period of at least 12 months before the other company went into liquidation. The exception, in r. 22.7, is aimed at a situation where there is a previously established and active business trading with limited liability. The Judge concluded that “The non-dormancy requirement in r. 22.7 (b) is clearly there to avoid the device of a company being kept 'on the shelf' with a prohibited name, ready to be used when an earlier company enters into liquidation.” The Judge rejected the defendants’ submission that it was sufficient to demonstrate that McFee Ltd. had been non-dormant at some time during the 12-month qualifying period as this would go against the clear wording of r 22.7. The second company had to demonstrate that they undertook transactions of the first, as required by Section 386 of the Companies Act 2006.
The directors were found not in breach on the grounds of non-dormancy as the Judge was not convinced by Maxima’s submission that there was insufficient evidence of qualifying transactions.
Implications:
As the Judge noted this groundbreaking decision is the “first time the true meaning and effect of the second of the two elements of the third excepted case from the general prohibition on the re-use of a prohibited name by a second company after the entry into insolvent liquidation of an earlier company that had used that name.” This illustrates how infrequent this practice is.
On top of being very detailed regarding the reasoning behind the exceptions in Section 216, this decision also establishes that for the exception to be valid, the company must have been trading for at least 12 months. It is not sufficient to demonstrate trading at some point during the 12 months, instead, accounting records must cover the whole qualifying period and the transactions must be in line with the requirements under Section 386 of the Companies Act 2006.