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Section 216 of the Insolvency Act 1986 restricts the use by a Phoenix company or successor business of a similar name or trading style to that of a company in insolvent liquidation.

That is well known, as are the exceptions ñ or are they?

The Exceptions

S216 works by making any director of the insolvent company who is involved in managing the successor, unless he has leave of the court and subject to the exceptions in rules 4.228 to 4.230 Insolvency Rules 1986, both liable to criminal prosecution and personally liable (under s217) for the debts of the successor.

• The first exception, giving notice to creditors (rule 4.228), will rarely be available, contrary to widely adopted practice, because the notice must be given before the relevant director is involved with the successor, as the Court of Appeal made clear recentlyin Churchill & Churchill v First Independent Factors and Finance Ltd ([2006] EWCA Civ 1623).


• The second exception, a six week grace period following an application for leave made to the court no later than 7 days after the date of liquidation (rule 4.229), may be more common but requires an application anyway.


• The third exception, when the successor company has been known by the prohibited name for 12 months prior to the liquidation (rule 4.230), will also not assist most directors who wish to acquire and continue a business from an insolvent company.

Consequences

The first exception does not work in the way many people have thought. Notice to creditors is ineffective if the director is already a director, shadow director or de facto director of the successor business (but the notice cannot be given until the transaction has occurred).

What s216 therefore requires in most cases is an application to court for permission to be involved with a similarly named business, as a recent article ìRe-use of company names: the efficacy of the notice procedure called into questionî points out (Recovery, Summer 2006, p25).

Unless the application is made before the end of the first week of liquidation, making use of the second exception, there may be a period of several weeks during which the business cannot be transferred, pending the hearing.

Since the criminal and civil liabilities that result from breaching s216 are strict and automatic, and the court will actively consider whether approval is appropriate, and the court is unlikely to give retrospective permission (following Arden LJ in ESS Production Ltd v Sully [2005] EWCA Civ 554), a director would be ill-advised to rely on seeking permission after the event.

Sales by administrators

There are most likely to be unforeseen difficulties when the business was sold to the director by an administrator, administrative receiver or voluntary arrangement supervisor some time before the company went into liquidation. S216 will apply if the vendor company goes into insolvent liquidation at any time during the 12 months after it stopped being known by the prohibited name being used by the purchaser.

The only way for a director to avoid liability in these circumstances is to apply to court under s216. The application should be made before liquidation ñ although there is some doubt as to whether this would be valid ñ or within 7 days afterwards (making use of the six week period within which the application can be heard without liability attaching from the date of liquidation, provided the application is successful).

Addressing the problem

The situation is clearly unsatisfactory as MBO directors cannot wholly avoid the risk of liability and the Insolvency Service is therefore considering an urgent, albeit not retrospective, rule change.

In the meantime, directors involved in purchasing a business from an administrator may seek to agree with the officeholder that he avoids using insolvent liquidation as an exit mechanism. They are also likely to want him to avoid the vendor company being known by the prohibited name from the date of sale.

For those who have already breached s216 following an insolvency sale, in the mistaken belief that notice to creditors when the director was already involved with the successor was adequate, an application under s216 now would at least offer the prospect of relief from personal liability for the successor companyís future debts. Otherwise the director, whilst he remains involved in management of the successor company, will continue to be personally liable for all the successor companyís debts for up to 5 years after the liquidation of the vendor company.

Phoenixes beware!