Bulletins | November 5, 2024

Maxima Creditor Resolutions Ltd v Fealy & Anor [2024]

Section 216 Insolvency Act 1986 provides that a person who has been a director of a company at any time in the 12 months before it goes into insolvent liquidation is prohibited for five years from being a director of, or directly or indirectly being concerned in or taking part in, the promotion, formation or management of a company with the same or similar name to the liquidated company (a “prohibited name”). Section 217 imposes personal liability on a director for debts incurred by a company which acts in breach of s 216. The director of an offending company may also face criminal charges.

There are three exceptions to the general rule on the use of a prohibited name:

(1) use pursuant to a sale or acquisition from the liquidator of the whole, or substantially the whole, of the insolvent company (r 22.4 Insolvency (England and Wales) Rules 2016);

(2) use with permission of the court (r 22.6);

(3) use by a company which has been known by the name for the whole of the period of 12 months ending with the day before the liquidating company went into liquidation; and has not at any time in those 12 months been dormant within the meaning of s 1169(1), (2) and (3)(a) Companies Act 2006.

His Honour Judge Hodge KC’s judgment in Maxima Creditor Resolutions Ltd v Fealy & Anor [2024] EWHC 2694 (Ch) considers, apparently for the first time, the meaning and effect of the second of the two elements of the third excepted case, specifically, the question what is meant by the requirement that the second company should not have been dormant at any time in the whole of the period of 12 months ending with the day before the first company went into liquidation (the “non-dormancy requirement,” as the judge called it).

Maxima, the claimant, takes assignments of debts due to creditors from insolvent companies, many of them arising out of the use of a prohibited name. The defendants, Mr Fealy and Mr Barrett, were the directors of two companies, McFee Interiors Limited and McFee Limited (ML). When ML went into liquidation it owed one creditor £226,991, and another £11,924. Those debts were undisputed: they had been confirmed by Mr Barrett in ML’s statement of affairs. After giving credit for reclaimed VAT, the total outstanding was £191,143 plus interest under the Late Payment of Commercial Debts (Interest) Act 1998.

Maxima sued Mr Fealy and Mr Barrett on the basis of ML’s use of a prohibited name. The defendants relied on the third exception to the use of a prohibited name..

Maxima challenged the defendants’ ability to rely on the excepted case, contending that, to do so, they had to show ML undertaking transactions of the kind required by s 386 Companies Act 2006 to be included in its accounting records throughout the whole of the qualifying 12 month period (in this case ending on 19 November 2013). It submitted that there was insufficient evidence of any qualifying transactions before 20 November 2012. It was not sufficient for the defendants simply to demonstrate trading at some point during the 12 month qualifying period; nor was it enough for ML to have engaged in some activity, such as tendering, or providing services, or in preparing to transact business: there had to be evidence of actual transactions involving the receipt or expenditure of money, or affecting ML’s balance sheet. It followed, Maxima contended, that ML had not been non-dormant for the whole of the qualifying period, so the third excepted case did not apply.

The defendants’ case was that it was sufficient to demonstrate that ML had been non-dormant at some time during the 12 month qualifying period. In any event, the evidence demonstrated that ML had“hit the ground running” and engaged in trading, so was non-dormant from its incorporation on 14 November 2012, activity continuing at all times thereafter, both during, and after, the 12 month qualifying period.

From a review of the authorities on prohibited names the judge set out a number of propositions, many of general significance:

(1) The principal target of the statutory restrictions on the re-use of prohibited company names was the “phoenix” problem.

(2) The “phoenix” problem resulted from 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 conceal their previous failure from the public. “The phoenix company rises out of the ashes of the defunct company.”

(3) Although “phoenix syndrome” was the principal target of the statutory provisions, their wording encompasses factual situations that cannot be described in those terms. The court should not strive to strain the clear language of the statutory provisions by unacceptable methods of judicial interpretation, or seek to adopt a strained interpretation of the words of the statute simply in order to confine its operation to true cases of the phoenix syndrome. Moreover, it is difficult to distinguish between good and bad phoenix situations, and between honest and unscrupulous traders; the court needs to recognise that the statutory provisions do not attempt to do so.

(4) Nevertheless, the statutory provisions should not be construed so as to include transactions which do not fall within their scope on a fair interpretation.

(5) Further, since s 216(3) refers expressly to “such circumstances as may be prescribed,” the provisions in the Insolvency Act on prohibited names should be construed together with the rules so as to produce a rational and coherent scheme.

(6) The “principle against doubtful penalisation” mandates that a person should not be penalised except under clear law. The court should therefore 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.

(7) The purpose of the third excepted case is to exclude the operation of ss 216 and 217 where the second company is not a “phoenix” company. The exception in r 22.7 is aimed at a situation where there is a previously established and active business, trading with limited liability. Customers and suppliers who deal with such a business will know that they are dealing with an entity with limited liability, just as they always have done. The non-dormancy requirement in r. 22.7 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 goes into liquidation.

The judge rejected the defendants’ submission that it was sufficient to demonstrate that ML had been non-dormant at some time during the 12 month qualifying period. That, he said, ran counter to the clear wording of r 22.7. When the requirement that the second company “has not at any time in those 12 months been dormant” was construed in conjunction with the reference to “the whole of the period of 12 months ending with the day before the liquidating company went into liquidation,” it was clear that the construction argued by counsel for the claimant was correct. The defendants, in his view, had to show that ML had undertaken transactions of the kind required by s 386 Companies Act 2006 to be included in ML’s accounting records throughout the whole of the qualifying period of 12 months, in this case ending on 19 November 2013, and thus starting before 20 November 2012. It was not sufficient for the defendants simply to demonstrate trading at some point during the 12 months qualifying period.

In his view counsel for the defendants, who had relied on a passage in Butterworths Corporate Law Service, had conflated company law and insolvency considerations:

“For the purposes of the third excepted case in r 22.7, the question is whether the company is non-dormant throughout the qualifying period. For the purposes of the accounting provisions of the Companies Acts, the question is whether the company is dormant at any time during the relevant period. The quotation from Butterworths Corporate Law Service…that ‘a company that is dormant ceases to be so as soon as a significant accounting transaction occurs’ is entirely apposite when a dormant company ceases to be so for accounting purposes: as soon as a company ceases to be dormant, it loses the exemption from the requirement for an annual audit for that financial period. But it has no direct application when one is considering the third excepted case because that exception only applies when a company is non-dormant throughout the whole of the 12 months qualifying period. The passage cited cannot be translated from an accounting to an insolvency scenario.”

Ultimately, however, the case was decided on the evidence. The judge rejected the claimant’s submission that there was insufficient evidence of qualifying transactions:

“On the evidence, I find, consistently with [the defendants’] case, that the evidence demonstrates that ML ‘hit the ground running’, even before it was incorporated; and that ML was engaged in significant accounting transactions, and thus non-dormant, throughout the period from its incorporation on 14 November 2012, with physical work starting…on Friday 16 November, and with such transactions continuing at all times thereafter, both during, and after, the 12 months qualifying period ending on 19 November 2013.”

The claim was accordingly dismissed.

The fact that this judgment considers the issue of non-dormancy for the first time makes it interesting on its own terms but arguably illustrates how infrequently it crops up in practice. The judgment also contains a useful, albeit obiter, analysis of the law on limitation in relation to claims such as that pursued by Maxima. A limitation point was initially taken but later abandoned by the defendants. The judge’s conclusion on the issue was ultimately based on the acknowledgment of the debts in ML’s statement of affairs which set time running afresh.