Ashes to ashes

By Adam Bernstein, Monday 23 October 2017

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It’s a sad fact of life that businesses can and do fail and the fallout impacts many – owners, shareholders, employees, customers and suppliers alike.

phoenix

Often there is nothing underhand about the failure – the company is fatally wounded by a lost contract, a massive hike in a rent or rates, or has been unable to adapt to changing market conditions.

Elle Media Group’s acquisition of the goodwill of MPC Print Solutions in July of this year (2017) is a case in point. MPC failed, despite a £7.5m turnover, because of six-figure bad debt and an ill-fated site move. The MPC brand will continue, much to the chagrin of some creditors, but at least some 15 members of staff have been taken on by Elle Media, an unconnected business. 

There are other examples, such as the collapse of Leeds-based overprinter Wepos in May following an HMRC winding-up petition. Wepos was itself the result of a purchase (when Print On Solutions – run by the same directors as Wepos – went into administration owing £1.4m). The now former directors of Wepos have since set up a new bag and packaging business called Alpacka.

And it’ll be interesting to see what happens to the remnants of Nova Direct, a West Sussex-based direct mailing firm that went into administration in August 2017. Its last accounts cited a profit of £24,000 while creditors were owed £600,000. The company suffered through client consolidation and the loss of contracts.

Ian Carrotte, proprietor of ICSM Credit, has seen a rise in firms going to the wall this year with print firms particularly vulnerable “as it is a declining market”. He says that “competition is fierce, margins are cut and one bad debt can cause a print firm to become insolvent”. He has also witnessed the vulnerability of printers, finishers and sub-contractors to large companies that have got into trouble.

The rise of the phoenix

The remnants of a failed business are often bought by the directors of the former company in what is known as a ‘phoenix’ company. It’s a process that Sarah Carlton, an associate at law partnership Fox Williams, describes as the practice of carrying on the same business or trading successively through a series of companies which in turn become insolvent. Each time this happens, the business of the insolvent company (but not its debts), is transferred to a new, but similar, company, usually through the use of a pre-pack administration. This involves the business of the liquidated company being sold as a ‘going concern’ through a process orchestrated by an appointed insolvency practitioner. The insolvent company then ceases to trade.

The issue of pre-packs is tricky for the sector says Charles Jarrold, chief executive of the BPIF. “We’re a capital-intensive industry operating in a changing sector, parts of which have needed restructuring. Historically, rather than exiting, some businesses have refinanced using pre-pack legislation to slough off debts to the intense frustration of incumbent stronger businesses.”

Dave Mullett, credit control manager at paper firm Elliott Baxter (EBB) agrees with Jarrold: “With phoenix companies and pre-packs it can be argued that in many cases, those businesses opt for insolvency, to then start afresh, dumping their financial obligations, purchasing kit and supplies at a fraction of their true cost, and starting again as if no changes had occurred... this can have a serious effect in any industry, and that is certainly true in the printing industry.”

William Martin, managing director of Aston Colour Press, takes a blunter view: “We have to compete against companies who periodically dump their debts and carry on unchallenged. How do you imagine that affects us?” 

Martin is irritated that he’s “undercut by people who offload their responsibilities” and because others in the supply chain who incur losses then recover these monies from “others who trade honestly”.

Misfortune is one thing, but there is no doubt that some directors do set out to commit insolvency fraud to deliberately reform a business to avoid paying creditors. As Carlton sees it, “they set the phoenix up to appear slightly different from the insolvent entity. The bad news for creditors and suppliers is that they will have no contractual claim against the new company for debts incurred by the old, defunct, company”.

Mullett says EBB naturally takes a dim view of this: “More often than not... it results in a second failure. However, not before the re-start has inflicted damage on the opposition who may well have shed jobs in order to reduce costs, and most likely put pressure on their suppliers to drive down prices in order to compete against those who had the unfair advantage.”

He notes the ripple effect of the consequences resulting from the actions of unscrupulous directors and says: “EBB is committed to not supporting such ventures.” The company states this policy on its website – that it will not supply a phoenix company for cash or credit under any circumstances “unless”, as Mullett says, “the new owner is completely unrelated to the failed business, brings a substantially new management team in to run the new business and invests significant funds into the new business.” He adds that “if we subsequently discover that we are trading with a phoenix company, we will trade out or close this account at the earliest opportunity.”

This philosophy is worth keeping in mind because, as Carrotte says, “in a number of recent of cases I know of involving pre-pack agreements, smaller jobbing printers have been left high and dry and thus have created further potential business failures. The rules need tightening.”

What, then, are the rules?

What the law intends can be very different from the way it works in practice. Mullett believes “the law was designed with the intention of protecting jobs and to encourage the entrepreneurial attributes of the owners, to ‘have another go’.” His view, to an extent, is correct, says Carlton: “The governing law of England and Wales allows shareholders, directors and employees of insolvent firms to set up new ones to carry on a similar business, so long as the individuals involved aren’t personally bankrupt or disqualified from acting in the management of a limited company, and the trading name of the new company is not the same or similar to that of the insolvent company.”

Entrenched company law principles mean that a limited liability company is a legal entity separate from that of its shareholders and directors.

But it’s not all a bed of roses for phoenix directors says Carlton. “A director can be made personally liable, jointly and severally with the company, for all the relevant debts of the new company, where they contravene the Insolvency Act 1986 by acting as a director of a company with a prohibited name (i.e. a name which is similar to suggest an association with the previous company’s name). Here the director will also be liable to a fine or potential imprisonment.”

Seeking solace

Jarrold thinks that the law is forcing print creditors to think about their long-term interests – should they support and supply phoenix companies? The response will, no doubt, depend on whether the process is viewed fairly. He says: “These decisions determine the ultimate attractiveness and viability of phoenixing,” adding: “The Pre Pack Pool review process (an independent body of experienced business people who will offer an opinion on the purchase of a business and/or its assets) is meant to provide a means for testing whether a connected party pre-pack has at least been handled in a professional ethical manner, but it hasn’t seen sufficient uptake.”

EBB is very proactive in protecting its interests both through its no-supply policy and its credit processes. Mullett says: “We use many resources in order to ensure those customers who are offered credit are worthy, and we monitor for any information published in order to maintain a constant vigil over our customer base. In 2015, following the demise of Paperlinx, the UK’s largest paper merchant, we took the decision to adopt credit insurance, due to the increased demand which followed.”

So, what can printers do if they suspect insolvency fraud?

A company may or may not be insolvent. But if it is insolvent, the appointed insolvency practitioner’s function is to investigate the practices of the company and distribute any assets found to the creditors of the business. Carlton says that the underlying assets of the insolvent company are required to be sold at market value and not (deliberately) at an undervalue – “and you, as a creditor of this business, should have an interest in such investigations and you should speak to and assist the insolvency practitioner where possible”.

Jarrold makes the point that insolvency practitioners have a duty to look after creditor interests as a whole, and realise as much value as possible for creditors. “For pre-packs, the insolvency practitioner must report why the procedure was the best option for the creditors.” He emphasises that if creditors have concerns, they must engage with the insolvency practitioner who faces the possibility of fines and loss of licence if they haven’t complied with their obligations.

Moving forward, there are, says Carlton, strict duties placed on the directors of an insolvent company and any appointed insolvency practitioner regarding the use of a phoenix company to carry on the business of an insolvent company: “The intention of the regulations is to protect the interests of unsecured creditors and to prevent company directors from escaping their obligations. It is a criminal offence under the Insolvency Act to knowingly carry on business with an intention to defraud creditors.” She says that if this is proven an insolvency practitioner may make the decision that the director is liable to make a contribution to the company’s assets on winding up. 

Further, directors who don’t conduct business in line with their legal obligations face potential disqualification from acting as a company director. “The Company Directors Disqualification Act, 1986 is vocal here,” says Carlton, “as it prohibits directors whose conduct led to the insolvency of a company from taking on similar roles elsewhere for a prescribed length of time.” She advices creditors who suspect that a director of a company is conducting their business in an unfit manner, to report them to either the Insolvency Service, Companies House or the Serious Fraud Office.

There is an alternative, and one espoused by Carrotte – naming and shaming. “With phoenix companies, they [directors] trade on reinventing themselves periodically and at ICSM we put the word out by naming names.” Carrotte says he keeps his members in the print industry informed “as bad debts can hit anyone at any time so early warnings are often the one thing that keeps a business afloat in difficult times.”

To finish

It’s clear that those in print need to exercise caution. The last word, however, goes to Martin – he wishes the media would stop using the label ‘pre-pack’: “A phoenix is a phoenix, call it what it is. Stop insulting the rest of us by reporting a phoenix as a great thing. Remember who pays for it: we do. It is not good news for the honest majority. Diseased, flawed and broken companies should be allowed to fade away quietly, not shored up by profoundly unjust government policy.” 


Avoiding the pitfalls

Check who you’re dealing with

Information is available online at Companies House to any member of the public who wishes to see who is registered as a director of a company they are dealing with. The name of the company (which may be different from trading name) or the company number will be required to use the Companies House search function. Free company information covers, for example, the registered address and date of incorporation, current and resigned officers, document images, mortgage charge data, any previous company names, and any insolvency information.

Other filed documents such as company accounts, annual reports, annual returns and confirmation statements can be obtained for free from the new Companies House website. It’s also possible to monitor any company, including your own, for any new information filed, by registering online - there’s no fee for this. 

Another option is to subscribe to Companies House access via a Companies House Direct account. A subscription grants access to all historical company records, document packages (at a cost of £4 each, including multiple documents), detailed mortgage information, and to order online certified copies. Searches can also be made by director’s name. See bit.ly/pw-chdirect for more information.

Seek references

Conduct preliminary investigations on new customers before entering into a trade agreements or offering trade credit by seeking trade references and carrying out credit checks. There are a number of credit reference agencies, including ICSM, Dun & Bradstreet, Graydon, Equifax and Experian. These companies provide information gathered on a company or an individual to allow the assessment and analysis of a particular credit transaction. Credit information won’t insure bad debts and nor will it prevent them, but it will help keep bad debt in check with detail on customers.

Data held includes company addresses and registration, turnover, profit, bank address and sort code, director name and home details, personal payment defaults, corporate payment history and financial details, company mortgages and charges, share ownership, etc.

It’s also possible to have a company sales ledger or debtor book reviewed using the latest payment performance data to identify customers that are at high risk of paying late or defaulting.

Cover the bases

If in doubt, seek director’s guarantees. Get ‘out of pocket’ costs paid upfront - notably paper, which can constitute a major element of a job’s cost. Consider asking for cash up front at least while the trading relationship is being established. Ensure you’re reviewing debtors ageing regularly - both against age of debt and against due date. Don’t let overdue amounts build up - if there are problems, ensure that if there is to be on-going trading, it reduces the outstanding amount. Don’t give extended credit - this isn’t just about the financing cost, it’s about risk.

Check contracts

See whether supplier contracts have, or possibly should have, clauses which aim to protect legal ownership of any supplied goods until payment has been made by a customer. Some supplier contracts may include what are known as retention of title clauses which will state that the goods delivered by a supplier remain their property until payment by the customer has been made. Legal advice should be sought as retention of title clauses require careful thought and drafting to ensure that they are effective, an event of insolvency should be properly provided for in such terms and conditions in order for a supplier to limit exposure to the risk of non-payment. 

Official channels

A creditor to a business which is undergoing insolvency, should help the Official Receiver / insolvency practitioner to understand the causes of failure. They have a duty to investigate the affairs of companies in compulsory liquidation and report evidence of criminal offences to a prosecuting agency. If it’s believed that a company is withholding information about its assets, or information is available about the conduct of a company, the Official Receiver / insolvency practitioner should be given the relevant facts.

Suspicions that an individual is acting in breach of a disqualification or bankruptcy order should also be reported to the Insolvency Service. It is a criminal offence to contravene a disqualification order or undertaking, a bankruptcy order or a bankruptcy restrictions order or undertaking. It is also a criminal offence for another person to assist a disqualified person to act in this way.

An Enforcement Questionnaire can be obtained from www.insol vency.gov.uk. A person who contravenes the order or undertaking could become personally liable for any debts of the company which it incurs while the order or undertaking is contravened. Anybody who carries out that person’s instructions may also be personally liable. Details of disqualified directors can be found on the disqualified directors register at Companies House.

Where the Insolvency Service can’t help

The Insolvency Service has discretionary powers but they cannot investigate where a company has been dissolved because according to the law, dissolved companies no longer exist. The Insolvency Service also can’t use its powers to investigate or resolve individual commercial disputes between companies and their employees, customers, creditors or shareholders (such as non-payment of an individual supplier, an employee’s wages, not providing a customer with goods or services that they have paid a deposit for, supplying a customer with faulty goods, or decisions made by directors that a shareholder disagrees with) unless they are part of a broader pattern of unfit behaviour.

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