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As the recession continues to bite, more and more businesses are finding it difficult to continue trading. In this economic climate Phoenixing or Pre-Pack Administration would would remove the burden of historic debts and allow business to continue to trade.

With the continuing economic downturn, increasing numbers of businesses are finding it difficult to continue trading. Frequently these difficulties are not because customers have stopped buying completely. Rather, they are buying in reduced volumes and asking for lower prices.

In these circumstances if they were not saddled with historic debt many of these businesses could continue to trade profitably. Since the Enterprise Act of 1984, it has been possible to request relief from corporate creditors using a Company Voluntary Arrangement or CVA. With the agreement of creditors, a Company Voluntary Arrangement allows a portion of corporate debt to be repaid at a manageable rate over a set period of time, the remaining debt being written off. However, this procedure has long been criticised by both creditors and insolvency professionals alike due to the high percentage of early failures. The main argument against the CVA is that the fundamental structure of the business and its management team do not change. Therefore even with the burden of historic debt lifted the reasons for past failure are likely to repeat themselves.

Given the criticism levied against a Company Voluntary Arrangement, the process of Phoenixing (also known as Pre-Pack sale in liquidation or administration) has become more widely considered as a practical way of saving a business. Phoenixing is simply where a new company is formed which then buys the assets, contracts and goodwill of the failing business for a reasonable market rate. The legacy debt is left within the old business which is then liquidated thus allowing the new Phoenix business to trade on, debt free.

From the beginning of this year, much comment has been made about the Phoenix process in the media. Very often this has been from a negative point of view because of the fact that creditors are left with unpaid debts which may in turn lead them to suffer their own financial difficulties. The fact that these companies were already failing is often ignored in these published arguments. The reason for the failure was the company’s inability to continue to trade. In these circumstances, liquidation was extremely likely if not inevitable. The creditors would have been out of pocket regardless of the Phoenix process.

A further criticism of Phoenixing is that creditors are not afforded the right to reject the new company’s proposal to purchase the business assets from the failing company. However, it is widely recognised that to go through an open process of sale due to failure (often using administration) often destroys many of a company’s valuable assets such as good will and contractual obligations. In addition, discussing matters with creditors before a potential sale of assets opens the possibility of the creditor taking unilateral recovery action which may well be detrimental. As such, a Pre Packaged sale will actually deliver the best possible return to creditors. From November 2008 Creditors have been afforded better protection with the Insolvency Service publishing guidelines which require insolvency practitioners to ensure full market value is paid for the assets and provide a report to creditors of why this action is more beneficial to them.

The arguments for the Phoenix process are compelling. There is the obvious advantage that the new business is not saddled with the old company’s debts. In addition, unlike a CVA, there is no obligation for debt repayment. Fundamentally and unlike the CVA, a Phoenix allows a new business to begin with the introduction of new procedures and ways of working. All or part of the management team may remain the same. However, inappropriate property location or lease agreements are not taken on by the new company giving it every chance of success. In addition, the new Phoenix company will offer a far better chance that employees’ jobs are protected than if the business were simply liquidated. TUPE (Transfer of Undertakings and Protection of Employment) rules apply meaning that the maximum number of jobs are saved.

Given these advantages it seems certain that Phoenixing will be seriously considered by many business owners trying to manage the issues of a failing company. This is not to say that the process will be right in every situation. However, with increasing numbers of businesses under financial pressure and at risk of failure, Phoenixing must certainly be given serious consideration.

Resources:

Derek Cooper is Managing Director of Cooper Matthews Limited http://coopermatthews.com and a member of the Turnaround Management Association UK.

Cooper Matthews specialise in Business Recovery Services Advice providing straight forward insolvency advice for businesses with financial problems. They have significant experience in working with small to medium sized businesses.

More expert advice on Phoenixing http://coopermatthews.com/phoenixing.html