A story we published last week about a Harrogate company going into liquidation owing over £1 million, yet the owner launching a new, very similar business, caused quite a stir.

Many readers commented about how it should be illegal – but it’s not. At least, not totally.

This phenomenon is so regular it has a name: phoenixing. But there are two types: legitimate and abusive.

The whole idea for allowing a company to collapse, be liquidated and a new company be formed by the same person doing essentially the same thing – without creditors necessarily being paid – is to encourage entrepreneurship.

There are caveats to this.

Firstly, the law says that these news companies can be set up “as long as the individuals involved are not personally bankrupt or disqualified from acting in the management of a limited company”.

Someone may have been disqualified in the past for abusive phoenixing – when individuals use companies repeatedly to evade debts or for fraudulent purposes. If you were to ignore this you could face criminal proceedings.

HMRC also has powers to issue ‘joint and several liability’ notices to directors and others associated with the company after it becomes insolvent, making them personally liable for company debts.

How does going into liquidation actually work?

A company might go into liquidation when it can no longer pay its debts.

An independent liquidator will be appointed and their role is to try to get back as much money as possible to pay the creditors (the people the company owes money to). This is often by selling assets.

The other main things that happen are that the company ceases trading or employing people, it is struck off Companies House, and other bits of paperwork completed. 

Another slightly more controversial way it might happen is through a pre-pack administration. This is where the sale of a company’s assets is agreed before the liquidator is formally appointed.

While this can be useful for things such as job preservation, serving the community and reducing the costs of becoming insolvent, there are some criticisms of the strategy.

It is more open to abuse, with some cases seeing original directors buying back the company, or assets being under-valued. Although it's legal, insolvency practitioners must issue a detailed statement explaining why a pre-pack was chosen, who the buyer is, and how values were calculated.

The Insolvency Service

There is a government department that investigates these situations, with the aim of catching those who are abusing the system.

The Insolvency Service looks into the conduct of directors of companies that have entered into insolvency proceedings, ensuring that the conduct of these individuals has been appropriate.

Unfit contact, which would result in disqualification, might include failure to deliver accounting records, deliberately depriving creditors of assets, fraudulent behaviour and similar failures to comply with requirements.

Compensation orders may also be sought in cases where the conduct for which a person has been disqualified has led to a direct loss to creditors and insufficient action has resulted from the insolvency process.

There are also restrictions on the re-use of the former company name, including any trading name, by directors of a company that has entered into voluntary or compulsory liquidation.

In short, it’s a frustrating story that we hear too often. Why should an individual walk away from a failed business, leaving creditors (often including HMRC – in other words, taxpayers) losing out, only to start essentially the same business up again?

The simple answer is because it’s a trade-off – the government believes we need to allow business ventures to fail without it destroying the individual more than we need to avoid people exploiting the policy.