What is a phoenix company – and should I trade with one?

A phoenix company is reborn from a company that has failed. It often has the same directors, the same staff, and the same products and brands. But should you do business with them?

It’s an important question. Rising insolvencies mean they will become more common. Richie Pamma, Assistant Head of Risk Underwriting at Allianz Trade UK and Ireland, comments: “This is the sort of economic environment where we see an increase in phoenix companies.”

Phoenix company meaning

The term ‘Phoenix companies’ has a particular meaning, but the name can be misleading. In Egyptian mythology, the phoenix was a bird that flew into a fire when it got close to death and then emerged reborn and full of health. Phoenix companies, in contrast, are missing quite a few feathers. They face practical business problems that restrict their ability to trade and grow. And this has implications for firms that do business with them.

These problems are driven by how a phoenix company is created. Although various legal routes can create a phoenix company, the concept is simple: a business in financial trouble, perhaps with too much debt or an unprofitable unit that is dragging down the whole company, will go into administration or liquidation.

The directors will then set up a new company and buy most of the troubled firm’s assets, potentially including equipment, staff, and trademarks. They may settle with the landlord and operate in the same premises.

Those owed debt by the old company - typically banks and suppliers - will receive only part-payment as the old firm is wound up through the normal processes.

What is pre-pack administration?

The ‘pre-pack administration’ process for a phoenix company is the smoothest - and potentially the most exasperating for suppliers. Under a pre-pack deal, the directors arrange the phoenix process before the company is on the edge of collapse. Because of the advance planning, the business may transition smoothly into a new corporate entity, with the same directors, and not miss a day’s trading. Yet banks and suppliers still lose money.

Since May 2021, some brakes have been applied. A company’s assets in administration can’t be quickly sold to the previous managers or owners unless creditors agree, or an independent expert certifies that the deal is reasonable. This is a response to growing criticism that the phoenix process, particularly if done by pre-pack administration, makes it too easy for companies to walk away from debts.
 

However, Richie says if carried out correctly, the phoenix company process can preserve value for suppliers. A company sold as a going concern, with customers and staff, will yield better recovery for creditors than liquidating assets, possibly selling work-in-progress as scrap.

He explains: “If a company is liquidated, you as a creditor aren’t going to get anywhere close to what you would get if the business was sold.”

Richie also notes that trade credit insurance will cover losses incurred if a customer fails, whether or not it becomes a phoenix company later.

Should I trade with a phoenix company?

As your accounts team files proof of debt to try and recover something from your failed customer, reading the fine print of the dummy retention of title clauses in your contracts, the phoenix company may email and say they want to trade.

This can be a difficult decision. A phoenix company may be low on working capital and desperate for extended credit because the new directors or owners may have little funding to put into the business. The most vital suppliers may get preferential terms because the company can’t do business without them, which means poorer terms for the rest of the supplier base.

And there is good reason to be cautious. A phoenix company can fail again, either because of the disadvantages of being a phoenix company, or because it’s in a tough sector. An example is dummy New Look, the fashion retailer that collapsed in 2018 - and then hit problems again in 2020.
 

However, in the current environment, companies desperate for orders may decide to go ahead with a new relationship.

Richie comments: “In good times, people have more options. In today’s environment, they may want to trade with them again.”

However, Richie warns that Allianz Trade is highly unlikely to extend cover to invoices issued by phoenix companies until they have re-established a track record - which may take three or even five years.

Pros and cons of phoenix companies

The phoenix company process can be controversial. The legislation needs to strike a balance: productive assets (and people) must quickly be put to use if a business fails. But there also needs to be protections that stop directors from hopping from company to company, leaving a pile of debts behind them every few years.

There are protections to ensure that directors can’t use the process if they are at fault for collapse, such as taking too much cash out of the company. There are also protections against the new owners getting the assets too cheaply, short-changing the old company’s creditors and potentially committing fraud - dummy ActionFraud has more information.

But overall, Richie says the process makes sense if appropriately handled, and yields a better outcome for creditors than liquidation - even if they feel sore afterwards.

“It’s not ideal,” he says. “But it may be the best option in a bad situation.”