With rising insolvency rates, driven in particular by the number of creditors’ voluntary liquidations reaching record highs, the decision in the recent Court of Appeal case of PSV 1982 Limited v Langdon  EWCA Civ 1319 serves as a timely reminder for directors of the personal risks involved in re-using the name of a liquidated company.
This case related to the provisions of section 216 and 217 of the Insolvency Act 1986 (IA86), which concern the re-use of the name of a company which has gone into insolvent liquidation. Directors who fall foul of the prohibition in section 216 face potential criminal prosecution, as well as personal liability for the debts of the company which adopts the “prohibited” name. Such liability can be catastrophic for the individual concerned – PSV v Langdon being a prime example, where the director (who had been unaware that he was acting in breach of section 216) was found liable for a judgment debt against the company amounting to an eye-watering £1,125,824.67.
When a company is on the brink of liquidation, these provisions are unlikely to be “top of mind” for its directors – however, as PSV v Langdon demonstrates, it is crucial that directors familiarise themselves with the potential risks. This article therefore sets out some of the key points regarding use of “prohibited names” which all directors should be aware of.
- The section 216 restriction: Under section 216, any person who has been a director (or shadow director) of a company in the 12 months prior to it entering into insolvent liquidation, is prohibited from acting as director or otherwise being involved in the management or promotion of another company or business known by a “prohibited name”. The prohibition lasts for a period of five years from the commencement of the first company’s liquidation.
- What names are prohibited?: A prohibited name is any name by which the liquidated company was known during the 12 months prior to the liquidation, or a name so similar as to suggest an association. The prohibition is not limited to registered names - trading names, acronyms, and even personal names when used in relation to a business, may all be prohibited on the basis that they are sufficient to suggest an association between the two businesses in the minds of creditors.
- Breach of section 216 is a criminal offence: If prosecuted, directors risk a prison sentence or (more likely) a community service order, as well as disqualification from acting as a director. They may also face an order to pay compensation pursuant to the Proceeds of Crime Act 2002.
- Personal liability for debts of new company under section 217: Any director acting in contravention of section 216 is personally responsible (on a joint and several basis with the company) for all the debts of the new company incurred during the relevant time. The relevant time for these purposes is the period for which the breach was continuing – i.e., when the company was known by a prohibited name.
- The liability is automatic: As confirmed by the Court of Appeal in PSV v Langdon, the establishment of a debt against the new company – in that case a judgment debt - is sufficient to automatically render the defaulting director liable for the relevant debt. It was held to be irrelevant in that case that the director had not been a party to the proceedings against the company, and had not had chance to defend the claim. The court has no discretion to limit the amount of the director’s liability.
- Permission of the court may be sought: A director may avoid liability by obtaining the permission of the court to act as a director of a company with a prohibited name. However, such permission must be sought in advance – the court cannot “cure” a breach, or give retrospective permission. Rule 22.6 of the Insolvency Rules 2016 (IR2016) gives a brief grace period of six weeks during which the director may continue to act as a director of the new business, providing that the application to court is made within seven days of the first company going into liquidation.
- Exception applicable to pre-pack situations: Rule 22.4 IR2016 provides a further exception relating to the situation where the business of the insolvent company was purchased under arrangements made with the administrator or liquidator of that company. The director must give notice to all creditors of the insolvent company of their intention to act as a director of the new company with a prohibited name, within 28 days of the conclusion of the sale transaction. Importantly, this "safe harbour" is only available where the new company has purchased the "whole or substantially the whole" of the first company’s business. Therefore, if any assets were not included in the sale, there is a real risk that this ‘safe harbour’ will not be available to the directors concerned.
- Risk for directors of group companies: where a number of companies in a group trade under a “group” name or acronym, there is a risk for directors under section 216 where one company in the group enters insolvent liquidation. Rule 22.7 IR2016 permits a director to act in respect of a company with a prohibited name provided that it has been actively trading under that name for the 12 months prior to the first company’s liquidation. However, clearly this will not apply to more recently incorporated group entities, or indeed any which have been dormant during that period.
The courts apply sections 216 and 217 strictly – there is no room for judicial discretion in their application, even where a breach has been committed innocently or inadvertently. The consequences, for honest or unwitting directors, can be harsh. A breach of section 216 may arise without any intention to mislead creditors, including in relation to pre-pack sales or in group situations where one group company becomes insolvent.
Directors can avoid the consequences of section 216 altogether by applying for permission to act in relation to a company with a prohibited name or by taking action to fall within one of the exceptions set out in rule 22 IR2016. However, the exceptions are narrowly drafted, requiring prompt, if not pre-emptive, action and the court will not act as a rubber-stamp in permission applications. Directors must therefore ensure that they are aware of the risks of acting in breach of section 216, and take advice and action at an early juncture to protect their position.