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22 Int'l Insolvency Rev. 1 (2013)

handle is hein.journals/intvcy22 and id is 1 raw text is: 








  Small Business Financial Distress and the

  Phoenix Syndrome -A Re-evaluation


                              Yaad Rotem      t

                       Center of Law & Business, Ramat Gan, Israel



                                  Abstract

In a typical phoenix syndrome scenario, a small business entrepreneur who con-
trols the financially distressed Company A registers Company B, to which the
assets of Company A are transferred in what appears to be fraudulent conveyance.
Company B serves as a vehicle through which the business is kept running, without
the pressures of the business creditors. If necessary, the entrepreneur will also regis-
ter Company C and repeat the process. The law usually considers the execution of
a phoenix syndrome scheme (phoenixizing) to be fraud against Company A's
unaware creditors. Two major problems undermine, however, the efficient regula-
tion of phoenix syndrome schemes. First, although criminal sanctions are available,
phoenixizing entrepreneurs are not regularly prosecuted and are usually only
subject to monetary sanctions (e.g., personal civil liability to creditors). Because
defrauders tend to be judgment proof, the result is sub-optimal deterrence. Second,
lawmakers have not considered a more sympathetic explanation to account for the
phoenix syndrome phenomenon: an entrepreneur resorting to a phoenix
syndrome scheme might actually be arranging for a last-resort home-made
bankruptcy proceeding, that is, the entrepreneur might be mimicking the role of a
formal bankruptcy stay on unsecured creditors' collection efforts, against the
background of a cost prohibitive formal bankruptcy proceeding. Put simply,
the phoenix syndrome scheme is, occasionally, a poor man's bankruptcy
proceeding. Deterring a phoenixizing entrepreneur attempting to rescue a viable
business is, of course, unwarranted, as the result is viable businesses being lost. These
two problems of under-deterrence and over-deterrence mandate a re-evaluation
of the manner in which phoenix syndrome schemes are regulated. Obviously,
the main question concerns implementation: How can good entrepreneurs,
attempting to rescue a viable business, be separated from bad ones, who attempt


*E-mail: rotem@clb.ac.il                Law; Assistant Professor, Center of Law & Business,
Visiting Scholar, Center for the Study of Law &  Israel. For helpful discussions I thank Eric Talley, Boaz
Society, University of California, Berkeley School of Sangero and Anat Rotem.
Copyright C 2012 INSOL International andjohn Wiley & Sons, Ltd  Int. Insolv. Rev., Vol. 22:1-28 (2013)
                                    Published online 4 December 2012 in Wiley Online Library
                                            (wileyonlinelibrary.com). DOI: 10.1002/iir. 1202

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