Small Business Financial Distress and the “Phoenix Syndrome”—A Re-evaluation


  • Yaad Rotem

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    • Center of Law & Business, Ramat Gan, Israel
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    • Visiting Scholar, Center for the Study of Law & Society, University of California, Berkeley School of Law; Assistant Professor, Center of Law & Business, Israel. For helpful discussions I thank Eric Talley, Boaz Sangero and Anat Rotem.



In a typical “phoenix syndrome” scenario, a small business entrepreneur who controls 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 register 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 regulation 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 to defraud or to rescue a non-viable business? The paper discusses and evaluates several solutions. Copyright © 2012 INSOL International and John Wiley & Sons, Ltd.