You are here: Home > Mortgages > Refused a mortgage > Guide to bankruptcy

Insolvency and bankruptcy

Insolvency and bankruptcy


If your business gets into a situation where you cannot pay your debts when they become due, then your business is insolvent. You will also be insolvent if the assets of your business are less than your debts.

Unless you can find cash to pay those debts quickly, then the insolvency will lead to bankruptcy or winding up. Bankruptcy applies to people such as sole traders and those that have given personal guarantees for loans. Winding up and liquidation apply to companies.

Becoming bankrupt involves restrictions, but the situation is less onerous for individuals whose businesses have failed through no fault of their own. Most are freed from their restrictions within 12 months.

Insolvency rules differ slightly in different parts of the United Kingdom. There are separate departments that deal with insolvency.

This guide describes how bankruptcy can be avoided.

Avoiding bankruptcy


To keep your business solvent you must bear the following in mind:

If your assets - eg stock, buildings, machinery or debts owed to you - equal the amount of loans and debts that you owe then you are in a situation where all of your capital has been wiped out.
Your creditors effectively own your business and if the value of the assets falls further your creditors will realise that their money is at risk and will want it back. This makes you insolvent, as you won't be able to pay them all.

To avoid this you need to make sure that your capital is maintained. You should try to keep your own capital up by holding back profits where possible. Do not be tempted to take on loans that would increase your borrowing far above your own investment in the business.

Even though you are making profits and have enough capital you can still become insolvent if you cannot make payments on time. You need to make sure you have a good cashflow so that you can pay debts on time.

A common problem is to take on too much debt while chasing new business. This is known as overtrading. Careful planning and forecasting will help you to avoid this.

Avoiding bankruptcy: voluntary arrangements

If you get into financial trouble you may be able to avoid bankruptcy by entering into an arrangement with your creditors.

There are two possibilities:

So-called family arrangements are where family and friends may be prepared to give or loan cash or give guarantees to help you out in the short term. Creditors are often prepared to agree to these, as they are aware that the family is likely to help out if it will avoid the stigma of bankruptcy.

If formal proceedings are started, then family and friends are less likely to help out.

Formal voluntary arrangements are where your creditors hold a meeting and vote on a proposed arrangement. You will put the proposal forward as debtor with the help of your advisers. The advisers will include a licensed insolvency practitioner.

If the creditors vote to accept your proposal, then they are all bound by the arrangement and cannot sue for their debt. The new moratorium rules in the Insolvency Act 2000 give extra protection if your company qualifies as small. 

One of the main creditors that will be involved in the arrangement is HM Revenue & Customs, which produces advice leaflets on voluntary arrangements through its Joint Voluntary Arrangement Service.

Accountant in Bankruptcy (AiB) is responsible for liquidation and receivership in Scotland.
The Northern Ireland Assembly is responsible for dealing with insolvency in Northern Ireland.

Administration and receivership

When a company or partnership gets into financial trouble an administrator or administrative receiver may be appointed.

Administration

The role of an administrator is to get you out of trouble and trading again.
Administrators can be appointed to a company or partnership that is unable, or is likely to become unable, to pay its debts. They can be appointed by any of the following:

An administrator's primary goal is to rescue the company as a going concern. If this isn't possible, the administrator will try to get a better result for the creditors than would be possible if the company was wound up.

If neither of these is possible, the administrator will sell the company's property to make at least a partial payment to one or more secured or preferential creditors, such as employees or the bank.

Receivership

A creditor whose debt is secured by a floating charge appoints an administrative receiver. This is a form of security often required by banks. The Enterprise Act 2002 introduced a prohibition on appointing administrative receivers for floating charges created after 15 September 2003.

The receiver is only concerned with getting back the money owed to that creditor and has the power to take control of the assets covered by the charge. Often this may be the cash or debts owed to the business, which means the receiver has control of your whole business.

Once the receiver finds enough to pay off the creditor, and the costs of the receiver, you will be given back control of the business.

Insolvency of companies

If your company becomes unable to pay its debts and no arrangement or period of administration is likely to save it then you, as director, can propose a creditors' voluntary liquidation (CVL).

In a CVL you must pass a resolution that the company cannot continue and then call a meeting of the creditors. The creditors will appoint a liquidator who will carry out the winding up of the company.

Your company can also be wound up by compulsory liquidation under a court order. You can apply for the court order yourself but usually it will be made by a creditor owed more than £750.

In a compulsory liquidation the official receiver is appointed to wind up the business.

Companies House publishes guidance on winding up for companies in England and Wales. The Accountant in Bankruptcy (AiB) is responsible for liquidation and receivership in Scotland.

In general, directors aren't liable for company debts. Shareholders' losses are limited to the value of their shares. Therefore, the insolvency of a company doesn't always lead to personal bankruptcy unless any personal guarantees you have given are called in.

When your company is insolvent the accounting date is reset to start a new accounting period at the date the liquidator or administrator is appointed. At the end of a winding up a company is struck off the register and ceases to exist.

Insolvency of partnerships

Partnerships can become insolvent if the partnership debts are greater than its assets or its trading income cannot cover its debts as they are due.

As a partner you can propose a voluntary arrangement to its creditors but otherwise you and your fellow partners are liable to pay off the debts and then either dissolve the partnership or inject new money and carry on.

If you are unable to pay the debts of the partnership, then you will be subject to personal bankruptcy.
If one of your partners becomes personally bankrupt, then their share of the partnership will be taken by the trustee in bankruptcy and this will lead to the partnership being dissolved. However, the business can be saved if the existing partners or a new partner can buy out the bankrupt partner's share and a new partnership can continue in place of the old one.

In a limited liability partnership (LLP) the situation is similar to that for the insolvency of companies. Companies House publishes useful guidance on the winding up of these partnerships in England and Wales. The Accountant in Bankruptcy (AiB) is responsible for liquidation and receivership in Scotland. 
In limited partnerships - rather than LLPs - there must be at least one general partner and while the limited partners lose only their investment, the general partner(s) will be liable without limit for all the outstanding debt. This could lead to personal bankruptcy of the general partner(s).

Bankruptcy of individuals

If you are unable to pay your debts on their due dates, then you can be made bankrupt. But bankruptcy has serious implications and you should look into avoiding it.

Voluntary arrangements should be your first option with an informal arrangement the best choice, as it will have the least long-term effect.

If you cannot get creditors to agree to an arrangement, then bankruptcy will be the only option. You can apply to the court yourself for a bankruptcy order or any creditor (or group of creditors) owed more than £1,000 can apply.

An official receiver will be appointed by the court to manage your affairs while you are bankrupt. During this period you are referred to as an undischarged bankrupt. At the end of the bankruptcy you will be discharged by the court and will regain control of your own finances.

While you are undischarged all money you are entitled to will be paid to the receiver. They will use it to pay off your debts and give you an allowance to live on.

Except in cases where the court thinks that you have been to blame for your bankruptcy, you should be discharged from bankruptcy within one year under the rules of the Enterprise Act 2002.

Official receiver and insolvency practitioners

Official Receivers are civil servants attached to each court and when a bankruptcy or compulsory winding up is ordered one of them will be appointed as Official Receiver for your case.

When appointed, the Official Receiver will interview you and take over the financial affairs of you or your company.

If the amount of money involved is small in relative terms, then the Official Receiver will manage the bankruptcy or winding up. But if your affairs involve a large amount of money, then the Receiver will try to get an insolvency practitioner appointed as trustee in bankruptcy or liquidator.

Insolvency practitioners are paid out of the money they can salvage from your business, so unless there is likely to be enough money to pay them they will not act and the Official Receiver must handle the case.

In the voluntary winding up of a company, an insolvency practitioner must always be appointed to act as liquidator. Even in a members' voluntary winding up where the company is still solvent, an insolvency practitioner must be appointed by the members. In a creditors' voluntary liquidation, the creditors will appoint the insolvency practitioner.

Effect of insolvency on employees

If your business becomes insolvent, then it is likely that your employees will be made redundant. If you can make a voluntary arrangement or your business is put into administration, then the business will carry on as a going concern and some jobs may be saved.

Also, if the administrator or receiver can find a buyer to take over a part of your business as a going concern, then the employees in that part will be transferred to the buyer with their rights protected under special rules that apply to transfers of undertakings.

In most cases, however, your employees will be made redundant.
However, your employees will be preferred creditors for up to four months' arrears of wages or salaries, holiday pay and any occupational pension contributions they are owed. This means they will be paid before other creditors.

Employees are also entitled to be paid the amounts they are owed by the Redundancy Payments Service (RPS), which makes immediate payments to the employees up to set limits.
The RPS is entitled to claim back the payments it makes out of the money recovered by the liquidator. Money owed to the employees above the RPS limits must also be claimed from the liquidator and may not be paid for some time and then not in full.

Long-term effect of insolvency

For a company or partnership the effect of insolvency is usually terminal and it ceases to exist.
If the business is saved by a voluntary arrangement or a period of administration, then your company may survive and a partnership may be able to continue. But more often it will be a different company or partnership that takes over the business.

People survive bankruptcy, but you will find that there will be problems to overcome in starting again.
Once discharged from bankruptcy, you regain control of your own money and can start trading again. But there will be some long-term consequences.

Your credit rating will be very badly affected and you will have trouble getting credit and may have to pay higher interest rates.

Undischarged bankrupts cannot be a director of a company and even after discharge bankrupts cannot hold some elected positions.

If the court decides you were to blame for the insolvency of your company, you can be disqualified from being a director for up to 15 years.

Business Debtline
0800 1976 026

National Debtline
0808 808 4000

Joint Voluntary Arrangement Service Enquiry Line
01903 701 222

Insolvency Service Enquiry Line
0207 291 6895

Companies House Contact Centre
0870 333 3636

VAT National Insolvency Unit Helpdesk
0151 703 8450

HM Revenue & Customs Enforcement and Insolvency Service Enquiry Line
01903 701 444

Redundancy Payments Service Enquiry Line
0845 145 0004


Related web sites you might find useful

Find information on insolvency at the Insolvency Service website
http://www.insolvency.gov.uk

Read about Scotland's insolvency rules at the Accountant in Bankruptcy website
http://www.aib.gov.uk

Read about insolvency rules in Northern Ireland at the DETI website
http://www.detini.gov.uk/cgi-bin/gethome

Find information on voluntary arrangements at the HM Revenue & Customs website
http://www.inlandrevenue.gov.uk/pdfs/cwl5.htm

See a guide on bankruptcy at the Insolvency Service website
http://www.insolvency.gov.uk/guidanceleaflets/guidetobankruptcy/guidetobankruptcy.htm

See a guide to insolvency for company directors at the Insolvency Service website
http://www.insolvency.gov.uk/guidanceleaflets/guidefordirectors/guidefordirectors.htm

Find out more about bankruptcy and its alternatives at the Insolvency Service website (PDF)
http://www.insolvency.gov.uk/pdfs/guidanceleafletspdf/guidetobankruptcy.pdf

Get guidance on winding up in England & Wales at the Companies House website
http://www.companieshouse.gov.uk/about/gbhtml/gbw1.shtml

Download a guide for directors to compulsory liquidation from the Insolvency Service website (PDF)
http://www.insolvency.gov.uk/pdfs/guidanceleafletspdf/guidefordirectors.pdf

Find out how to remove your company from the Companies House register
http://www.companieshouse.gov.uk/about/gbhtml/gbw2.shtml

Get information on how to wind up a partnership at the Insolvency Service website
http://www.insolvency.gov.uk/guidanceleaflets/dealingwithdebt/howtowindupapartnership.htm

Get guidance on winding up LLPs in England and Wales at the Companies House website
http://www.companieshouse.gov.uk/about/gbhtml/gbllp3.shtml

Download notice 700/56 on insolvency from the HM Revenue & Customs website (PDF)
http://www.hmce.gov.uk/channelsPortalWebApp/channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageVAT_ShowContent&id=HMCE_CL_001557&propertyType=document

Search the Individual Insolvency Register at the Insolvency Service website
http://www.insolvency.gov.uk/guidanceleaflets/iir/iir.htm

Download guidance on trustees and liquidators from the Insolvency Service website (PDF)
http://www.insolvency.gov.uk/pdfs/guidanceleafletspdf/TrusteesandLiquidators.pdf

Download guidance on complaints about insolvency practitioners from the Insolvency Service website (PDF)
http://www.insolvency.gov.uk/pdfs/guidanceleafletspdf/ipcomplaint.pdf

Download guidance on visits by an official receiver from the Insolvency Service website (PDF)
http://www.insolvency.gov.uk/pdfs/guidanceleafletspdf/interviewedbytheOR.pdf

Download guidance on employee rights in insolvency from the DTI website (PDF)
http://www.dti.gov.uk/er/redundancy/insolvency-il1.pdf

Read information on employee rights at the DTI website
http://www.dti.gov.uk/er/individual/tupe-pl699.htm

Read information on the disqualification of directors at the Insolvency Service website
http://www.insolvency.gov.uk/guidanceleaflets/cddafc/cddafc.htm

 

© Crown copyright 2005
The material featured on this page is subject to Crown copyright protection unless otherwise indicated and has been provided by The Insolvency Service.
Published October 2005

You should seek appropriate advice before acting on any information contained on this page.