Insolvency: the basics

If you cannot pay your business debts, or if the assets of your business are less than your debts, your business is insolvent.

Unless you pay those debts quickly, insolvency may lead to bankruptcy or a winding-up order.

Bankruptcy is a legal declaration that you cannot pay your personal debts – it applies to individuals, sole traders or individual members of a partnership and those that have given personal guarantees for loans. If you are made bankrupt, your personal and business assets may be lost.

Liquidation is a legal process where a liquidator is appointed by order of the court to ‘wind up’ the affairs of a limited company. At the end of the process the company ceases to exist. A partnership can also be wound up.

The Insolvency Service is the government agency responsible for dealing with financial failure and misconduct through its network of official receiver offices throughout England and Wales.Bankruptcy cases and company winding ups will be allocated to your local official receiver office who will then determine how and why you or your company became insolvent.

This guide describes how companies, partnerships and individuals in England and Wales can avoid insolvency, bankruptcy or winding up, and what happens if they cannot.

There are slightly different rules on insolvency in Scotland and Northern Ireland.

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Avoiding bankruptcy and winding up

If you cannot pay your debts or the debts of your business, or if your assets are less than your debts, this could mean that you or your business is insolvent.

Insolvency may lead to bankruptcy for personal debts – including debts incurred as a sole trader or when trading in partnership with someone else – or the winding up of a limited company or partnership.

Bankruptcy applies to individuals, sole traders, individual members of partnerships and anyone that has given personal guarantees for loans. For more information, see the page in this guide on the insolvency of individuals.

Winding up applies to companies or partnerships which have been put into compulsory liquidation and is the legal process in which a liquidator is appointed to bring the company’s business to an end and to sell the company assets to pay the company’s debts. See the page in this guide on the insolvency of limited companies.

To keep your business solvent, you should make sure you:

• don’t allow your debts to exceed your assets
• take care before offering personal guarantees for limited company loans
• keep an eye on your cashflow – see our guide on cashflow management: the basics
• choose the right business structure – see our guide on legal structures: the basics
• implement good credit-control structures

If your assets – eg stock, buildings, or debts owed to you – equal the amount of debt that you owe, then your capital could be wiped out. Your creditors effectively own your business and if the value of the assets falls further, your creditors may find that their money is at risk and want it repaid. This would make you insolvent, as you wouldn’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. Taking on too much debt, while chasing new business, is called overtrading.

For more information, see our guide on how to avoid the problems of overtrading.

Even though you are making profit and have enough capital, you can still become insolvent if you cannot make payments on time, so make sure you have a good cashflow.

For more detailed guidance, see our guides on how to avoid insolvency and organisations that can help you with debt problems.

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Insolvency of limited companies

If your company is unable to pay its debts, you should take financial and legal advice as soon as your business starts getting into trouble. Your accountant may be able to advise you on how to avoid insolvency and the winding up of your company by a liquidator. To find out about the role of a liquidator, see the page in this guide on the official receiver and insolvency practitioners.

There are several options for limited companies, including:

• Informal arrangements – consider writing to all your creditors to see if a mutually acceptable agreement can be reached. It is advisable to include a timetable of when payments will be made.
• Informal ‘family’ arrangements – where family and friends may be prepared to give or loan cash or give guarantees to help you in the short term. Creditors are often prepared to agree to this.
• Company voluntary arrangements – this is a formal version of the informal arrangement. The company directors would need to apply to the court with the help of an authorised insolvency practitioner (IP). The IP would supervise a meeting with creditors, you would propose an arrangement and you would pay the creditors in line with the accepted proposals.
• Administration – this gives your company breathing space from any action by creditors. Your business survives as a going concern – without the threat of liquidation for at least 12 months. This is managed by an administrator who must be an authorised IP, appointed by the court.

If you are advised by your accountant or solicitor that no arrangement or period of administration is likely to save your company, then you or your creditors may propose liquidation. This does not mean all your creditors will get paid, but it ensures that all your company’s affairs will be dealt with properly.

There are three types of liquidation:

• Creditors’ voluntary liquidation – the most common form, where shareholders decide to put the company into liquidation, but there are not enough assets to pay all creditors, ie the company is insolvent. The creditors will appoint a liquidator who will carry out the winding up of the company.
• Members’ voluntary liquidation – where the shareholders decide to put the company into liquidation, but there are enough assets to pay all the debts of the company, ie the company is still solvent.
• Compulsory liquidation – where either a creditor or the company petitions the court to make an order for the company to be wound up.

To find out more about insolvency and liquidation, see our guides on:

• liquidation and alternatives for companies and limited liability partnerships
• compulsory liquidation for companies and limited liability partnerships: the process
• owed money from a bankrupt or a company in liquidation
• organisations that can help you with debt problems

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Insolvency of partnerships

If your partnership’s debts are greater than its assets, or its trading income cannot cover its debts, then your partnership could become insolvent.

You should take financial and legal advice as soon as your partnership starts getting into trouble. Your accountant, who may already be familiar with your business, may be able to advise you on how to avoid insolvency and the winding up of your partnership by a liquidator.

You and your partners can propose a partnership voluntary arrangement to settle the partnership’s debts with its creditors. In partnerships, individual partners have “joint and several liability”. This is where any individual partner has to pay back the entire amount of a debt which all partners entered into. To remove the individual partners’ joint or several liability to meet the partnership debts, the partners will either have to pay off the whole partnership debt or propose an individual voluntary arrangement (IVA).

If individual partners are unable to pay the debts of the partnership or propose an IVA, then that individual partner could become subject to personal bankruptcy. See the page in this guide on the insolvency of individuals.

If one of your partners becomes personally bankrupt, provided the partner has applied to be made bankrupt without winding up the partnership, the remaining partners can continue trading. Although the debt will be written off for the bankrupt partner, a creditor can still pursue the other partners for the whole debt.

A creditor can also apply:

• for one of the partners to be made bankrupt, without the winding up of the partnership
• to have the partnership wound up without action being taken against the individual partners
• for the partnership to be wound up and bankruptcy orders presented against one or more of the partners

In certain circumstances, the trustee in a bankruptcy can make a claim against the partnership estate. The trustee can be the official receiver (OR) or an accountant or insolvency practitioner appointed either by the court where a bankruptcy order follows a failed IVA, by a meeting of creditors called by the OR or by the Secretary of State. The trustee can take possession of any assets, sell them and distribute the proceeds to creditors. If, however, the remaining partners pay off the joint debts, then they may have a claim in the bankruptcy instead.

Joint bankruptcy petition by individual members of a partnership

It is also possible for all members of a partnership to present a joint bankruptcy petition to the court. This costs only the same as an individual presenting their own bankruptcy petition – £175 court fee and £525 deposit on petition. When the bankruptcy orders are made this dissolves the partnership. All debts of the partnership as well as the debts of the individual partners are included in the bankruptcies.

Find the Insolvent Partnership Order Forms on the Insolvency Service website- Opens in a new window.

In a limited liability partnership (LLP) the situation is similar to that for the insolvency of limited companies. See the page in this guide on the insolvency of limited companies.

In limited partnerships – rather than LLPs – there must be at least one general partner, and while the limited partners lose only their investment – provided they have not taken part in the management of the partnership – 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). Unlike in a general partnership, the bankruptcy of a member of a limited partnership does not result in the dissolution of the partnership.

To find out about the insolvency of partnerships, see our guide on liquidation and alternatives for partnerships.

You can also see the page on The Insolvency Service in our guide on organisations that can help you with debt problems.

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Insolvency of individuals

Individuals, members of a partnership and those that have given personal guarantees for loans, who are unable to pay their debts, can all be made bankrupt.

You should take financial and legal advice as soon as you get into trouble, as you do not have to become bankrupt just because you are in debt.

You can use our interactive tool to discover alternatives when considering bankruptcy.

Your solicitor, accountant or Citizens Advice Bureau may advise you that bankruptcy is in your best interests, as it will relieve you of your debts. However, they may advise you how to avoid bankruptcy, as it has serious implications. See the page in this guide on the long-term effects of insolvency.

There are various alternatives to bankruptcy, including:

• Informal arrangement – write to your creditors to see if a mutually acceptable agreement can be reached.
• Debt relief order (DRO) – you can apply for a DRO if you have debts of less than £15,000, assets worth less than £300 and a low income. A DRO protects you from enforcement action by creditors during the period of the order. See our guide on insolvency options for individuals: Debt Relief Orders for more information.
• Individual voluntary arrangement – a formal version of the informal arrangement, where you apply to the court with the help of an authorised insolvency practitioner, who would supervise a meeting with your creditors to propose a repayment arrangement.
• Administration order – managed by your local county court. You would make regular payments to the county court to pay what you owe your creditors. The court charges a small fee, which may not exceed ten pence in the pound on the total amount of the debts. Your total debts must not be more than £5,000 and you must have at least one judgment creditor.

To find out about the options available, see our guide on insolvency options for individuals.

If your creditors do not agree to an arrangement, or you do not qualify for any of the other procedures, bankruptcy may be the only option. This is a serious matter. You will have to give up any possessions of value and your interest in your home. It also imposes certain restrictions on you.

You can apply for bankruptcy by petitioning your local county court. The court will issue a bankruptcy order, which sets out the terms of the bankruptcy. A creditor can apply to make you bankrupt if you owe them at least £750. The court will appoint an official receiver (OR) to administer your bankruptcy. See the page in this guide on official receiver and insolvency practitioners.

During this period you are referred to as an undischarged bankrupt. The proceeds from the sale of any assets that belong to the bankruptcy estate will be paid to the OR. You should normally be discharged from bankruptcy one year after your bankruptcy order was made. However, you may not regain full control of your own finances. For more information, see our guide on how to make yourself bankrupt.

The rules in Scotland are slightly different. Find out about insolvency in Scotland on the Accountant in Bankruptcy website- Opens in a new window.

You can also see our guide on organisations that can help you with debt problems.

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Official receiver and insolvency practitioners

Official receivers (OR) are civil servants from The Insolvency Service. They are attached to courts with insolvency jurisdiction and when a bankruptcy or compulsory winding up is ordered, an OR will be appointed for your case.

When appointed, the OR will interview you and investigate the cause of your bankruptcy or your company’s liquidation. For more information on how this occurs during a compulsory liquidation, see our guide on compulsory liquidation for companies and limited liability partnerships: the process.

For more details on how this happens during a bankruptcy, see our guide on being interviewed by the official receiver.

If there are no assets or the amount of assets is small, then the OR will manage the bankruptcy or winding up. However, if there is a larger amount of assets, then the OR will seek the appointment of an insolvency practitioner (IP) as trustee in bankruptcy or as liquidator, either by calling a meeting of creditors to vote for an IP or by asking the Secretary of State to appoint one.

The trustee’s main duties are to sell these assets and share the money out amongst the creditors.

IPs are paid out of the money from the sale of a bankrupt’s or a company’s assets, so unless there is likely to be enough money to pay them, they will not act and the OR must handle the case. You can find information about insolvency for businesses in England and Wales on the Insolvency Service website- Opens in a new window.

In the voluntary winding up of a company, an IP must always be appointed to act as liquidator. Even in a members’ voluntary winding up where the company is still solvent, an IP must be appointed by the members. In a creditors’ voluntary liquidation, the creditors will appoint the IP. See the page in this guide on insolvency of limited companies.

You can find information about insolvency for businesses in Northern Ireland on the Department of Enterprise, Trade and Investment (DETI) Insolvency Service website- Opens in a new window.

Also see our guide to organisations that can help you with debt problems.

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Effect of insolvency on employees

If your business becomes insolvent, then it is likely that your employees will be made redundant. For more information, see our guide on redundancy: the options.

If you can make a voluntary arrangement or your company is put into administration, then the business may carry on as a going concern and some jobs may be saved.

Also, if an administrator or supervisor of a company voluntary agreement can find a buyer to take over a part of your business as a going concern, then the employees in that part may be transferred to the buyer. Their rights may be protected under special rules that apply to transfers of undertakings. For more information, see the page in this guide on the official receiver and insolvency practitioners.

For further information, download a guide to TUPE from the Department for Business, Innovation and Skills (BIS) website (PDF, 188K)- Opens in a new window.

In most cases, your employees will be made redundant. However, your employees will be preferred creditors for up to four months’ arrears of wages or salaries up to a limit of £800, all holiday pay and certain occupational pension contributions which have been deducted from their pay in the four months preceding the insolvency date. This means that these debts will be paid before other unsecured debts.

Other payments such as the statutory redundancy lump sum payment, notice pay, and wages over the £800 limit are non-preferential unsecured debts.

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. For more information, see our section on leaving and retirement.

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 or trustee in bankruptcy and may not be paid for some time and then not in full.

You can find information on the effects of insolvency on employees in Northern Ireland on the Department of Enterprise, Trade and Investment (DETI) Insolvency Service website.

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Long-term effects of insolvency

For a company or partnership the effect of insolvency is usually terminal and the company or partnership 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 most often, it will be a different company or partnership that takes over the business.

Individuals can move on from bankruptcy – once you are discharged from bankruptcy you regain control of your own money, if there is no income payments order, and the restrictions imposed by the bankruptcy order are removed. However, there will still 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 when borrowing.

Undischarged bankrupts cannot be a director of a company. An undischarged bankrupt is someone whose bankruptcy is still in force. You may also be subject to a Bankruptcy Restrictions Order (BRO) for up to 15 years. During the period of the BRO you would be subject to the same restrictions as a bankrupt and would not be able to hold some elected positions.

Even if you are not disqualified, rules prohibit directors of companies that have gone into insolvent liquidation from becoming a director of another company with the same or similar name – known as a ‘prohibited name’ – to the insolvent company.

The rules also prohibit directors of companies that have gone into insolvent liquidation from acting in a way to promote, form or manage a company with a prohibited name. For more information, see our guide on the reuse of a company name after liquidation.

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.

Individuals may be rescued by voluntary arrangement but may still experience credit rating difficulties.

You can download guidance on the dissolution and restoration of businesses from the Companies House website (PDF, 392K)- Opens in a new window.

For more information, see our guide on organisations that can help you with debt problems.

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