Essential guide to insolvency

Companies or individuals with debts they are unable to pay are said to be insolvent. By the time a business starts thinking about insolvency, things are already going badly.

Simply allowing yourself to run out of money is the worst possible way of handling it. If you understand your options, you can take steps to improve the situation.

Reducing insolvency risks

Early action on insolvency

Company administration

Alternatives to administration

Bankruptcy

Alternatives to bankruptcy

1. Reducing insolvency risks

Choose an appropriate business structure

• A limited company offers the most protection against personal bankruptcy. But giving a personal guarantee removes the protection of limited liability.
• A limited liability partnership (LLP) offers some protection against bankruptcy.
• If you trade in a normal partnership, you can be liable for all the partnership's debts.

Use realistic, up-to-date cash flow forecasts to plan your financing needs

• Many businesses fail because of unrealistic cash flow assumptions, or because the problem is not noticed until it is too late.
• Your accountant will advise you and be a key ally if your business runs into trouble.
• If you identify a possible problem, take early action.

Protect yourself against customer non-payment with good credit control

• Limit the amount of credit you offer and make sure customers are financially sound.
• Search the bankruptcy and insolvency register on the GOV.UK website. It includes details of the individual subject to restrictions, the period of restrictions, and details of the misconduct.

If possible, avoid personal guarantees

• When you must give a guarantee, limit the amount it covers and how long it lasts.
• If several people are giving guarantees, avoid joint and several liability. In the worst case, you could be liable for all of the debt, not just your share.

Protect your family and friends

• Do not borrow more from them than they can afford to lose.
• Give them security to help them get their money back if things go wrong (see Creditors' rights).
• Make sure your spouse or civil partner has a separate bank account in case you go bankrupt.
• Do not ask your spouse or civil partner to give a charge over your home to secure a business loan.

2. Early action on insolvency

Can you improve your cash flow?

If long-term prospects are good, there are several possibilities to consider:

• approach your bank for more finance
• use factoring to lessen the effects of slow payment by your customers
• recover debts which you are owed
• sell assets which are not essential (you may be able to lease them back)

Can you negotiate with creditors?

• Communicating with creditors is essential if you want to agree a compromise.
• You can offer revised payment terms. Those lower down the pecking order if you become insolvent are more likely to co-operate.

Can you cover your debts?

• If prospects are poor, paying your creditors and putting a stop to trading is usually the best option.
• If you cannot cover your debts, consult an adviser immediately.
• If you allow a limited company or LLP to continue trading with no reasonable prospect of avoiding insolvency, you may be held liable for wrongful trading. You could become personally liable and be disqualified from acting as a director.

Do you need help?

• A licensed insolvency practitioner (IP) can advise on the best course of action. The first consultation is usually free.
• Avoid unlicensed advisers.
• The Government's Insolvency Service provides information for debtors and creditors.
• All the bodies that authorise and regulate IPs have adopted an Insolvency practitioner code of ethics. It has been designed to help IPs to work to high professional and ethical standards.

Avoid creating preferences when you are already insolvent

• A preference is anything which gives an advantage to a particular creditor (or to someone who has guaranteed your debts).
• Preferences can be set aside if your company becomes insolvent (or you become bankrupt) within set time limits.
• If unsecured creditors think you are creating preferences, they are more likely to press for liquidation or bankruptcy.

Do not try to protect your assets from creditors

• Putting your assets into your spouse's or civil partner's name will not work. Your trustee in bankruptcy can get them back again.

If you cannot avoid insolvency, choose the best way of dealing with it

• You can try to rescue a company using administration or choose other options.
• Individuals can enter bankruptcy but also have two main alternatives to bankruptcy.

3. Company administration

If there is some chance of rescuing your company, you and your creditors are encouraged to use administration.

An administrator is appointed to run the business and deal with the creditors

• The administrator will be a licensed IP.
• He or she arranges for the rescue of the company as a going concern, if possible.
• If it is not possible, or if it would achieve a better result for the creditors than rescue, he or she can take some other course with a view to achieving a better result than liquidation (eg selling the business).
• If there is no way of producing a better result for the creditors than liquidation, the administrator will sell assets to raise money for the secured or preferential creditors.

The company's directors or creditors can put the company into administration

• The directors can decide to put the company into administration.
• Anyone who holds a floating charge over all the assets of the company can put it into administration. Other prior floating charge-holders must agree. Whoever holds the first floating charge can choose the administrator.
• Other categories of creditor have to obtain a court order to do so.

Administration should end within a year

• The time limit can be extended, if the creditors agree or the court orders it.
• If it has not been possible to rescue the company, but there are assets available for the unsecured creditors, the administrator can arrange for a creditors' voluntary liquidation (see alternatives to administration), or ask the court's permission to pay creditors.
• If no assets are available for the unsecured creditors, the company will be dissolved.

4. Alternatives to administration

In particular circumstances one of the following options may apply.

Winding-up or liquidation is the death of a company

• The company stops trading and the assets are sold to pay creditors.
• Any creditor or group of creditors owed more than £750 (or, in certain situations, less) can ask the court to wind up your company (compulsory winding-up).
• Members can put the company into liquidation. Then creditors can appoint a liquidator (creditors' voluntary liquidation).

You can reach a company voluntary arrangement with your creditors

• This sets out a schedule of repayments to creditors.
• You use a licensed IP to prepare and negotiate the proposal. Fees to set up the arrangement will depend on the difficulty and length of the negotiations.
• At least 75 per cent by value of the creditors at a meeting must agree it.
• It can be difficult to reach agreement with secured creditors, who will often prefer to put you into administration or receivership.

A creditor with a floating charge can sometimes appoint an administrative receiver

• A company can be moved from receivership into administration, but only if the creditor who appointed the receiver agrees.

A company can get a short-term breathing space by applying for a moratorium

• The moratorium gives the business an initial 20 days to look at rescue options. The moratorium can be extended.
• The company is monitored by an insolvency practitioner during the moratorium.
• Creditors are unable to put the company into administration during the moratorium.
• A moratorium is most suitable for companies which have a short-term problem but where rescue as a going concern looks likely.

5. Bankruptcy

Bankruptcy is the formal procedure for individuals who are declared insolvent by the court. It could happen to you if you are a sole trader or in partnership, or have given a personal guarantee for the debts of a limited company.

A creditor may force you into bankruptcy

• Any creditor or group of creditors owed £5,000 or more can ask the court to bankrupt you. The creditor must first have served a demand for payment (unless a court judgment is already outstanding).
• If you can show you can raise the money quickly, you may ask for time to arrange it.

You can ask to be declared bankrupt

• You apply for bankruptcy online. It costs £680 but you may be able to get help if you cannot afford it.
• You give details of your assets, debts and so on.
• The court will usually declare you bankrupt immediately.
• If you owe less than £30,000 you may be able to get a debt relief order instead (see alternatives to bankruptcy).

Once you are bankrupt, you no longer control your assets

• Your assets are controlled by the official receiver or by an IP acting as your trustee in bankruptcy.
• Valuable assets will be sold. This could include your house, if it is worth more than the mortgage.
• You will be allowed to keep assets that are necessary for your business or employment and basic domestic needs, as long as they are not particularly valuable.

Repayments will be made to your creditors

• In addition to the money from selling your assets, you may have to commit part of your income (by an income payments order or agreement) for up to three years.
• You will be allowed to keep enough money to finance a reasonable lifestyle.

While you are bankrupt, you will have to live with certain limitations

• You will not be able to borrow more than £500 without disclosing that you are bankrupt.
• You cannot act as a company director, or create or manage a company, without the court's permission.

In most cases, people made bankrupt will be discharged within 12 months

• You will not get back the assets you had at the date of bankruptcy.
• Apart from any outstanding amounts secured on your house and any income payment orders or agreements, you are not made to make any further payments on your debts at the date of bankruptcy, except for certain debts which are excluded - eg fines and matrimonial orders.

'Culpable' bankrupts may be subject to Bankruptcy Restrictions Orders (BROs) or undertakings

• These are people who have been dishonest or irresponsible. For example, someone who traded knowing the business was insolvent.
• The restrictions can last for up to 15 years.

6. Alternatives to bankruptcy

There are four main alternatives to personal bankruptcy.

You can agree a debt management plan with your creditors

• A debt management plan is typically used to pay off debts like credit cards and personal loans.
• You negotiate a monthly payment that you can afford, which is then divided between your creditors.
• You can get help negotiating a plan from a free debt advice service, or pay a licensed debt management company.

You can reach an individual voluntary arrangement (IVA) with your creditors

• A licensed IP can help prepare and negotiate the proposal.
• At least 75 per cent by value of the creditors at a meeting must agree it.
• If you break the arrangement, the IP can apply to court to make you bankrupt.

You can ask your local county court for an administration order

• This is an option if you have debts up to £5,000 and already have at least one county court judgement against you.
• You are protected from your creditors and make payments to the court.

You can apply for a debt relief order (DRO)

• A DRO may suit you if you owe less than £30,000 and don't have significant spare income or assets.
• To apply for a DRO, you get advice from an authorised debt adviser. There is a fee of £90 when you file the paperwork.
• An order usually lasts 12 months, during which time you are protected from having to make payments for most kinds of debt. At the end of that time, those debts are written off.
• You face similar restrictions during the DRO to those that apply in personal bankruptcy.