Is Limited Company Bankruptcy the Same as Insolvency?

Running out of cash is one of the biggest worries company directors have, particularly in the early days when the business is still small. With staff, suppliers, bills, rent, tax and so many other liabilities to pay, maintaining a healthy level of cash in the business becomes a complicated balancing act. With company insolvencies on the rise, business failure is a real possibility. Read on to learn what happens when a limited company becomes bankrupt.

what happens if a limited company goes bust

Company Bankruptcy is Correctly called Insolvency for Company Debts

Bankruptcy is a commonly used term in the UK, but it should only be used to refer to individuals who can no longer afford to pay their debts. While individuals go bankrupt, companies become insolvent.

However, it’s not quite as clear-cut as that. Individuals who run sole traders and partnerships are considered to be the same legal entity as their business. There is no legal separation between their finances and their business’s finances. So, in the case of sole traders and partnerships, the owner can go bankrupt and the business will cease to trade.     

The act of incorporation, i.e. becoming a limited company, turns a business into a separate legal entity. The finances of the company and its owners become separate, so if the company does become insolvent, the finances of the owners will not usually be affected.

What Happens if a Limited Company Goes into Liquidation?

A company becomes insolvent when:

    • It is currently, or will in the future, be unable to pay its debts when they become due; or/and
    • The value of its assets is less than the sum of its liabilities, with future liabilities taken into account.

As a company director, as soon as you become aware the business is insolvent, you must act to limit creditor liabilities. Failure to do so could lead to you becoming personally liable for the business’s debts. At this point, giving us a call on 08000 746 757 for a confidential and fee-free discussion of your circumstances is strongly advised.

The insolvency of your business is not an untenable situation. Depending on your circumstances, there will be a number of options open to you. They include:

    • Company Voluntary Arrangement (CVA) – Formal negotiations take place with your creditors which, if successful, will allow interest and charges on outstanding debts to be frozen. A consolidated monthly payment plan will be put in place that allows you to pay all or part of the debts over an extended period of time, typically three to five years.
    • Company Administration – An administrator is appointed to restructure or reorganise the business to try and return it to profitability so you can continue to trade.
    • Liquidation – If the insolvent business cannot be returned to profitability, a Creditors’ Voluntary Liquidation (CVL) can be used to close the business down. The assets will be sold to repay the creditors. Alternatively, the creditors may choose to try and force the company to close through the process of Compulsory Liquidation.

If the company goes into liquidation then an insolvency practitioner will need to be appointed. It is their job to oversee the liquidation process. They will take control of the business and:

    • Settle any legal disputes or outstanding contracts
    • Sell the company’s assets and use the funds to pay the creditors
    • Make payments to creditors
    • Complete all the relevant paperwork
    • Pay the final VAT bill
    • Settle the liquidation costs using funds raised through the sale of company assets
    • Interview the directors and report on the factors that caused the liquidation
    • Remove the company from the Companies Register

At the end of the liquidation, the limited company will cease to exist.

Is a Company Director Liable for its Debts?

Usually, the director of a limited company is not personally liable for the company’s debts. That means, if the limited company cannot pay its debts and enters liquidation, only the company’s assets are at risk.

However, there are some circumstances when the court, acting on behalf of the creditors, can make one or more directors liable for all or a proportion of the company’s debts. That includes:

    • You have fallen behind on PAYE and National Insurance payments
    • You have income tax owing on money you have taken out of the company
    • You have signed personal guarantees, usually with banks, finance companies and landlords, to say that if the company cannot make repayments you will do so yourself
    • You have shown favouritism towards particular suppliers or creditors such as family and friends
    • You have been found guilty of wrongful trading. That occurs you when you continue to trade to the detriment of creditors despite knowing the company is insolvent and there’s no reasonable chance of avoiding liquidation.
    • You have benefited at the expense of creditors. For example, you have bought a company asset for less than it’s worth or paid off a director’s loan using company funds.
    • You have created a liability resulting from an act of fraud. For example, if you took credit in the company name but spent the money on yourself. This is called fraudulent trading

Company directors also have a legal obligation to ensure that shareholders, managers, employees and anyone else who actively participates in the running of the company does not do anything that’s to the detriment of the company’s creditors.

You should seek the advice of a licensed turnaround or insolvency practitioner at your earliest opportunity to avoid any potential personal liability issues.  

If My Ltd Company goes Bust will I Lose my House?

In the vast majority of cases, the directors of a limited company are not personally liable for the debts of the business, so any personal assets such as a family home would be perfectly safe. However, you may have some legitimate concerns if you have used a personally held property as collateral to secure a business loan.

Broadly speaking, there are four things you could do while running your limited company that could put your home at risk:

  • You’ve used personal property as collateral to secure a business loan

If you have used property you own personally as collateral on a business loan that you cannot repay then your property could be at risk. Ideally, the funds raised by the sale of company assets during the liquidation process would be enough to repay the loan in full, but unfortunately, that’s not always the case. If you do choose to take out a secured loan then we would always recommend using an expendable asset such as inventory, equipment or future invoice payments as security.

  • You’ve given a personal guarantee

If your business is small and unestablished or has a poor credit record then a finance provider may ask you to provide a personal guarantee before they can approve a loan. If the company later becomes insolvent and there is insufficient money following the liquidation to repay the loan, you could be held personally liable for a proportion of the company’s debts. If you don’t have the funds to repay the loan personally then your home could be at risk.

  • You owe the company money

It is not uncommon for company directors to take money out of the company in the form of a director’s loan. This money must be properly accounted for and repaid. Issues arise when the company becomes insolvent but the loan has still not been repaid.

On liquidation, the liquidator will review the situation and ask for the debt to be settled. If you cannot afford to settle the debt, the liquidator may take legal proceedings against you to recover the balance which could put your home at risk.  

  • You’re guilty of wrongful or fraudulent trading

In every liquidation, the insolvency practitioner acting as the liquidator must investigate and report on the reasons for the company’s failure. If this shows you have been involved in acts of wrongful or fraudulent trading then you could be made personally liable for company debts and your property could be at risk.

Can I be a Director of a Company After Liquidation?

The simple answer is yes. The only restriction you face is that you cannot set up a new company with the same or a similar name as the old company. This is called ‘passing off’ and can lead to criminal action against you and personal liability for the debts of the new company if it enters liquidation.

The only reason you will not be able to become the director of a company after liquidation is if you have been disqualified as a director by the courts or voluntarily chosen to sign a disqualification undertaking. A Director’s Disqualification Order prevents you from acting as a company director yourself and asking someone else to manage a company under your instructions for a period of up to 15 years.

A disqualification order can be made on the grounds of:

    • Wrongful trading – Continuing to trade while insolvent.
    • Unfit conduct – Fraudulent dealings; using company monies for personal benefit; failing to submit tax returns; failing to prepare and file accounting records; attempting to deprive creditors of company assets.
    • Not adhering to the filing rules laid down in the Companies Act
    • Failing to comply with Competition Law

What are Employee Rights in a Company Insolvency?

When a business becomes insolvent, a number of parties other than the company directors will be affected. Suppliers, customers, landlords and shareholders will all feel the impact of the financial failure of a business. However, the company’s employees could be the worst affected. Thankfully, there are special arrangements for employees who are dismissed as a result of an employer’s insolvency. You can read more here.  

What are the Alternatives to Company Bankruptcy?

There are a number of alternatives to liquidation that, depending on the circumstances, could lead to a more favourable result for the company, its directors, the creditors and employees.

  • Negotiate settlements and payment plans

Once a business has become insolvent, one option is to negotiate with your directors to try and come up with a settlement or a payment plan. A Company Voluntary Arrangement (CVA), which we have discussed above, is a formal agreement with your creditors to repay debts over a longer period of time.

It is also possible to negotiate with HMRC if you have tax liabilities. HMRC Time to Pay Arrangements allow you to spread existing tax debts over a typical period of 12 months. All other taxes must be paid as they arise during that time. A cash-flow forecast will be required to prove to HMRC that the company can afford to pay its arrears in instalments along with any new liabilities that arise.

  • Contribute capital or obtain finance

If you haven’t identified the issues or found a solution to the company’s financial problems then injecting more capital into the business is not a good idea as you’ll simply be throwing away good money after bad. However, if you have identified and fixed the issue and just need some working capital to get your company back in the black, you could try and source finance from lenders or even invest your own money in the business.

  • Develop turnaround and profit improvement strategies

Working on the business rather than in it can help company directors understand the issues they have and how to solve them. Turnaround practitioners will be able to help you explore opportunities for profit improvement, develop new revenue streams, look at the current business structure and consider new marketing and technological initiatives. Although there will be a charge for this type of professional assistance, often it will be the best money you can spend.

  • Sell the assets and continue to trade

If your company is unable to pay its creditors, you might think entering into a formal insolvency arrangement is inevitable. However, an alternative option is to sell the company’s business or assets to another entity through a Pre-Pack Administration. That business can then go on to trade profitably in the future. Prior to any sale, it’s essential you receive advice from an insolvency practitioner.

Need help?

If you are a company director who is concerned about company bankruptcy (insolvency) and would like to discuss any of the issues raised in this guide, please call 08000 746 757 for a no-obligation discussion with a specialist who can help.  

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