Company Bankruptcy: What Happens to a Limited Company and Its Directors

When a limited company can no longer pay its debts, people often describe it as going bankrupt. Legally, though, bankruptcy applies only to individuals. In England and Wales a company that can’t pay its debts is insolvent, and it may enter liquidation, administration or another formal insolvency procedure.

For directors, the distinction matters because a limited company is legally separate from its owners and directors, so you are not normally personally responsible for its debts.

There are important exceptions, though. If you signed a personal guarantee, owe the company money through your director’s loan account, or become personally liable because of how the company was run, you may still have to pay.

Insolvency doesn’t always mean closure. Depending on its position, a business may be able to agree terms with its creditors, restructure its debts or keep trading under a formal rescue arrangement.

Where closure can’t be avoided, directors usually choose a creditors’ voluntary liquidation (CVL), which lets them start an orderly closure themselves rather than wait for a creditor to force one through the court. A licensed insolvency practitioner then deals with the company’s assets, creditors and remaining liabilities.

The first step is to establish whether the company can be rescued and whether you face any personal exposure. A licensed insolvency practitioner can assess both, and it helps to have recent bank statements, a list of what the company owes and copies of anything you’ve signed personally.

What Happens When a Company Goes Bankrupt?

A company doesn’t become insolvent the day it first misses a bill. The usual tests, set out in section 123 of the Insolvency Act 1986, are whether it can pay its debts as they fall due and whether its assets are worth less than its liabilities.

When the company is insolvent, or close to it, you must take account of creditors’ interests, and the worse its position, the more weight those interests carry. In practice that means protecting the company’s assets, not taking money out for yourself beyond reasonable pay, not paying a favoured creditor ahead of the rest, and not running up debts the company can’t repay.

Insolvency does not by itself start a formal procedure. That happens when the directors, the shareholders or a creditor take action, and for a company that can’t be rescued, the procedure is usually liquidation.

Once a liquidator is appointed, trading normally stops and staff are usually made redundant, although the liquidator can keep the business running for a short time to sell it.

Your powers as a director end at that point, and creditors’ calls and letters go to the liquidator rather than to you, but you must still co-operate with the liquidator and provide the company’s records.

The liquidator sells the company’s assets, collects money owed to it and pays creditors in the order set by law. When that work is finished, the company is dissolved. Its unpaid debts generally can’t then be recovered from it unless it is restored to the register, but personal guarantees and other personal liabilities survive.

The liquidator must also send the Insolvency Service a report on the conduct of everyone who was a director at any time in the three years before the liquidation began. The liquidator has to file that report in every case, so the fact that one is filed says nothing about you.

The Insolvency Service then decides whether anything in the report needs further investigation, which can lead to disqualification proceedings. Separately, the liquidator can pursue claims against directors on the company’s behalf, for example to recover an overdrawn loan account or money paid out improperly.

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Can an Insolvent Company Be Saved?

Sometimes. The deciding question is whether the underlying business is still viable, meaning it could trade profitably if its existing debts were dealt with. If it could, it may be worth more to creditors as a going concern than broken up and sold, and that is the case a rescue proposal has to make to them.

Each option has conditions and limitations. A CVA needs creditors to vote for it, and the business then has to keep up the payments, often for several years.

Administration is generally more complex than liquidation and may involve higher costs, so it tends to suit businesses with real value to protect. Our guide to alternatives to liquidation compares the rescue routes in more detail.

The choice narrows quickly once a creditor goes to court. When a winding-up petition is advertised, the bank will often freeze the company account, because payments made after the petition was presented can be reversed if the company is later wound up. That can stop a rescue before it starts.

If the court makes a winding-up order, the company enters compulsory liquidation and the Official Receiver takes charge, rather than a practitioner the directors have chosen.

What Happens to Directors if Their Company Goes Bankrupt?

Limited liability protects you from the company’s debts, but not from your own. A debt can become yours in these ways:

• Personal guarantees. If you guaranteed a bank loan, a lease or a supplier account, the creditor can claim from you once the company defaults. Liquidation does not cancel a personal guarantee.
• An overdrawn director’s loan account. Money you took from the company beyond your salary and properly declared dividends is owed back to the company, and the liquidator will ask for it. See our guide to overdrawn director’s loan accounts.
• Court orders about your conduct. If you kept trading when you knew, or should have concluded, that insolvent liquidation or administration could not be avoided, and you did not take every step to minimise creditors’ losses, a court can order you to contribute. This is wrongful trading. Misusing company money can lead to a separate claim by the liquidator.
• HMRC personal liability notices. HMRC can make a director personally liable for unpaid National Insurance where the failure to pay was due to the director’s fraud or neglect. Separate joint liability notices can follow tax avoidance, evasion or repeated insolvencies.

A personal guarantee can leave two directors of the same company facing very different outcomes. Take a hypothetical company with two directors, where only one signed the bank’s personal guarantee on a £40,000 loan.

If the company goes into liquidation, the bank can pursue that director for whatever is still owed on the loan, up to the limit of the guarantee. The other director’s exposure is limited to anything owed through their loan account or any finding about their conduct, which is why we ask about guarantees early.

Claims about conduct turn on what you did once you knew, or should have known, that the company couldn’t pay its way, and those decisions may be examined during the liquidation. Starting a liquidation yourself doesn’t protect you from that review, but acting early leaves fewer months of trading to explain.

If none of these applies, your personal assets are not used to pay the company’s debts, and nothing is recorded on your personal credit file. A future lender or landlord may still ask whether you have been a director of a company that failed.

You can be a director again unless you’re disqualified, an undischarged bankrupt or subject to a bankruptcy restrictions order, and even then the court can give permission. The rules on reusing a liquidated company’s name still apply.

Disqualification lasts between 2 and 15 years and requires a court order, or an undertaking given to the Insolvency Service, based on conduct that made you unfit. Our guide to what happens to directors in liquidation covers the investigation in full.

What Happens to Company Debts, Employees and Creditors?

Creditors submit their claims to the liquidator with evidence of what they are owed, and in a compulsory liquidation they cannot start or continue legal action against the company without the court’s permission.

If you employ staff, they are usually made redundant when trading stops. Eligible staff can claim statutory redundancy pay, notice pay and limited arrears of wages and holiday pay from the government’s Redundancy Payments Service, all subject to statutory caps.

They apply online once the liquidator has provided their details, and anything above the caps becomes a claim in the liquidation. Our guide to what happens to employees explains who is eligible.

Creditors are paid in a fixed order, which is why ordinary suppliers often recover little. Lenders with a fixed charge are paid from the assets that charge covers. Other money goes first to the costs of the liquidation and then to preferential creditors.

Preferential creditors are employees, for wages owed for the four months before the insolvency up to £800 each, all accrued holiday pay and certain pension contributions. HMRC follows for VAT, PAYE, employees’ National Insurance, student loan and construction industry scheme deductions.

Before a lender with a floating charge is paid, a prescribed part of the floating-charge money is set aside for unsecured creditors, up to £800,000 where the charge was created on or after 6 April 2020. The lender takes the rest, and unsecured creditors share the prescribed part and anything left over.

Our guide to which creditors get paid first sets out the full order.

What Should You Do if Your Company Cannot Pay Its Debts?

1. Work out the cash position. List what the company owes, when each payment falls due, and what cash and assets it has. That shows whether you face a temporary cash shortfall or a more serious financial problem.
2. Protect the records and the assets. Keep bank statements, accounts, invoices and board minutes. Do not sell assets cheaply or move money to another company.
3. Stop making the creditors’ position worse. Paying one creditor ahead of the others, especially one you guaranteed or a relative, can be reversed later and counted against you. Do not take customer deposits or new credit the company cannot repay.
4. Check what you have signed personally. Find every personal guarantee and the balance on your director’s loan account.
5. Get licensed advice early. Do it urgently if a creditor has served a statutory demand or threatened a petition. Acting before a creditor goes to court keeps the choice of route with you.

Company Debt is a licensed insolvency practice. In a free, confidential consultation we look at the company’s figures and at any guarantees or loan account balance, then tell you which routes are open.

FAQs on Company Bankruptcy

Related Guides

• Insolvency vs bankruptcy: the two terms compared
• Can a director be made bankrupt if a business fails?
• Creditors’ Voluntary Liquidation explained
• Company liquidation: the full guide