In the UK, bankruptcy is a legal process specifically for individuals who cannot pay their debts, while liquidation pertains to companies.
Although the terms are sometimes used interchangeably, they have different legal meanings and consequences.
What is Liquidation?
Liquidation is a formal insolvency procedure in the UK that involves the closure of a company and the sale of its assets. This process is typically initiated when a company is unable to pay its debts and is deemed insolvent. The purpose of liquidation is to ensure that the company’s assets are distributed fairly among its creditors.
There are two main types of insolvent liquidation for UK companies:
Compulsory Liquidation – initiated by creditors applying to the court to forcibly wind up an insolvent company.
What is Bankruptcy?
In the UK, bankruptcy is a formal insolvency procedure that applies to individuals, rather than companies.
When an individual becomes bankrupt, their assets are sold to pay off as much of their debts as possible.
Once a bankruptcy order is made, a trustee is appointed to manage the bankrupt individual’s assets and distribute them among creditors. The trustee’s role is similar to that of a liquidator in a company liquidation.
Key Differences Between Liquidation and Bankruptcy
Key Differences
Liquidation
Bankruptcy
Applies to
Companies
Individuals (including sole traders and partnerships)
Process
Shareholders appoint liquidator to sell assets, pay creditors
Court appoints trustee to control and sell assets, pay creditors
Business Impact
Company dissolves, operations end
Sole traders/partnerships may continue under conditions
Asset Distribution
Liquidator sells assets, pays debts in legal sequence
Trustee sells assets, repays debts
Duration
Can be lengthy, especially with complex assets or many creditors
Generally quicker, often completed within one year
Credit Impact
Affects company credit rating, may impact directors with personal guarantees
Longer-lasting negative impact on individual’s credit rating
Does Liquidation Mean Bankruptcy?
The liquidation of a company does not automatically lead to personal bankruptcy for the directors. In the UK, a company is a separate legal entity from its directors and shareholders. This separation usually protects the directors’ personal assets if a company goes into liquidation.
However, there are circumstances where directors could be held personally liable and face financial difficulties that may lead to personal bankruptcy:
Personal Guarantees: If a director has given personal guarantees for company debts, they could be held personally responsible for these debts if the company is unable to pay.
Wrongful or Fraudulent Trading: If a director is found to have continued trading when they knew the company was insolvent, or if they are found guilty of any fraudulent activity, they could face personal liability.
Overdrawn Director’s Loan Account: If a director has an overdrawn loan account with the company, they may be required to repay this upon liquidation.
If a director faces personal financial liabilities as a result of a company’s liquidation and is unable to meet those liabilities, personal bankruptcy is an option to consider. However, this is not an automatic outcome and depends on the specific circumstances and actions of the director.
FAQs on Bankruptcy and Liquidation
If a sole trader goes bankrupt, can the business still operate?
Yes, in some cases, a sole trader can continue to operate even while bankrupt, subject to certain restrictions. However, a company in liquidation ceases operations entirely.
How do the processes affect a director’s future employment opportunities?
Bankruptcy can lead to restrictions on an individual’s employment in certain sectors. Liquidation generally does not have this effect on a director unless disqualification proceedings are initiated.
How does bankruptcy affect personal assets compared to company assets in liquidation?
In bankruptcy, personal assets are sold to pay off debts. In liquidation, it’s the company’s assets that are sold, not the personal assets of directors or shareholders, unless personal guarantees have been given.
Are there options to avoid bankruptcy or liquidation?
Yes, individuals may consider debt management plans or Individual Voluntary Arrangements (IVAs) to avoid bankruptcy. Companies may explore Company Voluntary Arrangements (CVAs) or administration to avoid liquidation.
How do bankruptcy and liquidation affect credit scores differently?
While both processes have a legal order for repaying creditors, the specifics may vary. Secured creditors usually take precedence in both, but the priority of other creditors can differ.
What are the legal obligations for declaring bankruptcy versus entering liquidation?
Declaring bankruptcy involves court proceedings, and individuals must disclose all assets and liabilities. Entering liquidation requires a resolution from shareholders or an intervention from creditors, followed by the appointment of a liquidator.
