What is the Difference Between Bankruptcy and Liquidation?
In the UK, bankruptcy is a legal process specifically for individuals who are unable to pay their debts, while liquidation pertains to companies. Although the terms are sometimes used interchangeably, they have different legal meanings and consequences.
In this article, we will delineate the key differences between bankruptcy and liquidation, focusing on the legal frameworks that govern each in the United Kingdom.
Key Differences Between Liquidation and Bankruptcy
Who do they apply to
- Liquidation: Companies
- Bankruptcy: Individuals, including sole traders and partnerships
- Liquidation: A resolution of the company’s shareholders appoints a liquidator to sell the company’s assets and distribute the proceeds to creditors and shareholders.
- Bankruptcy: A court procedure where an individual’s assets are taken control of by a trustee, who sells them to pay off creditors.
Effect on operations
- Liquidation: Dissolution of the company and the end of all business operations.
- Bankruptcy: Sole traders or partnerships may continue to trade under certain conditions.
- Liquidation: The liquidator disposes of the company’s assets and uses the proceeds to settle debts in a legally defined sequence.
- Bankruptcy: The trustee sells individual assets and uses the proceeds to repay debts in a specific order set by law.
- Liquidation: Can be a protracted process, especially if the company has complex assets or numerous creditors. It can take years to complete.
- Bankruptcy: Generally quicker, often completed within one year, although some restrictions may last longer.
- Liquidation: Negatively impacts the company’s credit rating. It may also affect the credit ratings of individual directors if they have given personal guarantees.
- Bankruptcy: Negatively impacts the individual’s credit rating for a longer period of time, making it difficult to borrow money or open a bank account in the future.
- Liquidation: Debts are less likely to be written off and may be transferred, especially if the company is sold as a going concern.
- Bankruptcy: Any unsecured debts that are not paid off during the process are usually written off.
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 typically protects the personal assets of the directors 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 does face personal financial liabilities as a result of a company’s liquidation and is unable to meet those liabilities, they may have to consider personal bankruptcy as an option. Nonetheless, 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.