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.

What is Liquidation?

Liquidation is the formal process of closing a limited company and distributing its assets to creditors.

1. Ceasing Operations: The company stops all trading activities and sells its assets, including equipment, inventory, and property.
2. Paying Creditors: The proceeds from the sale of assets are used to settle debts in this order of priority:
   • Secured Creditors
   • Preferential Creditors
   • Floating Charge Holders
   • Unsecured Creditors
   • Shareholders
3. Discharging Debts: Any debts that cannot be paid from the sales of assets are written off.
4. Dissolution: The company is removed from the Companies House register, ending its legal existence.

There are two main types of liquidation for UK companies:

1. Creditors’ Voluntary Liquidation (CVL) – initiated by the company directors when they recognise the company is insolvent (unable to pay debts).
2. Compulsory Liquidation – initiated by creditors applying to the court to forcibly wind up an insolvent company.

Liquidation is generally viewed as the final resort when a financially distressed company has no option to rescue, restructure or sell the business. It allows for an orderly winding down and distribution of assets under supervision before dissolving the company entirely.

What is Bankruptcy?

Bankruptcy is a legal process specifically designed for individuals who are unable to pay their outstanding debts. It does not apply to companies or businesses in the UK.

For individuals, bankruptcy involves:

1. Filing a bankruptcy petition with the court, either by the individual themselves or by one of their creditors.
2. A bankruptcy order is issued by the court, officially declaring the individual as bankrupt.
3. At this point, most of the bankrupt individual’s assets (with some exceptions) are transferred to a trustee in bankruptcy.
4. The trustee sells off the non-exempt assets to raise funds.
5. These funds are then distributed to creditors in a prescribed order of priority.
6. After a set period, usually 12 months, the bankrupt individual is discharged from most of their remaining debts that qualify for discharge.

Bankruptcy provides debt relief and a fresh financial start for overwhelmed individuals, but it has serious consequences, such as damage to credit ratings and potential restrictions on future employment or business activities.

Key Differences Between Liquidation and Bankruptcy

Liquidation applies to companies, while bankruptcy is a legal process for insolvent individuals, including sole traders and partnerships.

The legal process for liquidation involves a resolution of the company’s shareholders appointing a liquidator to sell the company’s assets and distribute the proceeds to creditors and shareholders. Bankruptcy, on the other hand, is a court procedure where an individual’s assets are taken control of by a trustee, who sells them to pay off creditors.

In terms of effect on operations, liquidation results in the dissolution of the company and the end of all business operations. In the case of bankruptcy, sole traders or partnerships may continue to trade under certain conditions.

Regarding asset distribution, the liquidator disposes of the company’s assets and uses the proceeds to settle debts in a legally defined sequence. In bankruptcy, the trustee sells individual assets and uses the proceeds to repay debts.

The duration of these processes can vary. Liquidation can be a protracted process, especially if the company has complex assets or numerous creditors, and it can take years to complete. Bankruptcy, on the other hand, is generally quicker, often completed within one year, although some restrictions may last longer.

Both liquidation and bankruptcy negatively impact credit ratings. Liquidation affects the company’s credit rating, and it may also impact the credit ratings of individual directors if they have given personal guarantees.

Bankruptcy negatively impacts the individual’s credit rating for a longer period, making it difficult to borrow money or open a bank account in the future.

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 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:

1. 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.
2. 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.
3. 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, personal bankruptcy is an option to consider, but this is not an automatic outcome, and depends on the specific circumstances and actions of the director.

FAQs on Bankruptcy and Liquidation