Guide to Insolvency

Insolvency happens when businesses or individuals have insufficient funds or assets to pay their debts. The term ‘bankruptcy’ is used for the formal procedure for individuals who are declared by the court to be deemed insolvent.

What happens when someone is declared bankrupt?

When someone is declared bankrupt by the court, all their assets come under the control of the Official Receiver. If there are sufficient assets to cover the costs of the proceedings, the Official Receiver calls a meeting of creditors, who may then decide to nominate an insolvency practitioner to act as the bankrupt’s trustee. The trustee is then responsible for realising the assets and passing on any proceeds to creditors. The bankrupt can usually keep household contents and their car or work vehicle.

After 12 months of the bankruptcy order, any unpaid balance of the debt is then written off. The exact date of discharge is determined by the date that the Official Receiver confirms to the court that there are no further matters requiring investigation.

Does a bankrupt have to sell their home?

If the bankrupt owns either all or part of their home, their share of the property must usually be released. If the bankrupt lives with children, then there must be an agreement made if the house is to be sold within that initial 12-month period, as it can not be sold by default with the children living there. During this time, the bankrupt, or their friends and family, can attempt to raise finance and avoid a sale.

The trustee must take steps within three years to realise the bankrupt’s interest in their home; otherwise, it will return to the bankrupt’s ownership. If the value of the property or interest is less than £1000 at the end of this period no action will be taken and the interest in the home will return to the bankrupt.

Can bankruptcy be avoided?

Bankruptcy can be avoided, and other insolvency solutions can save an individual from bankruptcy proceedings. This can be achieved via an individual voluntary arrangement (IVA) or a debt relief order (DRO).

Individual voluntary arrangements (IVAs)

Any individual who owes money, whether or not they are bankrupt, can put forward a scheme to their creditors to pay off all, or part, of their debt. If creditors agree, some of the debtor’s assets, which would otherwise be sold as part of the bankruptcy process, could be excluded.

For an IVA to be accepted, a majority (over 75%) of creditors need to agree. This only needs to be 75% of those creditors who are represented at the creditor’s meeting. If agreed, the IVA is then administered by a supervisor who must be an insolvency practitioner.

IVAs offer significant advantages over bankruptcy because

• They are not formally advertised
• Court involvement is minimal
• The Official Receiver is not involved

Creditors can also benefit from lower administration costs and the fact that the debtor is cooperating. It should be said that IVAs are only appropriate where the debtor can achieve the proposals they have put to their creditors.

If the IVA fails, then the debtor can be made bankrupt.

Debt relief orders (DROs)

DROs are an insolvency solution where debtors can make contributions to their creditors where the debtor has:

• (Relatively) lower liabilities, not exceeding £15,000
• No real assets exceeding £300
• Little or no disposable income exceeding £50 per month

As with most forms of personal insolvency, a DRO will adversely affect the debtor’s credit rating.

If a debtor has an interest in property, even if it is in negative equity, a DRO is not available. The £300 limit on assets is based on gross value, although there is an exemption for cars with a value of less than £1,000.

The upshot for creditors is that they lose their ability to recover the debts over an extended period, which could encompass the period where the debtor’s financial circumstances improve.

Corporate insolvency

A company becomes insolvent if it does not have sufficient assets to cover its debts and cannot pay its debts when they become payable. It is the director’s responsibility to know whether the business is trading whilst insolvent, as they can be held legally liable for continuing to trade.

The decision to appoint liquidators, receivers and administrators is the responsibility of the company directors, the courts, creditors, or appropriate funding bodies (such as banks), depending on the procedure used.

The procedures open to an insolvent company fall into five main categories:

Administrations

This holds a business together while plans are formulated by the administrator to either:

• Restructure the organisation
• Sell the company and its assets

Arguably, this produces a better outcome for creditors than a liquidation.

Company voluntary arrangements (CVAs)

CVAs are a ‘deal’ between a business and its creditors for repaying, in full or in part, the liabilities of the company. It is a formal insolvency process and involves the debtor company renegotiating the payments due to its creditors. It requires the approval of 75% of the creditors present and voting at the creditors’ meeting convened to approve the proposals. Partnership voluntary arrangements (PVAs) are modelled on CVAs and give a business partnership the opportunity to resolve its financial issues with creditors’ support.

Administrative receiverships

This is a remedy that is only available to a secured creditor of a limited company or a PLC who has a floating charge over a company’s assets and a fixed or floating security overall, or mostly all, those assets.

Compulsory liquidations

This procedure applies to both companies and partnerships and is started by a court order called a winding-up order. A winding-up petition is made in the High court, usually by a creditor, stating that the business owes a sum of money that it cannot pay.

Creditors’ voluntary liquidations (CVLs)

This is a liquidation process initiated by a director, which has to be managed by a licensed insolvency practitioner. If directors of a limited company know it to be insolvent, they can decide to voluntarily shut down the company by placing it into a CVL.