Tax & admin · 14 September 2017

The difference between insolvency, liquidation, bankruptcy and administration

Past Due
Which route should owners take when their business cant pay its debts?

There are a number of possible routes owners can take when their business can no longer pay its debts. Here, we’ve explained the difference between insolvency, liquidation, bankruptcy and administration.

Simply put, the difference between insolvency, liquidation, bankruptcy and administration, is that while one can be considered a financial “state of being”, the other three are processes by which the indebted can be paid back.   

In this way, insolvency – a state in which a company or an individual cannot pay its debts – stands apart from liquidation, bankruptcy and administration.

Insolvency

In the case of insolvency, a business cannot raise enough money to meet its contractual obligations, or pay off its debts as they fall due.

Legally referred to as “technical insolvency”, it’s possible for this to happen even when the total value of a business’s assets exceeds that of its liabilities. Therefore, simply being insolvent doesn’t provide enough grounds for a firm’s creditors to petition for bankruptcy, or force a liquidation.

There are three options that allow you to carry on trading as the director of an insolvent company. You must either contact all your creditors to see if you can reach an informal agreement to meet your obligations, enter into what’s called a “company voluntary arrangement”, or put the company into administration, which offers a break from the legal action taken by creditors to recover their debts.

Putting the company into administration will allow directors to sell off valuable business assets, like property. In the worst cases of insolvency, company directors also have the option of liquidating their business, selling its assets to creditors to creditors in the process.

Read more: The difference between a court and a tribunal

Liquidation

A liquidation is the legal ending of a limited company. It will stop a company from doing business, or employing staff.

Following liquidation, a business will be removed from the official Companies House register – a process known as being “struck off” – from which point that business ceases to legally exist.

Both solvent and insolvent companies can be liquidated, but the process for doing so differs slightly for each one.

Insolvent companies can be liquidated via a creditors’ voluntary liquidation, in which a firm’s creditors will appoint a liquidator to take over control of its affairs, or a compulsory liquidation, in which a company director will themselves “wind up” a business, providing a petition is made to and accepted by a court.

For solvent companies, who’s directors have decided to stop trading and end the business (perhaps because they want to retire, or can’t find a replacement to run the firm), the process is known as members’ voluntary liquidation.

There are several key aspects to the procedure of liquidating a company. Firstly, a liquidator will make sure all company contracts (including employment contracts) are completed or transferred.

All business transactions will then be closed down, and any legal disputes will be settled. After this a liquidator will sell the business’s assets before collecting any debts that are owed to the company. Finally, a liquidator will pay the firm’s creditors, and distribute any remaining share capital to shareholders.

Read more: The difference between a sole trader and a limited company

Bankruptcy

Unlike insolvency, bankruptcy is a process for individuals (including business owners or directors) to deal with debts they’re unable to pay. But, it doesn’t legally apply to companies.

With some restrictions, bankruptcy can provide individuals with a fresh start, free from their previous debt, while ensuring that their assets are shared amongst the creditors they owe money to.

A bankruptcy order can be issued to an individual for one of three reasons. Firstly, if they can’t pay what they owe, and choose to declare themselves bankrupt. Secondly, if creditors apply successfully to make them bankrupt, because they’re owed more than £5,000. And thirdly, because an insolvency practitioner has made them bankrupt, after the person has broken the terms of an individual voluntary agreement to pay off all their debts to creditors.

It costs £680 to apply to the government to become bankrupt, and within two weeks of the order being made, an official receiver, working for the Insolvency Service, will contact you to explain the process. Acting as your “trustee”, the receiver will then go about selling off your business’s assets to pay off debts.

During the bankruptcy process, money from the business will be distributed in a specific order. First, any claims from employees of the business will be settled. Next, creditors will receive payment, before interest on any other debts are then paid.

After this, any money left over from the business is returned to the individual, and if everyone is paid in full, an application can be made to have the bankruptcy cancelled.

Read more: The difference between contracts and deeds in small business

Administration

By entering their company into administration, an owner hands over legal ownership of that company to an insolvency practitioner, or “administrator”.

The administrator will come up with a plan either to restore the company’s viability and come to an arrangement with its indebted creditors, realise the company’s assets to pay a particular creditor, or sell the business as a going concern on the basis that more can be more money cab be made from its assets than if the firm was liquidated.

One benefit of the administration process is that while an administrator is on charge, a business’s creditors can’t take legal action against it to recover any debt or begin compulsory liquidation without the permission of a court.

It’s up to creditors to agree with an administrator’s plans, which may or may not achieve a better result for them in the long-run than immediately liquidating that company would.

Administration can mean your company doesn’t have to pay all its debts in full, but it can still be liquidated with the consent of the courts.

Read more: The difference between flat rate and standard VAT

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ABOUT THE EXPERT

Fred Heritage is deputy editor at Business Advice. He has a BA in politics and international relations from the University of Kent and an MA in international conflict from Kings College London. He previously worked as a reporter at Global Trade Review magazine.

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