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What Does It Mean When Your Business Is Bankrupt?

When a company goes bankrupt, its liabilities (or debts) exceed its assets, and bills cannot be paid.

We explore the ins and outs of business bankruptcy, the role of insolvency practitioners, and the various options available for insolvent companies.

We’ll also discuss the responsibilities and liabilities of company directors in such situations and the protection of employees and creditors.

Understanding Business Bankruptcy

Bankruptcy is a state of insolvency in which liabilities surpass assets or bills cannot be paid punctually or in full.

While bankruptcy applies to individuals unable to meet their financial obligations, the term insolvency is used for businesses that cannot settle their debts.

When a business is faced with insolvency, it may attempt to be rescued or enter into a Creditors’ Voluntary Liquidation (CVL).

The CVL process is designed to facilitate an orderly winding down of an insolvent company’s affairs in order to bring about its end.

If you believe your company is facing bankruptcy, it is crucial to seek the assistance of a certified insolvency practitioner.

They can help evaluate whether the company is insolvent and outline the potential courses of action. Inappropriate actions taken during this period could result in allegations of wrongful trading.

For sole traders and partnerships, bankruptcy is the applicable term, as there is no difference between the proprietor of the business and the business itself.

Determining Insolvency in a Limited Company

Insolvency is defined as a situation in which a company is unable to pay its debts. A limited company can evaluate if it is insolvent by running a cash flow or balance sheet test.

Falling into arrears can trigger compulsory liquidation, as the company debt creditor tolerance reaches its limit.

Upon becoming aware that the company is likely to become insolvent, it is advisable for the director to take steps to minimise losses to creditors, which may include ceasing trading or continuing trading with the advice of a licensed insolvency practitioner.

Balance Sheet Test

The balance sheet test is a tool used to evaluate a company’s financial standing, determining whether its liabilities exceed its assets.

If total liabilities do surpass assets, the company is considered balance sheet insolvent.

The process of the balance sheet test involves analysing the organisation’s financial standing to ascertain if its liabilities surpass its assets.

The assets must be larger than the liabilities or insolvency could be an issue. In such a situation, the business may not be able to fulfil its financial commitments.

This test helps businesses determine their financial health and whether they should seek professional help to address potential insolvency.

Cash Flow Test

The cash flow test is a method used to evaluate a company’s ability to meet its financial obligations as they become due or in the foreseeable future.

It assesses the capacity of a company to generate sufficient funds to pay its debts when due or to liquidate its assets quickly enough to pay its creditors.

A cash flow test is utilised to assess a company’s ability to fulfill its payment obligations as they come due. The company is in trouble if it misses payments.

This may mean a company bankruptcy if it is insolvent.

A failed cash flow test can result in the company being placed into administration or liquidation, and the directors may be held accountable for any debts incurred.

The Role of Insolvency Practitioners

Insolvency practitioners are responsible for managing the company’s assets, realising them, and distributing the funds to creditors.

They play a crucial role in helping businesses facing bankruptcy by evaluating the company’s financial standing and providing objective, confidential advice, and assistance to assess the situation and obtain advice on potential options.

Before consulting an insolvency practitioner, the company should have precise financial records that reflect its financial position.

This enables the insolvency practitioner to provide accurate and relevant advice tailored to the specific situation of the company.

An insolvency practitioner can also provide other services to a bankrupt company, such as exploring funding alternatives and negotiating with creditors to reach agreements that may help the company stay afloat.

Their skills and expertise can be invaluable in guiding struggling small companies house and businesses’ through the complex process of bankruptcy and helping them find the best solution for their unique circumstances.

Options for an Insolvent Company

There are several options available for insolvent companies, including funding alternatives, HMRC Time to Pay arrangement, Company Voluntary Arrangement (CVA), and Company administration. Formal debt restructuring is one option.

Considering the financial standing of the company and its potential future sustainability, there may be options available to rescue the company and return it from the brink of insolvency.

Engaging in informal negotiations with creditors, administration, and establishing a Company Voluntary Arrangement may be viable options.

Company Voluntary Arrangement (CVA)

A Company Voluntary Arrangement (CVA) is a formal insolvency procedure that provides a company with the opportunity to pay creditors over a fixed period.

This debtor-in-possession process requires minimal court involvement and typically lasts between three to five years.

A CVA is a legally binding arrangement between a company and its creditors, stipulating that the company will pay a portion of its outstanding debt back over a fixed period, usually spanning three to five years. Interest and fees are suspended, and any remaining debt at the end of the term may be annulled.

The benefits of a CVA include enabling a company to continue operating even when insolvent and allowing the company to make payments to secured creditors over a predetermined period, which can alleviate financial pressure on the company.

However, it is important to be aware of the potential risks associated with a CVA, such as the possibility of the company being unable to fulfill its obligations under the agreement, which could result in the company facing liquidation.

Additionally, creditors may not accept the terms of the CVA, which could lead to the CVA being denied.

Company Administration

Company administration is a formal insolvency process in which an insolvency practitioner is appointed as an administrator to manage an insolvent company with the objective of either restoring it to profitability or liquidating its assets to satisfy creditors.

The process of administration involves restructuring the company into a more efficient and profitable entity, which may include reducing staff and selling assets, all with the intent to help the company return to profitability and maximise creditor returns.

Administration can provide a lifeline for struggling businesses, offering them a chance to restructure and rebuild while protecting them from legal action by creditors.

However, it is important to note that not all companies will be able to successfully emerge from administration, and some may ultimately still face liquidation.

Company Liquidation

Company liquidation involves the winding up and dissolution of a company, typically through a Creditors’ Voluntary Liquidation (CVL).

An insolvency practitioner is appointed to oversee and manage the company voluntary arrangements during the liquidation process. Upon conclusion of the liquidation process, the company will be dissolved.

Creditors would be paid in accordance with priority, if funds are available for such purposes.

However, company liquidation can be a difficult and emotionally draining process for all involved, particularly for company directors and employees who may lose their jobs as a result.

It is important for small businesses facing liquidation to also seek advice, professional advice and support to navigate this challenging process.

Director Responsibilities and Liabilities

When a company becomes insolvent, the primary responsibility of directors shifts to creditors rather than shareholders.

Directors must cease trading immediately and safeguard the company’s assets in the interests of creditors.

Should directors partake in wrongful trading, commit fraudulent activities, or breach their duty of care, they may be held personally liable for company debts.

In such situations, directors should prioritise limiting creditor liabilities to avoid personal liability and a ban from serving as a company director.

This can be achieved by seeking professional advice from a licensed insolvency practitioner and taking appropriate actions to minimise losses to creditors.

Protecting Employees and Creditors

Employees are preferential creditors, meaning their claims take precedence over those of suppliers, customers, or contractors.

When a company is liquidated, the Redundancy Payments Office may offer statutory payments to all company assets to employees, including arrears of wages, holiday pay, notice pay, and redundancy pay, if the company’s assets do not cover the money owed to them.

Directors, who are employed by the company, may be able to claim director redundancy and other statutory entitlements.

This is done in the same way as for all other staff members.

This protection can provide some financial relief for employees and directors who may be facing job loss and other financial distress and uncertainty as a result of the company’s liquidation.

Personal Assets and Limited Company Bankruptcy

The limited company structure is a business structure that limits the liability of its directors for the company’s debts.

Directors are safeguarded from personal liability unless they have provided personal guarantees for business borrowing.

However, directors of limited companies can become personally liable if they provide a personal guarantee on a loan or other finance agreement.

In cases where personal guarantees are provided, directors may be held personally liable for the company’s debts, putting their personal assets at risk.

It is crucial for directors to fully understand the implications of providing personal guarantees and to seek professional advice before entering into such agreements.

Costs and Consequences of Closing an Insolvent Company

Closing an insolvent limited company incurs higher costs than a solvent one, starting at £5,000 through a Creditors’ Voluntary Liquidation (CVL).

In contrast, a solvent company that is no longer trading and has few assets can be struck off for a nominal fee of £10, or closed via a formal agreement for a Members’ Voluntary Liquidation (MVL) which starts at £1,500.

These costs can be a significant burden for struggling businesses, but it is important to remember that the consequences of not addressing insolvency can be far greater, potentially leading to further financial difficulties, legal action, and damage to the company’s reputation.

Seeking professional advice and taking appropriate action early on can help mitigate these consequences and ensure the best possible outcome for all parties involved.

Frequently Asked Questions

What happens if a business is declared bankrupt?

If a business is declared bankrupt, many businesses its assets will be sold to to pay bills and creditors, any remaining debt will not be recovered, and the business will close.

Employees are dismissed and the whole company is bankrupt and limited company director dissolved in the corporate bankruptcy process.

Do you lose your money if a company goes bankrupt?

Unfortunately, if a company goes bankrupt and does not have enough assets to even pay bills or creditors, you may not be able to get your money back.

It is important to take necessary precautions, such as researching the company beforehand, before investing any funds.

What makes a business bankrupt?

Bankruptcy occurs when a company’s cash flow is insufficient to cover its financial obligations, resulting in an inability to pay creditors on time and in full. It may also occur if the business’s liabilities exceed its assets, making it balance sheet insolvent.

Being aware of the warning signs can help prevent a business from falling into bankruptcy.

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