Running a business always involves some financial risk. Even strong businesses can face difficulties if debts build up and income cannot keep up. In the UK, the terms bankruptcy and insolvency are often used as if they mean the same thing, but there is an important difference. Bankruptcy is a legal process that applies to individuals, including sole traders and partnerships. Limited companies follow insolvency procedures instead.

This guide explains what both routes involve and sets out the steps you may need to take if you are struggling financially.

Bankruptcy or Insolvency: Understanding the Difference

A sole trader or a business partnership is not legally separate from its owner. If debts cannot be paid, bankruptcy is the process of dealing with those debts.

A limited company, however, is a separate legal entity registered with Companies House. When it cannot pay its debts, it is classed as insolvent. Insolvent companies do not go bankrupt; instead, they may enter the liquidation process or other insolvency procedures.

Knowing this difference helps business owners and company directors understand which route applies to them.

First Actions if You Are Struggling Financially

Bankruptcy or liquidation should not be the first response. Some businesses can find short-term solutions. For example, HMRC may agree to a Time to Pay arrangement for tax debts, helping to ease cash flow pressure. In other cases, creditors may accept a repayment plan.

If debts are more serious, it is important to seek professional advice from a licensed insolvency practitioner. They can assess the business’s financial position and explain whether it is possible to continue trading or whether it would be safer to cease trading and begin formal insolvency.

Sole Traders and Partnerships: Bankruptcy Step by Step

For individuals running their own business, bankruptcy is the process used when debts cannot be paid. This can be started voluntarily or forced by a creditor.

Applying for Bankruptcy

Applications are made online through the government website. The fee is £680 and must be paid in full before submission. Once the application is submitted, an adjudicator reviews it and decides whether to approve. This usually takes less than four weeks.

What Happens Next

If approved, an official receiver is appointed. They take control of the bankrupt person’s assets and review their financial history. Business records must be handed over.

Some work-related items, such as tools or vehicles, can be kept. Stock and other assets may be sold. If the bankrupt person employs staff, those employees lose their jobs and can make claims for redundancy and unpaid wages.

Length and Restrictions

Bankruptcy usually lasts 12 months. During this time, the bankrupt individual is limited in borrowing and in running a company. At the end of the period, most remaining debt is cleared, although some debts, such as student loans or fines, still need to be paid.

Limited Companies: Insolvency Procedures

When a limited company cannot meet its debts, the directors must act quickly. Continuing to trade once a company is insolvent can risk personal liability for the directors.

Options to Rescue a Business

Some companies can be saved through restructuring:

• Company Voluntary Arrangement (CVA): An agreement between a company and its creditors to repay debts over a set period. A CVA can help a company keep trading and improve cash flow, but it requires creditor approval.
• Administration: An administrator is appointed to protect the company from legal action while working on a plan. This may involve restructuring, selling part of the business, or moving into a CVA.

Closure Routes

If recovery is not possible, closure may be the only option.

• Creditors’ Voluntary Liquidation (CVL): Directors decide the company cannot recover and place it into liquidation. A licensed insolvency practitioner manages the sale of assets and distributes money to creditors. When the process ends, the company is removed from Companies House, and debts are written off unless a personal guarantee has been given.
• Compulsory Liquidation: A creditor can apply to the court to wind up the company. If approved, the official receiver takes control, and the company must cease trading.

Responsibilities and Risks for Directors

When a business becomes insolvent, the duties of the company director change. Their first responsibility is to protect creditors. Continuing to trade when there is no chance of recovery may be treated as wrongful trading.

Directors also face risks if they have signed a personal guarantee on business borrowing. Even after the company enters liquidation, they remain personally responsible for those debts. Investigations are common after the liquidation process, and if misconduct is found, directors may be disqualified from running a company in future.

Employees and Creditors

Employees of a bankrupt or insolvent business can claim statutory payments for redundancy, notice, and unpaid wages. Creditors are repaid in order of priority. Secured and preferential creditors are paid first, while unsecured creditors may only recover a small share of what they are owed.

Costs, Timelines, and Aftermath

Bankruptcy for a sole trader or partnership involves a fixed fee and usually lasts one year. Company insolvency procedures vary in length and cost depending on the complexity of the case, but all require the involvement of a licensed insolvency practitioner.

After bankruptcy or liquidation, the business is closed, and debts are dealt with. A sole trader may be able to continue trading once discharged, but credit will be hard to obtain. A former company director may set up another company if not disqualified, although they cannot use the same or a similar name without permission.

Alternatives to Bankruptcy or Liquidation

Not all businesses need to go through the formal insolvency or bankruptcy route. Some can recover through careful restructuring, agreements with creditors, or additional funding. However, taking out new loans without a realistic repayment plan can create more risk, especially if the business is already insolvent. Speaking to an insolvency professional early often provides more options.

Conclusion

Business bankruptcy in the UK can mean different things depending on the business’s structure. Sole traders and partnerships may apply for bankruptcy, while limited companies undergo insolvency procedures such as CVAs, administration, or liquidation.

The key for both business owners and directors is to act quickly, understand responsibilities, and seek advice from a licensed insolvency practitioner. While the process can be difficult, it provides a way to deal with debt, protect creditors, and move forward with a fresh start.