This information only applies in England and Wales.

If a company or individual is unable to pay their debts, this situation is known as insolvency. In practice, this usually means that bills cannot be paid when they become due - but insolvency also applies to the state of having more liabilities than assets. The term "insolvency" refers to both the situation of being insolvent and to the procedures of dealing with insolvency.

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Insolvency is a general term which can apply to both individuals and companies. Bankruptcy, meanwhile, only applies to individuals (including sole traders); it does not apply to limited companies or partnerships (although partners or company directors may become bankrupt if the partnership or company becomes insolvent). Bankruptcy is just one type of personal insolvency; there are other forms such as individual voluntary arrangements (IVAs) or debt relief orders.

Limited companies (but not individuals) which become insolvent may be put into liquidation (also known as "winding-up"). This will result in the cessation of trading, the sale of any assets to pay creditors and being struck off from the companies register. There are three types of liquidation:

  • Creditors' Voluntary Liquidation (CVL) - this is the most common type of liquidation and needs to be proposed by directors and agreed by 75% (by value of shares) of shareholders.
  • Compulsory Liquidation - a company with debts of £750 or more can apply to the court to be liquidated. A director can ask the court to wind up the company, as long as 75% (by value of shares) of shareholders agree.
  • Members' Voluntary Liquidation (MVL) - although this is a type of liquidation, it does not apply to insolvency. Instead, it is a procedure used to wind-up a solvent company (eg due to retirement).

A company which is unable to meet its payment deadlines and is unable to achieve any sort of compromise agreement (such as a CVA - see below), may end up facing a winding-up application from its creditors. This entails a creditor applying to the court to shut down and liquidate the company. If the court issues a winding-up order, an "official receiver" will be put in charge of managing the liquidation process, including freezing the company bank account and selling its assets.

Once a liquidator is appointed, company directors cannot act on behalf of their company and no longer have any control over it. If there is a CVL or compulsory liquidation, they will be banned for five years from forming, managing or promoting any business with the same (or similar) name to the liquidated company (subject to certain exceptions).

If company directors are found to have been negligent in their legal responsibilities and contributed to the company insolvency through "wrongful trading" (ie allowing a company to trade when it cannot pay its debts), they may be held personally liable for company debts. If their conduct is deemed to be unfit, they can also be disqualified as a director for up to 15 years.

The rights of the employees where the company is made insolvent will depend on the type of insolvency regime.

The employee may be made redundant by the employer. An employee can apply to the National Insurance Fund for unpaid wages and other payments via the website. 

If the company is bought by another company the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) will be applied to protect employees. The new employer will take on all the liabilities, including employment protection under TUPE, of the insolvent employer.

Sole traders are personally responsible for all the debts of their business. Whereas directors of a limited company are generally cushioned from the liabilities of the enterprise should it get into financial difficulties, sole traders are inextricably and personally linked to the fortunes of their business. Sole traders cannot go into liquidation; instead they must either apply for bankruptcy or enter an Individual Voluntary Arrangement (IVA). An IVA is a legally binding agreement to repay debts over a period of time; it must be agreed to by creditors holding 75% of overall debt.

A Company Voluntary Arrangement (CVA) is an agreement between an insolvent company and its creditors to negotiate a flexible debt repayment structure. This allows the company to attempt to trade itself out of financial difficulty.

If a CVA is not appropriate or does not work out, creditors can seek to recover the debt by obtaining a county court judgment (CCJ), issuing a statutory demand and ultimately by applying to wind-up the company.

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