What is Insolvency?
Insolvency describes the situation where a person or company cannot pay its debts. This means the value of assets and income will not cover what is owed. Read on to find out more about the implications you need to know.
The thought of being declared insolvent can be daunting and scary. But while it may well feel like a last resort, the process of insolvency can be a positive course of action for some people or businesses in the long term.
One of the problems with the subject of insolvency is that there can be a lot of misconceptions as to what it involves, how it works and what the implications might be. So, let’s clear some of that up.
What is insolvency?
When a person or a business enters insolvency, it generally means they have reached a point where they aren’t able to repay their debts.
In other words, the amount they owe is more than the value of their assets, and the income they have coming in.
» MORE: What is business insolvency?
What are the different types of insolvency?
Insolvency can take several different forms.
Perhaps the best known type of insolvency is bankruptcy. You will typically have filed for it yourself, or in rare cases if a creditor has applied to have you made bankrupt.
A common form of insolvency in England and Wales is an individual voluntary arrangement (IVA), which is an alternative to bankruptcy. The corporate equivalent is a company voluntary arrangement (CVA).
A debt relief order (DRO) is an alternative to insolvency, available if you owe less than £30,000. Visit this page for more information on debt relief orders.
Are there different options in Scotland?
Yes. It’s important to note that insolvency terms and laws in Scotland are sometimes different to those in England and Wales.
For example, the Scottish term for bankruptcy is sequestration.
The closest IVA equivalent in Scotland is a protected trust deed (PTD), a formal arrangement between debtors and creditors that allows as much of the debt to be repaid as the debtor’s assets will allow.
Other options include debt arrangement schemes (DAS) and informal debt solutions that can be worked out with a debt adviser.
What is the difference between insolvency and bankruptcy?
The two terms are often used interchangeably, but there are important differences.
In the UK, insolvency refers mainly to businesses. Bankruptcy refers mainly to individuals and sole traders. However, that isn’t always the case, and you’ll often see references to personal insolvency.
In the US, bankruptcy is often used to describe corporate insolvencies.
Bankruptcy is a form of insolvency that involves a legal process. Insolvency just refers to the scenario of not being able to repay debts. This means you can be insolvent without being bankrupt.
» MORE: How bankruptcy works
Why might I declare myself insolvent?
The most common reason for declaring yourself insolvent is that you’re no longer able to pay your debts, either as a business or an individual.
There are several red flags that can indicate when some form of insolvency might be worth considering:
- you’ve been refused credit
- you’re running out of money before the end of each month
- you’re only paying the interest on your debts each month and not repaying the capital
- you’re borrowing to pay your existing debts
- you’re using high-cost credit (such as payday loans) to get by
- you’re receiving letters from creditors demanding payment or threatening legal action.
While one of these situations alone may not mean you will pursue insolvency procedures, it’s always worth exploring your options.
For example, there are several reasons that you might be rejected for credit – checking your credit score could help you understand what’s going wrong.
How do I declare myself insolvent?
The process of entering insolvency varies, depending on which type you may need to take.
To declare yourself bankrupt in England and Wales you need to apply online to the Insolvency Service, which costs £680. You’ll find out within 28 days if your application has been accepted.
On the other hand, an IVA is generally applied for through an insolvency practitioner, who will charge a fee. A debt relief order (DRO) can be accessed through an authorised debt adviser.
The application forms for sequestration in Scotland are on the Accountant in Bankruptcy website, though you need to speak to an approved money adviser first.
PTDs are usually accessed through insolvency practitioners, again at a potentially significant cost.
What assets are included in insolvency?
When you apply for bankruptcy your bank accounts will usually be frozen while an official receiver examines your spending history. The bank may close your account entirely after this process concludes, and you may need to open a new account with a new bank.
Assets, including your property, can be sold in order to repay your debts. However, you should be able to keep items needed for your work, and basic household items such as bedding and clothing.
With alternative arrangements such as PTDs, DROs and IVAs your assets are less likely to be claimed, although you may be encouraged to sell any expensive items you own if it can help you clear your debts.
What other implications do I need to know about?
Aside from the assets involved, the disadvantages vary between the types of insolvency.
For example, bankruptcy will stay on your credit record for six years, making it much harder and more expensive to borrow money. You’re also not allowed to be a company director until you’re discharged.
IVAs, PTDs, DROs and other types of insolvency will also show up on your credit record for a period. The insolvency practitioner fees for arrangements such as PTDs and IVAs can also be expensive, prolonging the time it takes to get out of debt.
Certain types of jobs, such as accountants and lawyers, may not allow you to continue working if you become insolvent.
What help is there if I declare myself insolvent?
It’s important to get advice when you’re considering any form of insolvency. Free, impartial debt advice is available from organisations including the following:
- MoneyHelper (formerly the Money Advice Service) – 0800 138 7777
- Stepchange Debt Charity - 0800 138 1111
- National Debtline - 0808 808 4000
- Debt Advice Foundation - 0800 043 40 50
» MORE: How to get debt help
How to get yourself out of insolvency
Once you’ve entered a form of insolvency, the main route out of it is to clear the relevant debts and meet the terms of any arrangements you have reached.
With bankruptcy, it’s usually 12 months before you’re discharged, although that can be delayed if necessary. However, any income payments you’re making as part of the agreement will continue after you’ve been discharged, typically for three years from the date of bankruptcy.
Sequestration also lasts for 12 months, except in some circumstances, and you may have to continue making repayments for a further 36 months.
You can get out of an IVA if your insolvency practitioner and creditors agree, perhaps because you won’t be able to repay any more money or you can show that you’ll be better able to repay your debts without an IVA in place.
Before any type of insolvency, make sure you understand how you can get out of it, as the conditions can vary between different arrangements.
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Jeff is a freelance journalist who writes across finance & business. He was the personal finance editor at The Scotsman & Scotland on Sunday & a member of the Financial Services Consumer Panel. Read more