What is bankruptcy?
Bankruptcy is a statutory insolvency procedure designed to help an insolvent individual repay as much of their debt as possible. Bankruptcies are overseen by a licensed insolvency practitioner or Official Receiver acting as a 'trustee'. Bankruptcies are an option in England & Wales and Northern Ireland, although the process in Northern Ireland may differ slightly to what is set out below. In Scotland, the equivalent process is known as Sequestration.
Following a court order or an adjudicator decision to declare an insolvent person to be bankrupt, the person's affairs are administered by a trustee, in the interest of creditors (the people or organisations to whom the individual owes money). The person's assets are 'realised' (i.e. distributed or sold) to raise money to repay their creditors in a legally prescribed order of priority.
Having been made bankrupt, an individual is subject to certain restrictions, such as not being able to act as a company director. These restrictions last until they are 'discharged' from bankruptcy, which usually happens after one year.
Once discharged from bankruptcy, a person is considered 'free' in respect of their pre-bankruptcy debts, although their trustee will often continue to remain in office in order to realise any remaining bankruptcy assets, make dividend payments to creditors and to fully investigate the bankrupt's affairs and business dealings.
Bankruptcy can also be used as a means to combat fraud: insolvency practitioners are often appointed as trustees so that they can track down and take control of a fraudster's assets, and make repayments to victims and other creditors.
Although bankruptcy is the best-known of the three types of personal insolvency procedure, it is actually the least common.
How do bankruptcies start?
To be made bankrupt, an individual must be insolvent: they must be unable to pay a debt when it is due, or their liabilities must outweigh their assets.
There are two ways someone can be declared bankrupt:
- Self-application - The insolvent person applies online to make themselves bankrupt; there is no minimum or maximum level of debt that has to be owed before bankruptcy can be considered. The application is considered by an adjudicator.
- Creditor petition - A person or organisation owed £5,000 or more by the insolvent person can apply for a court order to have that person made bankrupt.
Self-application must be done online, via the gov.uk website. The process costs £680 in government fees, which must be paid in full before an application can be submitted. The payment can be made in instalments, but the process won't begin until all payments are received. If the person applying for bankruptcy decides not to continue the process, any money they have already paid is returned to them. There is no time limit for payments. Around 70-80% of bankruptcies are through self-application.
Applications are looked over by an adjudicator working for the Insolvency Service, a government department. The adjudicator decides whether or not the person applying should be made bankrupt. It is a criminal offence to make false statements on the application form.
In around 20-30% of bankruptcies, it is a creditor petition which leads to a bankruptcy order. This can only happen when the amount owed to a creditor or creditors jointly is £5,000 or more. Additionally, if someone has broken the terms of an IVA, or if they gave false information when applying for their IVA, they can be made bankrupt by the Supervisor of the IVA. These petitions are made to, and decided on, by the court.
People who do not agree that they ought to be made bankrupt can give notice of their opposition to the bankruptcy order, via a form which must be submitted at least five days before their scheduled bankruptcy court hearing.
What happens during a bankruptcy?
- The person who has been declared bankrupt (by the adjudicator or by a court) receives a copy of the bankruptcy order.
- The bankrupt person is sent an information pack, and might be asked for further details about their financial situation (either through a phone or face-to-face interview, by filling in a questionnaire, or by sending more information about their assets, income, debts and creditors).
- They may be interviewed about their situation (sources of income, assets, life circumstances) by their trustee or the trustee's staff so that the trustee can get a fuller picture about the person's finances and assets, and so the trustee can get an initial idea of the amount that can be returned to their creditors. If an application is especially complicated, or if there is a suspicion that the bankrupt person is not telling the whole truth about their assets and income, an interview is more likely to take place.
- The bankrupt person's name and details are published in the Individual Insolvency Register. Details remain on this register for the length of the bankruptcy, and are removed three months after the bankruptcy ends.
- The bankrupt person's assets are realised and distributed for the benefit of creditors. As part of this process, the trustee takes ownership of the bankrupt person's belongings and sells them, then uses the funds gained as a result to repay creditors.
- After a year (in the vast majority of cases), the bankruptcy period ends and the individual is 'discharged'. The formerly bankrupt person may still subject to certain restrictions, however, and it may take more than a year for the bankrupt person's assets to be realised.
Who oversees a bankruptcy?
Bankruptcies are overseen by an insolvency practitioner or Official Receiver acting as a 'trustee'. The trustee's role is to try and get the best possible outcome for creditors. They are also an officer of the court, which gives them special legal powers, which they can use to investigate a bankrupt person's affairs if they need to, as well as responsibilities to uphold.
In all bankruptcy cases, either self-applications or creditor petitions, the Official Receiver is automatically appointed as trustee. Creditors holding 25% or more of the debts owed by the bankrupt person have the right to apply for an insolvency practitioner to be appointed as the trustee instead. The Official Receiver may also choose to pass a case to an insolvency practitioner without creditors asking for this to happen. An insolvency practitioner is usually appointed in more complicated cases where the failure of the bankrupt person's company is involved, where the person has significant or complex assets and debts, or where creditors believe the bankrupt person has not been honest about their asset levels.
What happens to a bankrupt’s assets and income?
After a bankrupt person's assets have been handed to their trustee, the assets may be sold to repay creditors.
Where repayments are made to creditors out of the individual's assets, this is done according to a strict hierarchy set out by government. You can find details of this hierarchy here. The amount of money repaid to creditors depends on the value of the insolvent individual's assets.
The bankrupt person is allowed to keep anything they need for their job, and household items, including furniture and clothes.
Cars can be kept if they are essential (for example, if the bankrupt person or someone in the household needs the car to get to school or work, or if they are disabled), but if they are wholly owned by the bankrupt person and are worth over around £1,500, the trustee may require the car to be sold, and a replacement purchased for £1,000. Where a car has been purchased on finance (for example, using a 'Personal Contract Purchase' loan), the trustee may allow the bankrupt person to keep making payments to retain the use of the car if it is deemed essential.
If the bankrupt person owns outright or has equity above £1,000 in their home, the trustee may require the property to be sold, and the bankrupt person to find alternative accommodation. This also applies to properties which are jointly owned, and the share in the property due to the bankrupt person will be passed to the trustee. Typically, to avoid a sale, a trustee would first offer the bankrupt individual the opportunity to purchase the trustee's interest in the property.
A trustee has three years from the date of the bankruptcy order to deal with an individual's family home. After that period, if no action has been taken by the trustee, ownership of the bankrupt person's share of the property is handed back to them and becomes unavailable to creditors.
The bankrupt person may be required to make a contribution from their income for a period of up to three years if the trustee considers they have surplus income, via an Income Payments Order or an Income Payments Agreement.
Action can also be taken by the trustee to recover assets which have been given away prior to bankruptcy in order to put them out of reach of creditors - for example, if a person signed over their share in a property to a spouse or family member prior to applying to become bankrupt, the trustee may reverse this transaction.
What restrictions are there on a bankrupt person?
During the period of their bankruptcy, a bankrupt person is restricted from certain jobs and activities. These include:
- Being the director of a limited company
- Running a company, without a court's permission
- Borrowing more than £500 without telling the lender that they are bankrupt
- Holding some jobs, such as insolvency practitioner, MOT authorised examiner, charity trustee, registrar, and consumer credit licence holder
- Holding lasting power of attorney for another person
- Using a different business name, if self-employed, without telling all customers about their bankruptcy.
Some private organisations may have their own rules which bar individuals subject to a bankruptcy order from membership.
Can bankruptcy be extended?
A trustee can apply to court for a Bankruptcy Restriction Order (BRO) if the bankrupt person is found to have been dishonest (by hiding assets from their trustee, for example, or breaking the terms of their bankruptcy agreement).
BROs can be granted for lengths of up to 15 years. People subject to bankruptcy restrictions are barred from being local or national politicians, magistrates, and school governors, in addition to the standard bankruptcy restrictions.
What happens after a bankruptcy has been discharged?
When a person is discharged from bankruptcy, their debts (excluding student loans, fraudulent debts and criminal fines) are written off and they are freed from the restrictions which have been placed on them. Three months after this, their details are removed from the Individual Insolvency Register.
Six years after bankruptcy, the details are removed from the formerly bankrupt person's credit file.
R3 members can provide advice on a range of business and personal finance issues. To find an R3 member who can help you, click below.