Personal insolvency occurs when an individual cannot pay their debts. The main formal procedures are bankruptcy, Individual Voluntary Arrangements (IVAs), and Debt Relief Orders (DROs). Each procedure has different consequences, eligibility criteria, and implications for the debtor's financial future.
Bankruptcy is a court order that declares an individual unable to pay their debts. The debtor's assets are realised and distributed to creditors. The bankruptcy order typically lasts for 12 months, after which the debtor is discharged from most debts. Bankruptcy has serious consequences including loss of assets, restrictions on financial activities, and impact on credit rating.
Bankrupts face significant restrictions: cannot obtain credit over £500 without disclosing bankruptcy status, cannot act as a company director, cannot practice as a chartered accountant or lawyer (in many cases), and public disclosure of bankruptcy through the Individual Insolvency Register.
The Official Receiver is a government official who becomes the trustee of the bankrupt estate. They investigate the debtor's affairs, realise and distribute assets, and may interview the debtor under oath. The Official Receiver may call a creditors' meeting to appoint an insolvency practitioner as trustee instead.
The bankruptcy estate consists of all assets belonging to the debtor at the start of bankruptcy, plus assets acquired during bankruptcy. Exempt property includes: tools of the trade (equipment needed for work), clothing, bedding, furniture, and basic household items. The family home is NOT exempt and may be sold to realise equity.
The trustee has 3 years from the date of the bankruptcy order to deal with the family home. Options include: selling the property, selling the debtor's share to a third party, or applying for an order for sale. Any equity above the mortgage debt belongs to the bankruptcy estate.
Most debtors are automatically discharged from bankruptcy after 12 months. Discharge releases the debtor from most bankruptcy debts, though some debts survive bankruptcy (e.g., student loans, fines, CSA arrears). Early discharge is possible if the Official Receiver concludes investigation early.
If the debtor engaged in misconduct (fraudulent trading, gambling, reckless speculation), the Official Receiver may apply for a Bankruptcy Restrictions Order (BRO) or the debtor may accept a Bankruptcy Restrictions Undertaking (BRU). These extend restrictions for 2-15 years beyond discharge.
An Individual Voluntary Arrangement is a formal agreement between debtor and creditors to repay debts over time, typically at a reduced amount. If approved, it binds all creditors who were notified, including those who voted against. IVAs are supervised by an insolvency practitioner.
IVA avoids the stigma and restrictions of bankruptcy, allows debtor to keep assets (including home), protects professional status, and provides certainty for creditors. However, creditors must approve, and arrangement typically lasts 5-6 years.
If the debtor fails to comply with IVA terms, the supervisor may petition for bankruptcy. The bankruptcy is treated as starting from the date of the IVA failure, potentially affecting assets acquired during the IVA.
A Debt Relief Order is a low-cost alternative to bankruptcy for people with less than £30,000 of debts, less than £75 per month disposable income, and assets worth less than £2,000 (or £1,000 for a car). It lasts for 12 months, after which all included debts are written off. Application fee is £90.
While a DRO is in effect and for 6 years after, the debtor is listed on the Individual Insolvency Register. Cannot obtain credit over £500 without disclosing DRO status. Some professions restrict employment of those with DROs. Debts included in DRO are written off after 12 months.
Included: Most consumer debts - credit cards, personal loans, overdrafts, rent arrears, utility bills, council tax. Excluded: Student loans, court fines, CSA arrears, debts from fraud, secured debts (mortgage arrears on property can be included but secured lending itself is not affected).
An Administration Order is a court order requiring the debtor to make regular payments to the court, which distributes to creditors. Available for debts under £5,000. If the order requires full payment plus interest within a reasonable time, it binds all creditors.
Administration Orders are rarely used now due to low £5,000 debt limit. Most debtors with this level of debt are advised to consider DROs or negotiate informally with creditors.
A statutory demand is a formal demand for payment of a debt of at least £5,000. It gives the debtor 21 days to pay or secure the debt. If unpaid, the creditor can use this as evidence of insolvency to petition for bankruptcy.
The debtor can apply to court to set aside a statutory demand within 18 days of service. Grounds include: dispute about the debt, counterclaim exceeding the debt, set-off, or that the debtor has assets exceeding the debt. If set aside is successful, creditor cannot use it for bankruptcy petition.
| Feature | Bankruptcy | IVA | DRO |
|---|---|---|---|
| Cost | £680 (fee) | IP fees (~£5,000+) | £90 (fee) |
| Duration | 12 months | Typically 5-6 years | 12 months |
| Asset impact | Assets realised | Assets usually protected | Assets limited to £2,000 |
| Creditors' approval | Not required | 75% approval needed | Not required |
| Publicity | Individual Insolvency Register | Individual Insolvency Register | Individual Insolvency Register |
| Home impact | May be sold | Usually protected | Not allowed if homeowner |
| Best for | No realistic repayment option | Regular income, want to protect assets | Very low income and assets |
A Debt Management Plan (DMP) is an INFORMAL agreement between debtor and creditors to repay debts at affordable rate. It is not legally binding, does not involve court, and does not appear on the Individual Insolvency Register. Typically offered by debt charities or commercial providers.
DMPs are flexible and avoid the stigma of formal insolvency. However, creditors can still take enforcement action, interest and charges may continue, and the plan depends on creditor cooperation. Suitable for those who can realistically repay debts but need time.
A charging order secures an unsecured debt on the debtor's property. If the property is sold, the debt is paid from proceeds before the debtor receives anything. Charging orders are increasingly used by creditors, especially for credit card debts and personal loans.
Bankruptcy affects many professions: solicitors must obtain permission from SRA to practice, accountants may be prevented from practising, company directors are disqualified during bankruptcy, FCA-regulated roles are restricted, some public sector jobs have restrictions.
Undischarged bankrupts cannot act as company directors except with court permission. The court may grant permission for a specific company. Breach is a criminal offence. Directors of insolvent companies may face separate disqualification proceedings under the Company Directors Disqualification Act 1986.
Sole traders are personally liable for all business debts. Business assets and personal assets are treated identically in bankruptcy. This unlimited liability is a key disadvantage of sole trader status compared to limited liability companies.
Partners are jointly and severally liable for partnership debts. If one partner becomes bankrupt, creditors can pursue the remaining partners for the full debt. The bankrupt partner's share of partnership assets becomes part of the bankruptcy estate.
A partner's bankruptcy does NOT automatically dissolve a partnership, but the partnership agreement may provide for dissolution. The remaining partners may need to buy out the bankrupt partner's share or dissolve the partnership.