What is bankruptcy?
Bankruptcy (also known as ‘sequestration’ in Scotland) is a process designed to help people who are unable to pay off their debts. If an individual is not able to meet their financial obligations (eg pay their mortgage, credit card bills or hire purchase agreement payments), they may be able to apply for bankruptcy. This can provide relief from their debts and, in some circumstances, a new financial start.
For more information on applying for bankruptcy, read Bankruptcy process.
What are the main consequences of bankruptcy?
Applying for bankruptcy is not something that should be taken lightly as it has multiple consequences, both negative and positive. The practical implications of bankruptcy include:
-
most of the bankrupt individual’s debts are written off (ie cancelled)
-
the bankrupt individual’s assets need to be relinquished and disposed of (ie sold) by the trustee in bankruptcy (or simply ‘trustee’). This is the person who handles the assets of the bankrupt individual and distributes them, or the proceeds from their sale, to the bankrupt individual’s creditors (ie the people or businesses the bankrupt individual owes money to)
-
the bankrupt individual’s bank and building society accounts will be frozen and controlled by the trustee
-
during the bankruptcy period, accessing any form of credit is extremely difficult for the bankrupt individual (and there are other restrictions)
-
the bankrupt individual’s credit scores can be affected for up to 6 years following a bankruptcy order
What are the advantages of bankruptcy?
Bankruptcy enables an individual to write off most of their debts. If the level of debt exceeds the total amount of assets held by the bankrupt individual (including any equity in their home) and repayment would take many years, bankruptcy may be preferable to other debt repayment options.
Bankrupt individuals are allowed to keep some of their assets. These include:
-
vehicles needed for work purposes, basic needs, or to look after a dependent (eg a disabled relative or a child). In Scotland, vehicles must be worth less than £3,000 to be retained
-
items that they need for their job (eg tools)
-
household items (eg clothing, bedding and furniture)
-
money that’s urgently needed (eg to buy food)
-
money belonging to the bankrupt individual’s partner that is held in a joint account. This is given back to the partner
-
generally, any money put into a pension
-
any belongings that are necessary for the bankrupt individual’s basic family needs
If a family home (ie where the bankrupt individual and/or their current or former spouse/civil partner resides) has not been sold by the trustee within 3 years of the date of the bankruptcy order, it may be returned to the bankrupt individual.
What are the disadvantages of bankruptcy?
Bankrupt individuals will lose most of their assets and access to credit for at least a year. Their home may be sold (depending on the amount of equity). Additionally, they will face certain restrictions during the bankruptcy period. These include not being allowed to:
-
borrow more than a certain amount (£500 in England and Wales or £2,000 in Scotland) without informing the lender of their bankruptcy status
-
act as a director of a company (unless the court gives permission)
-
create, manage or promote a company (unless the court gives permission)
-
manage a business under a different name (unless they inform anyone they do business with that they are bankrupt)
-
work or act in certain sectors or roles. For example:
-
as insolvency practitioners
-
in certain roles in the gambling industry (eg as dealers or croupiers)
-
in certain regulated professions that require licences or registrations that are invalidated by bankruptcies (eg law, accountancy, financial services, and banking)
-
as Members of Parliament, members of any local council, or Justices of the Peace
-
as members of a school board (this only applies in Scotland)
-
Although most debts will be written off once the bankruptcy has been discharged (ie once the bankruptcy comes to an end), the bankrupt individual may need to make monthly payments towards their debts.
In England and Wales, payments may be required as part of an Income Payments Agreement (IPA) for up to 3 years following bankruptcy. IPAs can be changed if there are changes to the bankrupt individual’s income or expenses (eg if they get a raise, inherit money or have a child).
In Scotland, bankrupt individuals who are assessed as having enough money will have to pay contributions towards their debt for 4 years. Further, if a bankrupt individual obtains (eg inherits) new property or money within 4 years of declaring bankruptcy, it may be claimed by the trustee.
How to decide whether or not to go bankrupt?
Individuals considering bankruptcy should weigh up the pros and cons of bankruptcy before deciding whether to proceed. If there is no prospect of improvement in their financial situations - and if the individual’s debts will take many years to repay - bankruptcy may prove to be a sensible option. However, the individual should first consider all relevant alternatives. You can use the government’s tool for finding alternative ways of dealing with debts.
Potential bankrupt individuals should assess the consequences of bankruptcy upon the full value of their assets. This is particularly important if they own significant equity in their home. Furthermore, regulators for certain professionals (eg solicitors and accountants) apply restrictions on membership regarding individuals who have been bankrupt, so it is important to check this aspect as well.
