Sole Trader Insolvency
According to the Office for National Statistics, sole proprietors represented 23.8% of all UK enterprise in 2010. Of that number, more than half a million sole traders were operating via the PAYE or VAT system alone. Sole traders are a distinct legal entity, operating as one type of UK business structure. In the event of financial problems affecting the business, they are subject to different rules to those that govern companies.
- 1 Overview
- 2 UK Insolvency statistics
- 3 UK Insolvency Law and sole traders
- 4 Insolvency options for sole traders
- 5 See also
- 6 References
Sole trader insolvency occurs when the business cannot meet financial obligations. It may be that bills cannot be paid on time, leading to debts which eventually attract legal action by creditors. Insolvency does not automatically equate to bankruptcy; definitions of insolvency are provided within the Insolvency Act 1986. Cash flow insolvency occurs when a business cannot meet its credit obligations as they fall due. Balance sheet insolvency occurs when the businesses’ liabilities exceed its assets. According to Business Link there are a number of factors that can lead to sole trader insolvency. These can include late invoicing for goods or services, accepting orders that exceed its financial capacity to deliver, failure to recover debts, excess inventory and unsuitable credit arrangements and often personal drawings taken in excess of profit.
A sole trader is the simplest type of business structure defined in UK law. It refers to an individual who owns their own business and retains all the profits from it. When starting up, sole traders must complete a straightforward registration with HM Revenue and Customs as self-employed for tax and National Insurance purposes. They are responsible for maintaining the businesses records and submitting an annual Tax return for all income from self-employment and other work.
Becoming a sole trader is relatively simple compared to other business structures. It can rapidly enable a business to begin trading; the requirements for record keeping are far more straightforward than other business structures. Sole traders make all operational decisions and are solely responsible for raising business finance. They can invest their own capital into the business, or may be able to access business loans and/or overdrafts. Unlike limited companies or partnerships, it is not necessary to share decision making or the profits.
The simplicity of this structure also has its limitations. Unlike forming a limited company, it lacks the clear cut definition between personal and business income from the perspective of the tax authorities. The business owner is personally liable for income tax and National Insurance contributions due for the business profits in each given tax year. They are also personally liable for any debts the business incurs. Business analysts may advise sole traders to form a limited company in order to access greater levels of financing, for example for expansion plans. This can limit their personal liability; business lenders may be more inclined to co-operate with a limited company. It can also be the case that within certain industries it is easier to secure work if presenting potential business partners with a limited company structure.
UK Insolvency statistics
During 2010, the recorded number of individual insolvencies in England and Wales was 135,089 according to the UK Government’s Insolvency Service (including provisional figures from the final quarter). The figures had fallen by 13.6% during the final quarter compared to the same quarter during 2009. 12,049 individuals declared formal bankruptcy, a drop of almost a third (29.2%) on the previous year. 12,058 entered formal Individual Voluntary Arrangements (IVAs), representing an annual drop of 5.4%. A further 6,172 entered a formal Debt Relief Order (DRO), an increase of 15.4% on the previous year’s figures. The levels of self-employed bankruptcies had fallen slightly by the third quarter of 2010 to make up 11.9% of the total within England and Wales. This represented an improvement on the number of bankrupt sole traders during the previous year and up to June 2010.
UK Insolvency Law and sole traders
Insolvency Act 1986
This legislation provides the legal framework for two key formal insolvency solutions relevant to sole traders: namely bankruptcy and Individual Voluntary Arrangements. It also makes provision for company insolvency
Bankruptcy laws vary somewhat between Scotland, Northern Ireland, Wales and England. In England, Wales & Northern Ireland, the applicable law is the Insolvency Act 1986.[example needed] Bankruptcy requires the surrender of all valuable assets to the Official Receiver, including any property interests. It is extremely unlikely the business activities would be permitted to continue. Additionally, there are quite a number of other legal restrictions upon the bankrupt individual. Individuals are therefore cautioned by the Insolvency Service to explore whether alternatives exist.
Individual Voluntary Arrangements (IVAs) operate in England, Wales & Northern Ireland as a contractual agreement between the insolvent individual and the creditors they owe money to. IVAs are facilitated by an Insolvency Practitioner and are an agreement that the individual will repay agreed instalments over a fixed period of time. In Scotland, the Protected Trust Deed serves a similar purpose.
Insolvency Act 2000
This act was introduced in two stages: 2 April 2001 and 1 January 2003. It made provision for a new moratorium method to address financial difficulties faced by small companies. Relevant to sole traders, it also somewhat amended Individual Voluntary Arrangements procedures.
Key amendments for sole traders
The Insolvency Act 2000 somewhat modified procedures for Individual Voluntary Arrangements. Previously, under the Insolvency Act 1986 an individual had to initially apply to the court for an interim order. This order would then be followed by the next legal procedures towards arranging the IVA itself. The Insolvency Act 2000 removed the need to apply for an interim order, except where a petition for the individual’s bankruptcy already applied.
There were also changes aiming to fulfil the overall purpose of the IVA, namely coming to an acceptable agreement between the individual and those they owed money to. Two cases were heard in the High Court of circumstances where this interim order had been granted but landlords were nonetheless able to lawfully gain the right of peaceable re-entry / seizing of goods in respect of rent arrears. The Insolvency Act 2000 accordingly introduced amendments aiming to prevent this type of intervention and accordingly promote the negotiation phase instead.
Insolvency options for sole traders
It may be possible to continue to trade by negotiating with creditors to gain more flexible payment arrangements. This type of informal arrangement may be facilitated by a business rescue professional but will not be legally binding on creditors. By contrast, Individual Voluntary Arrangements are legally binding on all creditors providing those representing 75% of the total debt owed agree to the IVA proposal.
An individual may voluntarily petition the local Court with bankruptcy jurisdiction for a Bankruptcy Order (BO)to be made, usually by a District Judge. The petition will require a supporting statement of affairs. On the making of the BO, the Court notifies the Official Receiver (OR) and may in certain cases also appoint an Insolvency Practitioner. The OR has a dual function, to investigate the causes of financial failure and report any misconduct and to act as Trustee if no trustee is appointed by the Court.  A creditor may petition for an individual’s bankruptcy using a prescribed series of legal steps and must be owed a minimum fixed amount of debt of at least £750. A County Court Judgement must be granted in their favour for that debt. The creditor must then issue a statutory demand for repayment. Should the demand fail to be settled within 21 days, the creditor has the option to proceed with a bankruptcy petition to the court. Following the issue of a bankruptcy order from either route, the individual cedes control of their assets to an Insolvency Practitioner, to be sold to raise funds towards repaying creditors.
- Office for National Statistics, Number of UK Businesses down
- Office for National Statistics, UK Business Activity, Size And Location 2010
- Business Link, Legal Structures: The Basics - Sole Trader
- Business Link, Insolvency Outcomes For Partnerships And Sole Traders
- "Insolvency Act 1986: Section 123". Crown. Retrieved 30 July 2014.
- Business Link, Avoid Insolvency: Improve Cashflow
- HMRC, First Steps To Register As Self-Employed
- Business Link, Legal Structures: The Basics - Sole Trader
- "Set up as a sole trader". gov.uk. Crown.
- UK Insolvency Service: Statistics Release: Insolvencies In The Fourth Quarter 2010
- "Insolvency Act 1986: Section 73". Crown. Retrieved 30 July 2014.
- UK Insolvency Service, A Guide To Bankruptcy
- UK Insolvency Service, Alternatives To Bankruptcy
- Accountant in Bankruptcy, Scotland's Insolvency Service Protected Trust Deeds
- "Insolvency Act 2000". legislation.gov.uk. Crown. Retrieved 30 July 2014.
- Third Party Mediation Business Rescue
- Smith, Mike. "Company Rescue; or Business Turnaround Solution". Retrieved 30 July 2014.
- UK Insolvency Service, Bankruptcy Information
- DirectGov - Bankruptcy - A Guide
- UK Insolvency Service - Creditor’s Petitions Information from the Insolvency Service