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The Difference Between Bankruptcy and Liquidation

Operating a business through a limited company offers various benefits compared to running one as a sole proprietor, including the ability to avoid personal liability for your company’s trading debts.

Operating a business through a limited company offers various benefits compared to running one as a sole proprietor, including the ability to avoid personal liability for your company’s trading debts. This means that you can protect your personal assets if the business fails. If you and your company are unable to pay the debts, then the consequences would be your company going into liquidation, and you become bankrupt.

When Your Company is Overwhelmed by Debt

Liquidation and bankruptcy refer to two different events that occur when your limited company becomes overwhelmed by debt. A limited company owns all the assets that the business has acquired over time, and is also liable for any debts incurred. The directors or shareholders of the company are not personally liable for the company’s liabilities, including trading debts.

However, there are instances when banks, suppliers, and other creditors may ask you as a director to give a personal guarantee against any unpaid liabilities of the company. As a result, if the company is unable to pay, then you can be legally liable for the debt under guarantee.

In situations where both the company and you are under financial pressure from creditors demanding payment, you may seek professional help from a financial advisor. But if the company continues to operate and incur debts, despite its inability to pay when they are due, then you might become personally liable for those debts, irrespective of whether or not you gave a personal guarantee.

Personal Bankruptcy

A court can declare you bankrupt if you’re considered to be unable to make payments on your debts. Consequently, most of your unsecured debts may be eliminated, and debt collectors stopped from harassing you for payment. However, you will be legally bankrupt for several years, which could adversely affect your financial future. So, although bankruptcy offers relief for debt, you should seek professional help to determine whether you have better options before taking this course of action.

There are two ways you can become bankrupt:

  • Voluntarily, where you choose to make a “debtor’s petition”
  • Through a creditor’s petition, where the court orders that you go bankrupt following an application by one of your creditors

Upon your bankruptcy, a trustee is appointed to administer your bankrupt estate. This means that you’re no longer a director at the company. Basically, you hand over your shares and control of the company to the trustee. The trustee will decide what action to take regarding any interest you had in the company.

The trustee can choose to put the company into liquidation or sell the shares if this course of action can raise funds needed to pay your creditors. If the trustee chooses the former, you must help the liquidator by providing them with information about the company’s affairs, dealings, and property.

If the company doesn’t have any assets or has little to no value, the trustee doesn’t have to take any action. Instead, one of your creditors might apply to a court requesting that your company be liquidated.

Limited Company Liquidation

Liquidation is the process through which a limited company is brought to a close by an appointed liquidator or insolvency practitioner. A company can go into liquidation either by:

  • Voluntary liquidation following the resolution of the shareholders, or
  • Court liquidation when the court orders that your company be wound up, following one of your creditors filing an application with the court.

Once your company goes into liquidation, a liquidator is appointed to administer its ending. Once again, you will be required to help the liquidator by providing valuable information about the company to recover as much money as possible.

The liquidator maintains authority over how the liquidation will be conducted. He or she will investigate the company’s affairs, property, and businesses; evaluate any company assets that are worth recovering to aid in repaying the creditors; and look for any claims that may exist against the directors, such as breaches of director duties and failure to take action to stop the company from continuing operations and incurring further debt while insolvent.

If you’re not declared bankrupt, you will still be liable for personal debt, including your personal credit card and any company debts you had personally guaranteed. You will be expected to repay any debts you owe the company, such as personal loans received from the company. Your company’s liquidation will only resolve the company's indebtedness to its creditors, not your personal debts or guarantees.

Summary of Differences Between Liquidation and Bankruptcy

Both liquidation and bankruptcy occur as an option of last resort. They can be voluntary or imposed by the court, but the end result is an attempt to manage assets to pay off debts where possible.

However, the two are different states, as follows:

  • Bankruptcy is an insolvency situation for individuals, while liquidation can occur due to insolvency or another reason, such as ceasing operations.
  • Bankruptcy affects only one individual, whereas liquidation impacts many people, including the directors, shareholders, and employees, who will be affected by debt recovery or employment termination. Both situations influence creditors who are unable to recover their debt.
  • With bankruptcy, the individual will be given relief from paying most debts. Liquidation, on the other hand, means that the company will be shut down in an orderly manner as the liquidator attempts to dispose of any assets to repay company debts.
  • As a result, once a company is shut down from liquidation, it ceases to exist. The company structure is dismantled, and assets are sold off, so it will never return to operations. The legal state of bankruptcy, on the other hand, will only last for several years, after which it won’t show in your credit history.

Final Note

Business failure can cause a brush with the law, risking asset recovery actions and penalties if you don’t comply with certain legal obligations as a director. It’s important that you consult a qualified financial advisor as soon as you realize that you’re unable to keep up with the payments for your company debts. This advisor may be an insolvency accountant or lawyer, a registered trustee if you want to consult about your personal financial situation, or a registered liquidator if you want to discuss your company’s dire financial situation.

Keep in mind that the specialist you choose to meet with can provide preliminary advice at no cost. However, if the court appoints the trustee or liquidator, they will not act for you, but for the benefit of your company creditors.

Otherwise, if your company has failed, but you’re solvent, you should seek professional financial advice to determine whether you should voluntarily put your insolvent company into administration or liquidation, or wait for a creditor to apply for the same through the court. Seek an appropriately qualified specialist to assist you through this process.

For more information on the differences between bankruptcy and liquidation in Toronto, please contact Michaels Global Trading.

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