In 2012, The Office for National Statistics published figures which showed that 23.8% of UK enterprises were operated by sole proprietors. Rules, different to those applying to limited companies, apply to sole traders who are not protected by the provisions of the Companies Act, or Limited Liabilities Partnership Act. This means that those trading on their own carry full liability, and should their business become insolvent,
the business debts are their personal debts, meaning that they could lose the value
of their personal assets, including property, vehicles, and other
valuable goods and be declared bankrupt.
Definition of a sole trader
Sole traders are self employed people who own and operate their own businesses. They make all the decisions, are responsible for raising finance and for debts incurred, and they take the profits.
There is no legal distinction between the business and the trader. The sole trader must:
- Register with Her Majesty’s Revenue and Customs (HMRC) for Tax and National Insurance purposes;
- Keep accurate accounts and other business records; and
- Submit an annual Tax return to HMRC.
They are vulnerable and Business Analysts are likely to advise a self
employed business person to become a limited company in order to limit personal liability. This may also carry the advantages of other companies being more willing to trade with them, and they might find it easier to secure credit.
Sole trader insolvency
Sole traders who cannot meet their financial obligation and pay their bills on time are likely to become subject to legal action by creditors; the sole trader is likely to be either:
- Cash-flow insolvent – problems with income means that they cannot pay creditors on time or possibly at all; or
- Balance sheet insolvent – the trader’s liabilities exceed their assets.
Causes of sole trader insolvency
Some common factors underlying sole trader insolvency include:
- Sending invoices to customers for goods and services too long after those goods and services were supplied;
- Taking large orders that the sole trader is incapable of meeting;
- Failure to pursue unpaid debts and allowing them to mount up;
- Entering into costly and inappropriate credit agreements; and
- Taking cash, in excess of profit, out of the business.
Informal steps that can be taken by a sole trader to
deal with insolvency
Sole traders must, of course, exercise due care and diligence in running their businesses. Prior to reaching a situation where a creditor is likely to force matters, the sole trader should examine the business, perhaps with the help of a business consultant, so that they understand fully the position the business is in. In particular they should look at operating costs, financing and lease arrangements, and income. Their ultimate goal will be to restructure the business to reduce costs and maximize income so they can repay their creditors. They should consider the following:
- Shedding unnecessary staff (subject to redundancy pay and unfair dismissal considerations);
- Whether the business can operate from cheaper premises or perhaps from the sole trader’s home;
- Renegotiation of finance deals and leases; and
- How to increase demand for the businesses’ products and services.
If, by making changes to the business, a sole trader is unable to realise enough funds with which to meet credit commitments, they can try to reach agreement with their creditors. Creditors may be prepared to allow the sole trader to pay arrears over a longer period; however this is likely to be conditional on them also making full instalment payments. If the sole trader cannot agree to this, the creditors could be asked to accept reduced repayments. Creditors are under no legal obligations to accept such an arrangement, and even if they do, it is possible that a Default Notice will be issued to credit reference agencies, with the result that the sole trader may experience difficulty obtaining credit in the future.
If a sole trader is unable to avoid insolvency by restructuring the business or reaching informal agreement with the creditors, there are two possible courses of action.
Bankruptcy can only be instigated by petitioning the Court for a Bankruptcy Order (BO). A sole trader can instigate their own bankruptcy by paying the Court fee, completing the required forms, and lodging them, together with a Statement of Affairs, with the Court. If the BO is granted the Official Receiver (OR) will be
appointed as trustee and may, in some cases, appoint an Insolvency Practitioner (IP).
The OR will:
- Investigate the cause of financial failure of the business;
- Unless an Insolvency Practitioner is appointed, act as Trustee.
Bankruptcy petition submitted by a creditor
In order for a creditor to pursue a sole trader for bankruptcy the following must apply:
- The debt owed to the creditor must exceed £5,000;
- The creditor must have obtained a County Court Judgement against the sole trader;
- A Statutory Demand for payment within 21 days must have been issued to the sole trader, and the 21 day period must have expired.
Once the above stipulations are met, the creditor can petition the Court. Irrespective of the route by which it is obtained, once a BO is granted, the sole trader will lose control of affairs and the OR will sell any assets to raise
funds with which to settle creditors’ claims.
The consequences of bankruptcy
Bankruptcy is a serious step and should only be considered as a last resort after taking professional advice, preferably as soon as the sole trader knows the business is in trouble. Consequences for sole traders include:
- Their homes, vehicles or other valuable assets could be sold;
- They will have their behaviour scrutinised and reported on;
- Creditors will publicise the fact they have petitioned for bankruptcy of the sole trader by placing a notice in The London Gazette, and perhaps in local papers; and;
- Bankruptcy will be noted on the sole trader’s credit file for a
number of years.
- They may have difficulty trading in the future or securing
Advantages of bankruptcy
Bankruptcy does provide a sole trader with the opportunity to make a fresh start. The advantages include:
- Discharge from bankruptcy can be after one year;
- No more is owed following discharge;
- Considerable sums of money can be written off; and
- Bankruptcy no longer carries the stigma it once did.
Individual Voluntary Arrangements
Under the Insolvency Act 1986, a sole trader can apply for an Individual Voluntary Arrangement or IVA. An IVA is a formal way to reach agreement with creditors over repayment of debts. An IVA can only be arranged through an Insolvency Practitioner (IP) who will:
- Examine the state of the business and establish the amount of debt owed;
- Work with the applicant to set out a monthly budget; the amount needed to meet monthly outgoings, including, housing costs, secured debts, council tax, utility bills, necessary travelling expenses, food, etc. The amount available for paying creditors will be the difference between the expenses and income; this is called the available amount;
- Calculate what percentage of the total debt is owed to each creditor and offer payments, calculated by applying the percentage of debt owed to the available amount;
- Prepare the terms of the IVA for voting on ('the Proposals');
- Call a Creditors meeting. Although it is unusual for creditors to attend the meeting they must let the IP know whether they agree to the proposals. An IVA can only be set up if 75% of
voting creditors by value agree. Once in place, the sole trader pays the IP, by the due date, the
agreed amount each month. The IP deducts their fee and makes a payment, as agreed
in the proposals, to each creditor. An IVA normally lasts between 3 and 5 years. The IVA must stipulate how any interest in property owned by the debtor will be taken into account in the IVA.
A sole trader can still apply for an IVA, even if a petition for bankruptcy has been made. In such a case, an application can be made for an Interim Order to give an opportunity for an IVA to be put in place. IVAs are an increasingly popular way of handling insolvency because:
- Traders retain control of their businesses and can usually continue to trade;
- Any amount outstanding at the end of the IVA period (the treatment of assets, such a property, not withstanding) is written off;
- The debtor is allowed a personal budget providing enough to live on; and
- Pressure from creditors and debt collectors stops.