What Happens to Business Debts When a Business Closes?

May 30, 2023 / Business Insolvency

The decision to close a business is never an easy one to make. The reasons for doing so are plentiful, with some being worse than others. Directors may choose to close their company for the sake of retirement, as a response to a decline in profitability, or because their companies are buckling under the weight of business debts. However, although the first two reasons are more or less self-explanatory, there is some hesitation regarding the latter. Some directors are reluctant to wind up their business if it has debts, wondering exactly what happens to debts when a business closes.

In this article, Clarke Bell will answer this question, breaking down the various methods of closing a company and how business debts interact with each procedure.

What happens to business debts when closing a solvent company?

Closing a solvent company has very little effect on business debts, though the procedure you use will have a wider effect on other aspects of your company, as we discuss below.

Members’ Voluntary Liquidation

A Members’ Voluntary Liquidation (MVL) is one procedure for closing a solvent company. It requires the signing of a Declaration of Solvency, which is essentially a document confirming that your company has the financial ability to repay all its debts and liabilities, classifying it as solvent. If you decide to use this method of closing your solvent company, you must pay off all your debts before attempting to close the company. Assuming you do this, your business debts will have no further impact.

Closing through an MVL is a highly advantageous method for larger companies. This is primarily due to the tax efficiency of the procedure. Unlike other procedures for closing a solvent company, an MVL sees realised profits taxed under Capital Gains Tax rates, rather than Income Tax rates. This alone greatly reduces the tax burden for the company in question.

This advantage is not the only one offered by an MVL. The MVL procedure allows companies to apply for Business Asset Disposal Relief, which was previously known as Entrepreneurs’ Relief before 6th April 2020. If eligible, this relief can reduce the tax burden placed on a company’s profits considerably, when combined with the aforementioned advantage inherent to an MVL. When combined, the two tax reductions can bring the total burden down to just 10%, which can be a remarkable saving for larger companies. However, this relief does have a lifetime limit of £1 million.

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For solvent companies that are smaller and lack a level of retained profits that makes an MVL worthwhile, company dissolution offers a more than competitive alternative. It can be initiated by directors, using a DS01 form to begin the process. This form can be submitted in paper format or online, costing £10 and £8, respectively. This makes dissolution one of the most cost-effective methods of closing a company.

As with an MVL, directors will need to ensure their company is solvent before entering into this procedure, and that all debts and liabilities are paid before the company is closed. If this is done, business debts will have no further impact. If not, then creditors can obstruct the process, potentially cancelling it completely, and directors may be viewed as attempting to avoid repaying their debts.

What happens to business debts when closing an insolvent company?

If a company is insolvent, the previous methods of closing will not be available. Attempting to place an insolvent company into procedures meant for solvent companies is not likely to get very far, and can result in serious consequences for directors. Instead, directors should turn to methods of closing designed for insolvent companies.

Creditors’ Voluntary Liquidation

One of the best methods of closing an insolvent company is a Creditors’ Voluntary Liquidation (CVL). It can be initiated voluntarily by a company’s directors, and allows them to appoint an insolvency practitioner of their choosing to the role of liquidator. It is the job of the liquidator to carry out the procedure, which entails communicating with creditors, identifying company assets, and disposing of said assets. The money raised from this asset disposal will be distributed amongst company creditors, with the aim of paying all debts and liabilities. Although this is the aim, it is unlikely that an insolvent company will have enough assets to repay its debts.

If the company cannot pay all its loans and liabilities, this business debt will have an effect based on certain factors. In most cases, any business debt that remains outstanding will be written off completely. This includes business debt, tax debt, Bounce Back Loans, and other forms of debt. However, there are exceptions to this rule. If directors signed a personal guarantee as part of a loan agreement, responsibility for the loan will be transferred to them instead. As such, they must repay the loan from their own personal finances.

Insolvency Service

Another exception that would see otherwise written-off debt remain outstanding is director misconduct. As part of the CVL process, the liquidator will be responsible for carrying out an investigation into the company’s finances and its directors’ conduct. If any misconduct is found, such as preferential payments, fraud, or a general failure to act in the best interests of creditors once the company became insolvent, it will be included in a report to the Insolvency Service. The Insolvency Service will then decide whether to apply penalties. Amongst others, these penalties can result in fines and personal liability for company debt. If a director is made responsible for business debt, they must make repayments just as they would if they had secured the loan using a personal guarantee.

Clarke Bell can help

If your company is struggling with financial problems, don’t go it alone; let Clarke Bell help. We have more than 28 years of experience in helping companies find the best paths forward, and we can do the same for you. Whether it be a form of liquidation, the implementation of a business rescue plan, or otherwise, our team of experts can make sure you get the best result for your company. Don’t hesitate to contact us today for a free, no-obligation consultation and find out exactly what we can do for you.