Definition of bankruptcy: The legal process initiated when an individual or company is unable to repay their debts.

What is bankruptcy?

Bankruptcy means different things in different countries.

Bankruptcy is the ultimate method through which an individual or business can escape unaffordable debts.

In the UK, bankruptcy only refers to the process for individuals. Business bankruptcy is known officially as insolvency and is dealt with via the process of administration or liquidation.

Individual bankruptcy

Bankruptcy is a very severe and irreversible process, therefore the government does not advise individuals to apply for bankruptcy until all other options have been tried, such as:

• Arranging better payment terms directly with lenders
• Entering into an individual voluntary arrangement (IVA) with all lenders
• Restructure debts, with the aim of replacing higher interest rate debts with longer-term debts with lower monthly payments.

There are two ways an individual can be made bankrupt.

1. By applying directly to the government to become bankrupt

2. By being made bankrupt by someone else petitioning the government

You can be bankrupted at someone else’s request on the following grounds:

• You owe over £5,000 and cannot pay your debts
• You breach the terms of an IVA
• You lied to obtain an IVA

What is it like to become bankrupt?

Once triggered, the impact of becoming bankrupt is similar. Bankruptcy can be humiliating and financially crippling. However, this is still an attractive proposition for those who are being harassed on a daily basis for debts that they cannot feasibly repay.

Your assets can be liquidated and used to repay your debts.

This can leave you literally ‘penniless’. You must be honest and transparent about your assets when dealing with the court or whoever manages your bankruptcy.

You will be subject to restrictions for at least 12 months

• You must declare your bankrupt status to any potential lender for a loan > £500.
• You cannot act as the director of a company with the court’s prior written permission
• You cannot create, manage or promote a company without the same permission.
• You cannot manage any business (even business undertaken as a sole trader) without declaring your bankrupt status to customers and suppliers.

Breaking these rules is a criminal matter which could result in fines or a jail sentence.

You will feature on the Individual Insolvency Register

This is a register of public record which many lenders and businesses will check against when performing identity checks, credit checks or background checks.

These tough rules are designed to reduce the likelihood of debts accumulating again.

Why does bankruptcy exist?

The purpose of bankruptcy is to avoid a situation in that an individual is harassed for the rest of their life for debts that they couldn’t possibly repay.

Accumulating unaffordable debts can be seen as irresponsible behaviour, however it’s worth remembering that even honest, legitimate self employed workers and other individuals can find themselves in financial difficulty due to a variety of factors which could be out of their control:

• Business failure after taking a reasonable risk
• Significant losses on personal investments
• Personal loss through insured theft, flood or natural disaster
• Personal loss through fraud or deception

It feels morally justified that the state provides a way for individuals to pay everything they can, and then clean their slate.

If someone is hounded by a debt which will take the rest of their lives to pay off – they will have no incentive to earn any income as all the proceeds would simply go to the creditors.

Thanks to bankruptcy, an individual will regain the incentive to become an economically active member of society and maximise their income and taxes paid over the rest of the lifetime, which is in the interests of wider society.

How is the phrase bankruptcy used in a sentence?

“The individual who has filed for bankruptcy has no assets left to their name, and wishes turn their life around.”

How does the definition of bankruptcy relate to investing?

If you read business books or entrepreneurship books that cover the personal tales of rich and wealthy investors and business people, you will frequently see references to bankruptcy. Check out our article about rich and famous people who have been made bankrupt.

Entrepreneurs and sophisticated investors often take large risks, and when those don’t pan out – bankruptcy is often the natural conclusion.