Bankruptcy as a freelancer: a guide for bankrupt self-employed sole traders

A more commonly known and far-longer standing method for dealing with problem debt is bankruptcy, writes Gareth Wilcox, partner at Opus Business Advisory Group.

As with a Debt Relief Order, there are certain debts which are not included in -- and therefore cannot be avoided by -- bankruptcy. 

Excluded debts: arrears that bankruptcy won’t let you avoid

This list of excluded debts is not short, so freelance sole traders and other self-employed people in financial difficulty ought to consider if the nature of their arrears won’t be addressed by becoming bankrupt. The list is as follows:

  • a debt incurred in respect of, or the payment of which was avoided by, any fraud or fraudulent breach of trust to which the bankrupt was a party.
  • any liability in respect of a fine, or a security entered into before a court, including one imposed for a public revenue offence.
  • a liability in respect of a confiscation order.
  • a liability to pay damages for negligence, nuisance or breach of a statutory, contractual or other duty, or to pay damages under consumer protection law in respect of personal injuries.
  • a liability arising under any order made in family proceedings or under a maintenance calculation made under the child support legislation.
  • an obligation in respect of a budgeting loan or a crisis loan from the social fund where the bankruptcy petition was presented on or after March 19th 2012.
  • a debt due in relation to a student loan.
  • generally, any non-provable debt (which includes many of the aforesaid categories).

Bankruptcy considerations (including winning the lotto)

An individual who owes debts -- other than those listed above -- can either apply for bankruptcy themselves if they have concluded that they cannot afford to pay them, or a creditor can apply to court for a bankruptcy order, as long as they are owed over £5,000.

If a bankruptcy order is made, all assets of the individual (apart from those which are excluded in law) immediately vest in the trustee in bankruptcy, who has a responsibility to realise them and pay the proceeds to creditors, provided there are sufficient funds. 

Be aware, a person’s first bankruptcy usually lasts for a period of 12 months before they are discharged. However, this 12-month period can be extended where there has been wrongdoing, or a failure to cooperate with the appointed trustee. 

During the period of bankruptcy, if the bankrupt happens to win the lottery -- or receive any other form of windfall, a trustee may seek to recover it as ‘after-acquired property’ in order to increase the value of the estate. In some circumstances, an individual in receipt of the windfall may seek to annul their bankruptcy on the basis that their creditors can now be repaid in full!

How to apply for bankruptcy

A person who wishes to petition for their own bankruptcy needs to apply online and pay (at the time of writing) a fee of £680. 

The applicant will be required to submit various information regarding their financial circumstances, to demonstrate that they could not reasonably be expected to pay the debts they owe.

The application is reviewed by an adjudicator employed by the Insolvency Service, and the adjudicator determines whether a bankruptcy order should be made. Presuming the order is granted, a copy is sent to the applicant and the process begins.

What happens to a bankrupt freelancer’s assets?

The assets of a bankrupt vest in their appointed trustee. This will be the official receiver (who is a civil servant at the Insolvency Service) in the first instance, or could be an insolvency practitioner later on (if a majority creditor wishes to nominate due to complexity).

As to what assets comprise, the definition of assets is wide enough to cover all property, including legal claims and any debts due to the bankrupt. 

There are some exceptions though, including:

  • such tools, vehicles, and other equipment as are necessary to the bankrupt for use personally in their employment, business or vocation;
  • such clothing, bedding, furniture, household equipment, and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and their family;
  • Assets held on trust for another party.

Where exempt assets (e.g. vehicles) of significant value are owned, a trustee may sell these and provide a suitable alternative of a lower value, with the difference paid into the estate, assuming if it is commercial to do so.

It goes without saying that an individual who has been declared bankrupt is also likely to struggle to obtain credit, even after their discharge, and unfortunately if the bankrupt is you, usually for a not insignificant period of at least six years.

What if I am freelancing, or in-work in some other capacity?

A bankrupt will be required to give details of their income and expenditure to the trustee, for the trustee to assess whether they are able to make income payments to enhance the value of the estate for a period of up to three years under an Income Payments Agreement.

If an agreement cannot be reached, a trustee can apply to court for an Income Payments Order (IPO), which forces a bankrupt to make contributions as assessed by the court for up to three years.

Is my pension at risk in bankruptcy?

Pension schemes are specifically excluded from the bankruptcy estate as long as they are ‘approved’ by HMRC, which most are and there are provisions protecting even those that are not.

For this reason, there are avenues for a trustee to seek to recover excessive contributions to discourage individuals facing bankruptcy from seeking to shield their assets from creditors by placing them in a pension scheme.

Pension income can also be taken into account when a trustee is assessing when an IPO ought to be obtained.

Do self-employed people who are made bankrupt loses their house?

For any individual who owns property, their home is likely to be their most valuable asset, and potentially unfortunately if it’s you facing bankruptcy, it falls within the definition of ‘property.’

There are specific provisions for dealing with the residential home of a bankrupt, including a requirement that the trustee deals with the interest in the period of three years from the date of bankruptcy. If the trustee does not, the property ceases to be part of the estate, and ownership reverts to the (former) bankrupt.

Further, a trustee can only deal with a property to the extent that a bankrupt owns it, i.e. after taking into account mortgage lending secured on it, and the interest of any co-owners. 

Ordinarily, the calculation will be along the lines of:

Property value – mortgage(s) = equity. And then this equity is often shared with a spouse or other co-owner in order to determine the actual value available for the trustee to sell.

Can freelancers avoid their family being uprooted?

It is common practice for a co-owner (or family member) to buy out a bankrupt’s interest in the property, to save it from being vacated and avoid the family being uprooted.

If no agreement is reached, a trustee can apply to court for an order for possession and sale of a property, although this can only ordinarily be done after a year if there are other occupants and/or dependants at the property. 

These restrictions only apply to primary residences, not holiday lets, tenanted properties and the like – which can theoretically be sold immediately.

The actual approach taken by a trustee will be dependent on circumstances For example, if there are special accessibility adaptations to a property, or if there is under £1,000 equity, they may conclude that it is not possible or appropriate to pursue an interest. Any person affected by the bankruptcy of a spouse or co-owner should take proper legal advice.

What restrictions apply during bankruptcy?

Bankrupt individuals are banned from acting as a company director for the period of their bankruptcy (usually 12 months) and from creating, managing or promoting a company.

Be aware, there can be serious criminal and criminal consequences for breaching this restriction on incorporated trading, including personal liability for company debts both for the disqualified director and on any person taking instructions from them as a ‘patsy.’ 

Undischarged bankrupts are also precluded from:

  • borrowing more than £500 without telling the lender of the bankruptcy;
  • managing a business with a different name, without telling people you are doing business with that you’re bankrupt;
  • working as an insolvency practitioner.

Why bankruptcy is difficult to hide once you’re a bankrupt

Bankruptcy may affect professional qualifications and will preclude individuals from certain roles (e.g. those in finance, police or legal roles). 

Bankruptcy orders are advertised in the London Gazette and a bankrupt’s details are added to the Individual Insolvency Register.

To combat bankruptcy fraud, there are also several bankruptcy offenses with criminal consequences, for conduct such as attempting to give away or hide assets which should have fallen into the estate.

Keep in mind, if a trustee suspects wrongdoing, they can also apply for someone’s discharge from bankruptcy to be suspended. Such a suspension is common in cases where an individual is refusing to cooperate or disclose assets and/or information.

Restrictions can also be extended by way of a Bankruptcy Restrictions Order (or undertaking) for 2-15 years if an individual is found to have acted recklessly or dishonestly by the Official Receiver.

Bankruptcy, wiping the slate clean for self-employed sole traders?

Individual insolvency is a complex area, and heavily dependent on a person’s unique circumstances. Any person in financial difficulty should therefore take professional advice from a solicitor, insolvency practitioner, or the Citizens’ Advice Bureau before concluding what action to take in a given situation. Reaching out in this way really is imperative to achieve the best outcome.

But it is worth noting that the guidance herein (and please note -- it is only guidance, not a substitute for proper advice), applies only in England & Wales.

In Scotland, the equivalent of bankruptcy is sequestration, and there is also a process similar to the DRO, known as a Minimal Asset Process bankruptcy.

But whether you’re in England, Scotland or Wales, bankruptcy is oft-referred to as a way for the financially-distressed to ‘wipe the slate clean.’ While there is some truth in that, because bankruptcy certainly offers a clean slate, I’d urge caution here.

Not only are there significant, drawn out restrictions from becoming bankrupt, but the list of excluded debts (featured at this article’s outset) may preclude bankruptcy as a viable option for many, making the bankruptcy process usually only suited to individuals whose slate is already reasonably clean, in that they do not have much to lose from the consequences.

Finally freelancers, avoid the head-in-the-sand approach, so you can hear the crescendo

The typical sole trader and self-employed person might therefore wish to avoid bankruptcy altogether and to that end, we’d recommend all such independent workers against the ‘head in the sand’ approach. In other words, ignoring the gradual crescendo of threatening letters is very ill-advised! Sometimes freelancers put ‘blinkers’ on because of pride, but other times it’s a lack of understanding about just how serious the consequences can be for a self-employed person who is not protected by the limited liability that they would have had if they had operated as a limited company.


5th April 2022

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