Settling Business Debts After Ceasing To Trade
by Kate McCormick
This is our practical guide to settling business debts as a sole trader after ceasing to trade.
Most small businesses end up having to stop trading because of cash flow problems, leading to insolvency. If this happens, their owners can be left with various debts still outstanding and no cash to pay them with. This article is aimed at the owners of small businesses, who do not trade as limited companies and so do not have the protection of limited liability, who find themselves in this situation. It sets out the main priorities and steps that they should take to reduce their liability and to try to avoid bankruptcy and court proceedings.
These creditors may take one or any number of the following actions against you if you do not pay them:
- Repossession of your business premises or home or eviction from them;
- Termination of utility supplies;
- Entry and seizure of goods from your business premises or home;
These are evidently very serious consequences so you should ensure that these debts are prioritised and take immediate action to settle them.
1. Mortgage or rent arrears in relation to your home
If you own your home, you may well have a mortgage to pay. If you find yourself in arrears you should contact the lender as soon as possible and check the terms of the mortgage as to how long you have before they can repossess your home. If you contact them in time, the lender may be able to offer you a number of payment solutions such as extending your mortgage so that the instalments are less, giving you a ‘payment holiday’ or reduction in instalments for a short while, adding any arrears to the mortgage so you can pay them off gradually, or allowing you to pay off the interest only for a while. They may also offer a mortgage rescue scheme involving a shared ownership arrangement with you or tenancy after they have bought back your home. Another option could be for you to move to less expensive premises, although selling may be difficult at the moment. However, even after you have moved out or been repossessed, there is a risk, particularly in the current housing market, that there may still be a shortfall owed to the mortgage company if the value of your house is less than the remaining mortgage.
If you can no longer make the rental payments on a property that you rent, you should contact the landlord immediately and ask for a settlement or rent reduction. You may find it necessary to move to smaller premises in which case you should check whether there is a break clause in the lease and if not, try to negotiate a release with your landlord. Otherwise the landlord could take you to court for failing to pay the rent and obtain an eviction order.
2. Business rates or Council Tax arrears
Once you have moved out of business premises, you will only be liable for continuing business rates if the premises are a shop and remain empty for longer than three months. If you cannot make any payments or arrears, you should ask the Council for a payment arrangement. If you cannot keep to this, the Council may then ask the Magistrates’ Court for a liability order against you, which will include court fees. Penalties for failing to comply with a liability order include appointing bailiffs to take goods from your business premises or home. You should therefore ensure that you do not leave property at your business premises after you have finished trading. Bailiffs are not allowed to break in unless you have previously allowed them entry. The Council could also apply for your bankruptcy or even ask the Magistrates’ Court to send you to prison for up to three months, if you have deliberately refused or neglected to pay when you could have afforded to do so. At all times, you should ensure that you communicate with the Council, bailiffs and Court and arrange to pay an amount that you can afford, using a budget document that you have drawn up showing your debts, outgoings and income, as evidence. You should not allow bailiffs to enter your home.
Council tax arrears are dealt with in a similar way. If you cannot make the payments in relation to your home, you should ask the Council for a payment arrangement. Again a liability order can be obtained against you. You can request that this be adjourned if you have applied for Council Tax Benefit or appealed against a valuation. Again bailiffs can be appointed to enter your home but they cannot take any tools of trade used by you. In addition, the Council can request details of your finances, request a charging order against your business premises or home (if the debt is over £1,000) or request that the debt be set off from your wages or benefits.
3. Income tax arrears
These are a priority debt as HMRC has the right to seize your property for non payment, make you bankrupt or even send you to prison. You should inform HMRC as soon as you stop trading and send in your tax return within the deadline. If you do not, you will be sent an estimated determination which could be over what you would otherwise owe and also receive a late filing penalty of £100 and interest charged on the debt. You should contact HMRC with a repayment offer (e.g. payment by instalments), based on your budget and start to pay the amount that you have offered, even if they do not agree. If you do not pay, HMRC may seize goods from your business premises or you home and can request a warrant to enter with force. If this is unsuccessful they can obtain a County Court judgment against you (see below) which they can enforce through bailiffs, a charging order over your home or set off from your wages. Alternatively they may seek a Magistrates’ judgment if your debt is below £2,000. This can be enforced through set off from your wages or benefits or even by imprisonment if you deliberately do not pay. Another option available to HMRC if your debt is over £750 is to start bankruptcy proceedings against you (see below).
4. VAT arrears
Again, you should inform HMRC as soon as you stop trading. You will need to submit a final VAT return and will again need to negotiate a payment arrangement based on your budget, if you cannot pay the full amount owed. HMRC has the same enforcement options as it does for Income Tax arrears.
5. Utility arrears
As soon as you stop trading, you should take final utility readings at your business premises and inform the suppliers of these. If you have been unable to keep up with your utility payments, you should contact the providers immediately and try to negotiate a settlement. The water company cannot disconnect your water supply to a residential property but can do so to business premises. Electricity and Gas companies can disconnect their supply to both residential and business premises. Again, you should request a payment arrangement, using your budget for evidence. If you do not stick to an arrangement the companies can obtain a County Court judgment against you (see below). Outstanding debts for water or telephone charges incurred at business premises can be added to your home bills, if you are with the same company.
6. Magistrates’ Court fines
It is very important to pay Magistrates’ Court fines in accordance with the judgment and deadlines as if you do not, you can be sent to prison.
7. National Insurance arrears
The consequences of failing to pay National Insurance contributions depend upon which Class you fall into. Class 1 and Class 4 contributions are enforced by HMRC in the same way as Income Tax. Class 2 contributions are collected by the Contributions Office, which can obtain a County Court order against you if you do not pay.
8. Secured debts
Loans or debts which are secured by a charge over your assets or home or a guarantee, should be treated as a priority.
Secondary debtors do not have the remedies set out above that primary debtors have if you do not pay and so do not have to be prioritised. They include:
- Credit card and charge card debts.
- Unsecured loans and overdrafts with a bank, building society or finance company.
- Personal loans from family and friends.
- Credit sale agreements.
- Rent arrears for business premises (provided you are no longer trading).
- Hire purchase agreements or equipment leases.
- Debts owed to accountants or other professionals.
You should still contact these creditors as soon as you can as it may be possible to negotiate a settlement with them. You should ensure that any arrangement includes stopping any further interest from accruing. If a particular creditor does not accept your offer, you should attempt to start paying that amount anyway as by accepting the payment they may be deemed to have accepted the offer. Most trade associations instruct their members to be reasonable in cases of financial difficulty. Even so, a creditor may be particularly uncooperative and decide to take you to the County Court. However, you will still have the chance to make an offer to them on the reply to the claim form. If they still do not accept this, the court will decide how much you will have to pay but it will consider your income, outgoings and other debts in coming to a decision, provided you have detailed these on the reply to the claim form. You can request a re-determination from a District Judge if you cannot afford the amount the court has decided. It is most important to ensure that you reply to the claim form within the deadline stated, include sufficient details of your debts and outgoings and attend any hearing scheduled with copies of any relevant information and paperwork, for your reference.
1. Credit card and charge card debts
Interest and fees can quickly rack up on credit card debts if you do not pay the full amount off each month. You should try to pay the minimum amount at least each month. You may be able to transfer your debt to another credit card company with a lower rate of interest. They may offer an interest free period for doing this. However, you may have to pay a transfer fee. If you are a longstanding customer you could also contact your provider and simply ask them to reduce the interest rate, informing them that you will transfer to another company if they do not.
Another option could be to consolidate the debt into a personal loan with a lower interest rate.
2. Bank overdrafts and loans
Regularly going into your overdraft will involve interest and bank charges and can result in loss of the facility. The most important thing to do is to negotiate with your bank and show them your budget and any business plan that you have to reduce your debt or re-commence trading.
3. Business rent
Even if you are no longer using your business premises, you can still be liable for the rent until the end of the tenancy. You should check the lease to ascertain when the tenancy ends and whether there is a break clause. The landlord may allow you to transfer the lease to another tenant or to sublet or assign the premises. Again you should check the terms of the lease as to transfer/subletting. However, a landlord cannot unreasonably refuse this even if there is no right in the lease If you are very lucky, the landlord may agree to release you from the remainder of the term, provided you agree to pay any rent arrears, although this is doubtful as they will then be responsible for the business rates. It is therefore important to remain on goods terms with your landlord. An uncooperative landlord does have the right to enter and seize goods and equipment from business premises so you should be careful to remove all your equipment once you have finished trading, or they may obtain an eviction order, if you are still using the premises.
4. Hire purchase or leasing agreements
First you should read the hire purchase or lease agreement to ascertain at what point you own the goods and if there is a right to terminate the contract. If you have paid less than one third of the contract price, then the creditor is entitled to request that you return the goods, without the need for a court order. It is illegal to sell hire purchase or leased goods that you do not own. You may be able to return the item to the creditor and set off its price from the debt. If you have paid less than half of the contract price you will usually be liable for up to half the price plus any missed payments, after you have returned the item.
We have mentioned bankruptcy as an option available to various creditors to whom you owe over £750, particularly HMRC, if you do not pay a court judgment owed to them. If you receive a notice or ‘demand’ for bankruptcy, you should contact the creditor again and try to negotiate settlement as the court may decide not grant an order if the creditor has unreasonably refused an offer. You should always obtain legal advice and attend any court hearing. If you are made bankrupt, the Official Receiver or Trustee in Bankruptcy is appointed to manage your assets and affairs and will own your home. S/he will seek to sell any assets necessary to pay off your debts unless you require them for work or they are essential household items. This can include your home which they can sell or obtain a charge over. You will also not be able to borrow more than £500 without informing the creditor that you are bankrupt, although you may continue to trade as long as credit is not required, although you will find it difficult to open a business bank account. Utility companies will require a prepayment meter to be installed in your home. You will be likely to have an income payment agreement in place whereby amounts are taken from your income to pay off your debts, and you will be prevented from being a company director, accountant or solicitor whilst the bankruptcy order is in place. The court is likely to look more favourably upon traders whose businesses has failed simply because of the economic situation and a bankruptcy order is unlikely to last for more than twelve months. However, once you have been made bankrupt, your credit rating will be affected, making it much more difficult for you to obtain credit in the future. Also, the Official Receiver may deal with your property at any time within three years of the bankruptcy older or longer if they have a charge over it.
Getting into commercial debt is often unavoidable. However, there are certain steps that you can take to minimise your liability. The most important thing to do is to act quickly, particularly where priority debts are concerned, Secondly, you should maintain good communication with debtors and suppliers to keep them on good terms and try and negotiate a settlement with them. If they do not accept your offer, you should try to pay them what you can afford in any case as this is better than paying nothing at all. You should also try to obtain payment from your debtors as soon as possible. This may necessitate agreeing to a compromise arrangement with them or, obtaining a court judgment yourself or instructing a debt collection agency, if the debt is substantial and the debtor still has funds or assets.
You should ensure that you keep to any deadlines in court orders and attend all hearings. It is imperative that you draw up a budget showing all your debts, income and outgoings, which you can use as evidence when negotiating settlements with creditors and the court. Finally, do not obtain loans to pay off debts unless you are certain that your cash flow problems are short term ones. If you are still trading, the priority of some debts will be different as your business premises and major suppliers will be more important to you and you should take care to consider what action to take to save your business as well as to avoid liability.
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