Bankruptcy vs Insolvency: What’s the Real Difference?

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Often used in pretty much the same context, bankruptcy and insolvency are two terms that people struggle to differentiate. However, if you wish to come up with a solid debt management plan, you need fully understand both terms, as they do not the same legal meaning and repercussions.
Defining insolvency

Literally meaning “unable to pay” in Latin, insolvency is a form of financial distress. It occurs when a person is unable to meet their debt obligations when they are due. In terms of balance, this often means that an individual has more debts than assets or that they spend more than they earn.

When filing for bankruptcy, it is mandatory that you are first declared insolvent. Mind you, it is impossible to be insolvent if you still have assets that can be sold off to cover all the bills, even if it means being late with your payments. 

 

Defining bankruptcy

Unlike insolvency, bankruptcy is a legal term for eliminating your unsecured debts. The process might include selling off your assets, as well as other perquisites, to file for bankruptcy.

Once you file for bankruptcy, you are free to clear all unsecured debts, including personal credit card debt and loans you took out as a natural person.

Of course, filing for bankruptcy won’t erase secured debts, such as car loans, (those pesky) student loans, and mortgages.

Steps involved in filing for bankruptcy

As mentioned earlier, filing for bankruptcy is foremost a process that involves several steps. First, you need to consult a licensed insolvency trustee and file paperwork. Secondly, you should sell all assets that the authorities deem as unnecessary, but you get to keep the necessities, such as your living quarters.

After the selling process is over, it would be beneficial to meet with creditors or, at the very least, contact them via email or phone. Then you need to attend the credit counseling meeting (s), after which all relevant debts will be cleared, i.e., discharged. The outcome of the procedure is the restoration of your solvency.
How does insolvent liquidation work?

The process of voluntary insolvent liquidation is not as serious as filing for bankruptcy. For starters, the creditor will issue a statutory payment demand, which marks the beginning of the legal proceedings. Then, a winding-up petition gets issued, as the liquidation order is granted.

When companies look for corporate insolvency solutions, they wish to hire an advisory team that will help them with the upcoming liquidation. For individuals, this step is skipped, but everyone must undergo a post-Liquidation investigation.

The legal implications of both terms

Now that you have a better understanding of what bankruptcy and insolvency are, we can talk about the differences. As already mentioned, it’s necessary to be insolvent before you file for bankruptcy, but being insolvent doesn’t necessarily imply that you are obliged to file for bankruptcy.

In other words, insolvency is a term used when you are in a dire financial state, while bankruptcy is something you file for, i.e., it’s a legal term to denote a penniless person. Moreover, insolvency is simply a description of your finances, while bankruptcy can be forced upon you by others, i.e., creditors.

Legal and economic terms

As you might have realized by now, both terms have different meanings in terms of legal implications and the economy. Insolvency is a financial state, but it is not a legal term; that is, it doesn’t reflect the legal status of a company or an individual.

When it comes to bankruptcy, the situation is different. Bankruptcy is not a financial state, but it does reflect the legal status of an individual or a company. In fact, filing for bankruptcy is a legal procedure that ensures insolvent individuals or companies get the help they desperately require.

What happens to your credit rating?

When you enter financial dire straits, a bank loan seems like a reasonable bailout. However, bankruptcy will most definitely affect your credit rating, so banks and lenders will think twice before giving you a loan. Insolvency, on the other side, has no effect on your credit rating whatsoever.

Temporary or permanent?

The two terms differ when it comes to duration. When you become insolvent, this state is always temporary, i.e., it usually doesn’t last long. If you go bankrupt, the state is permanent, as there is no easy solution, especially since bankruptcy is often involuntary.

Essentially, when you or your company runs out of money, you automatically become insolvent. However, this is not the end of the world, as no legal actions have yet been taken. When this occurs and you file for bankruptcy, then your financial downfall becomes official, as creditors are informed. Bankruptcy is much more serious, as it affects your credit rating and your ability to continue doing business.