Difference Between Insolvency and Bankruptcy

Is There a Difference Between Insolvency and Bankruptcy?

There is a mistaken belief that insolvency and bankruptcy mean the same thing. However, whilst the terms do have similarities, there are several distinct differences between the two. First and foremost, insolvency is the financial state of a company or an individual, whereas bankruptcy is the legal procedure when an individual has been declared insolvent. However, in reality it’s not this simple so, let’s take you through the difference between insolvency and bankruptcy.

What is insolvency?

Insolvency is when a company or an individual is unable to pay their debts when due. There are two states of insolvency – balance sheet insolvency and cash flow insolvency.

Balance sheet insolvency – is when a company or individual’s debts are higher than the total value of their owned assets. However, this does not necessarily mean they don’t have any cashflow.
Cash Flow insolvency – is when a company or individual’s assets are higher than their liabilities but there is insufficient cash flow, or liquid capital, to pay debts when due.

Insolvency doesn’t necessarily mean liquidation but it does result in resolving the situation with creditors through a variety of options, such as voluntary arrangements. If the level of insolvency is irrecoverable on the part of the company, it will lead to liquidating the company; for an individual, it will mean declaring bankruptcy. Creditors are also entitled to apply to court to liquidate a company or declare an individual bankrupt if they are owed in excess of £750.

What is bankruptcy?

Bankruptcy is the legal process, defined by the Insolvency Act 1986, by which an individual has to abide if they are considered insolvent, i.e. their debts are in excess of £5,000. The individual can declare bankruptcy or one of their creditors can petition the court to declare them bankrupt.

Whilst bankruptcy stops creditors from taking court action against you and your debts will cease to increase, you are still obligated to pay back as much of your debt as you can over the bankruptcy period, which is usually one year.

There are two ways to declare bankruptcy:

● A creditor can apply to the court to make you bankrupt and get their money back, or
● You can declare yourself bankrupt. This can be done online in England and Wales but in Northern Ireland and Scotland, it must be done through the courts.

When you declare bankruptcy, an insolvency practitioner or bankruptcy professional will assess any assets you may have that can be sold to raise the money to pay back your creditors. These assets can include your car, any jewellery of value, any leisure equipment and tools, and can also include your house. However, you may be able to argue that any tools you have needed for work are not sold so you can continue to earn an income, and you may not lose your house.

It is worth noting that some debts are not covered under bankruptcy including court fines, student loans, maintenance or child support payments, personal injury debts, loans from social funds, IPAs or IPOs as well as secured debts, such as a mortgage.

Difference between insolvency and bankruptcy

Apart from the main difference being insolvency is a financial state of a company or an individual and bankruptcy being the legal process once declared insolvent, there are other areas where the similarity ends.

Insolvency is an umbrella term under which a variety of legal procedures to deal with insolvency are based, including bankruptcy. There are several different ways to deal with insolvency, including rescue packages that can help companies and individuals recover from an insolvent financial situation, such as IVAs (individual voluntary arrangements), CVAs (company voluntary arrangements) and DROs (debt relief orders).

Another key difference is that bankruptcy is only applicable to individuals and sole traders that have unlimited liability. Insolvency, on other hand, applies to individuals, sole traders and limited companies.

If a limited company is declared insolvent, and a rescue package, such as entering an administration process to source a buyer for the business, is not an option, the company will be liquidated via a Creditors Voluntary Liquidation (CVL) procedure to close the company and remove it from the Companies House register. This is a legal procedure in which the company’s directors and/or shareholders agree to close the company due to insolvency.

Any insolvency procedure must be managed by a licensed insolvency practitioner (IP), whether appointed by the company itself, i.e. voluntarily entering the CVL process, or by the court. When an IP, also known as an official receiver, is appointed by the court, it is because a creditor of the company has petitioned the court to declare the company insolvent and to liquidate the business.

The same applies to individuals that are insolvent in that they can voluntarily declare bankruptcy or a creditor can petition the court when they are owed over £5,000 and there is not a payment plan in place between the creditor and the individual.

In both situations, whether it is voluntary bankruptcy or liquidation due to insolvency, once the IP has been appointed and the procedure commenced, creditors are no longer entitled to take any further legal action, and interest being added to the debt must also cease. An advantage is that once the bankruptcy order has come to the end, any outstanding debts are written off. However, individuals will still find it difficult to secure any credit for six or seven years following bankruptcy.

A major drawback of bankruptcy is that the individual’s liability for the debts is unlimited and therefore, they are likely to lose high value assets, i.e. the IP will need to sell those assets at market value, in order to pay back creditors. When a limited company enters a liquidation process to close the business, the directors’ liability for the debts are limited and they are not held personally responsible for them, unless they personally guaranteed the loan or agreement prior to insolvency.

Company or individual insolvency is not something that anyone wants to deal with; however, the sooner a financial problem is recognised, the sooner it can be dealt with and the more potential the company has in recovering. If you are struggling with debt, are considering winding up a solvent company or declaring bankruptcy, contact Simple Liquidation for assistance. For more information on how our professional insolvency practitioners may be able to help your business, contact us today.