Insolvency vs Bankruptcy: Basic Differences Explained
Bankruptcy and insolvency are among those complex words that often get mixed up or used interchangeably. However, bankruptcy and insolvency are two different things and it is essential to understand the difference between the two to make an informed decision.
A bankrupt individual is considered insolvent, but an insolvent individual doesn’t equal a bankrupt one. The terms also have multiple applications. For instance, bankruptcy typically refers to individuals and insolvency to businesses.
Let’s have a closer look at both terms.
What Is Insolvency?
While bankruptcy and insolvency refer to excessive debts, being insolvent is a state leading to bankruptcy declaration if the situation doesn’t improve. Simply put, you are insolvent when you are unable to repay the lenders.
While declaring bankruptcy is one solution to becoming insolvent, it doesn’t necessarily lead to it. You can change your insolvency status using other options, based on your situation, like applying for a debt consolidation loan or making a consumer proposal.
There are two main types of insolvency:
Cash-Flow Insolvency
A company or individual enters cash-flow insolvency if their assets are more than their liabilities, but the liquid capital is not sufficient enough to repay the debts. This means you own a property that is worth more than your debts, but you don’t have enough cash to repay the debt.
Such a situation can easily be resolved with negotiation where the creditors might agree to wait until your assets are sold to get their payment instead of taking any legal action.
Balance-Sheet Insolvency
Balance-sheet insolvency is when your outstanding debt is higher than the overall worth of your assets. Again, this insolvency is also not necessarily terminal as individuals might have enough cash flow to continue making repayments to their creditors. If you are unable to do this, you might end up filing for bankruptcy.
What Is Bankruptcy?
Bankruptcy, on the other hand, is a proceeding that offers relief and protection to individuals who can’t repay their debts and have no means of doing so. When declaring bankruptcy, you will be assigned a licensed insolvency trustee responsible for liquidating all owned assets, investigating your financial situation, and getting in touch with creditors.
You would be obliged to comply with the requests of your Trustee. You would also need to share all your financial details with your trustee. While you are still allowed to work or even run a business, it comes with certain restrictions.
Bankruptcy in Australia lasts for three years and one day, and your name would be included in the public records.
The Differences Between Insolvency and Bankruptcy Simplified
Here are some of the main differences between insolvency and bankruptcy for further understanding:
- Bankruptcy is a court order or a legal process, while insolvency is a distressed financial state.
- Bankruptcy is not the only resolution for insolvency.
- Bankruptcy is applicable to sole traders and individuals with restricted liability, while insolvency is applicable to both businesses and individuals.
- Insolvency is a state of financial distress, while bankruptcy is the final resolution of insolvency that can’t be improved.
Here is a comparison chart:
Your Options With Insolvency vs Bankruptcy
Bankruptcy should be your last resort, which is why it is essential to go over your options with insolvency and avoid bankruptcy. According to the Bankruptcy Act 1966, there are four main options for insolvency and each comes with its own set of consequences:
- Temporary Debt Protection (TDP): When you apply for this option, you only get 21 days of protection from getting pursued by creditors. You would need to get professional assistance and advice during these days to come up with the ideal action plan to improve your financial situation.
- Personal Insolvency Agreements: These agreements are made between you and all the creditors you owe to determine a payment plan to either pay the lump sum or pay in instalment at a specified period of time.
- Debt Agreements: These are binding agreements you make with your creditors to pay back the amount you can afford.
- Bankruptcy: If all else fails, you can file for bankruptcy. The typical bankruptcy in Australia lasts for three years and one day and you would be released from most of your debts, but the bankruptcy will appear on your credit report for a few years, depending on your situation.
Declaring Bankruptcy: When Is The Right Time?
Bankruptcy provides immense relief from your debts but it shouldn’t be a decision that is taken lightly as it can have a major impact on your life. Declaring bankruptcy means you might lose your assets and it would impact your credit score for years to come.
Being bankrupt means you can’t apply for a mortgage and can’t become a director of a company until you are released from bankruptcy. Moreover, you also have to abide by certain obligations and restrictions.
It is crucial to consult a professional bankruptcy expert to determine whether or not bankruptcy is the right option for you. We recommend that you consult with a bankruptcy expert at the earliest possible time in order that you can weigh up your options – by waiting too long you may lose access to some of the alternatives to bankruptcy.
Wrapping Up
Bankruptcy and insolvency both denote the lack of finances and ability to pay your debts. However, insolvency is not the last resort, unlike bankruptcy, and you can improve your financial situation.
If you have become insolvent or are on the brink of becoming bankrupt, you need to get professional advice immediately. It is certainly a stressful time and the right guidance can certainly improve your situation and prevent you from going bankrupt.
There are multiple ways of dealing with insolvency based on your situation to avoid bankruptcy. Using the right professional bankruptcy assistance, you would be able to make an informed decision and come out of your financial problems. Get in touch with us for a free consultation
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