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Bankruptcy and insolvency are not the same thing, but they are closely related. Maybe that is why they are sometimes used interchangeably in the public domain. While this is understandable, it’s very important to know the difference between them.
We try to keep our articles, blogs, help and support, as ‘plain English’ as possible here at Smart Business Recovery. Financial matters for businesses and individuals can be a little jargon-filled at times and the technical language is a little forbidding. So, it is a guiding principle of ours to make the technical terms accessible. We believe it’s important to make sure the right terms are applied, and the right language is used, to keep things clear.
The recent coverage of the financial problems at Birmingham city council hasn’t helped in this goal. Mostly because the use of the term bankruptcy in relation to a city is very questionable.
So, the following is a point-by-point guide to the difference between bankruptcy and insolvency and where they do and don’t intersect.
While the terms 'insolvency' and 'bankruptcy' are often used interchangeably by the press, they have distinct meanings and implications. Bankruptcy is a big, dramatic, headline grabber, and while I accept it does convey meaning for the reader and is more familiar to them than insolvent, a solid understanding of the difference can help in making informed decisions. More to the point it reduces any possible confusion. So, let’s delve into the nuances of these terms and look at their unique characteristics and meanings.
We will start with insolvency.
Definition: At its core, insolvency is a financial state where a legal entity, most commonly a company, cannot meet its debt obligations as and when they come due or where its liabilities exceed its assets.
Types of Insolvency:
There are two tests for insolvency;
Insolvency for Companies
When a company is insolvent, it can enter into various procedures, such as administration, liquidation, or a company voluntary arrangement (CVA). These options aim to either rescue the company or ensure an orderly wind-down, whatever will provide the best outcome for everyone concerned.
So, while we accept that an individual person may be in a position of insolvency, i.e., lacking the money or assets they need, the term insolvency generally applies to companies.
Bankruptcy is a specific legal process initiated when an individual cannot repay their debts. It's one form of dealing with insolvency but exclusively relates to individuals and not companies.
An individual can either be declared bankrupt by their creditors or can choose to declare themselves bankrupt.
Once declared bankrupt:
- The person's assets can be used to pay off their debts.
- They may face restrictions, like not being able to take on significant credit or act as a company director.
- Bankruptcy usually lasts for a year.
So, taking the above into account, while all bankrupt individuals are technically insolvent, not all insolvent individuals are necessarily bankrupt. Bankruptcy is a specific route chosen or enforced due to insolvency, but other solutions might be more suitable depending on the circumstances.
Key takeaways and common-sense use of these terms.
Bankruptcy is a specific procedure applicable only to individuals. It's a formal court procedure and is just one of the several ways to address insolvency for individuals.
Insolvency is a broad term that describes the financial state of being unable to pay debts as they fall due or when liabilities exceed assets. Commonly it is applied to companies, not individuals. Yes, a person can be insolvent but one of the processes that can follow is bankruptcy. That is not applicable to companies… or indeed cities.
By understanding the distinctions between insolvency and bankruptcy, individuals and businesses can make well-informed decisions on navigating financial difficulties. Confusion over terminology certainly doesn’t help at a difficult and often very emotional time.
Whether you are facing insolvency as a company or considering bankruptcy as an individual, take advice to make sure you fully understand the situation.
For more information and to book an appointment if you need help, see our help pages for directors and for individuals.
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