Insolvency can be defined as a financial condition, where an individual or entity is unable to meet the financial obligations as they are due for payment. It is often confused with the term bankruptcy, but they are different. Bankruptcy is a situation when the court of law has declared the insolvency of a person or entity and passed orders for its resolution, i.e. the property of the bankrupt is disposed off, so as to pay creditors.
In other words, the fundamental difference between insolvency and bankruptcy is that the former refers to a state when the debtor is not able to pay the debts due to excessive liabilities over the assets, whereas the latter implies a legal scheme, wherein the court determines insolvency, and the bankrupt seeks relief.
Content: Insolvency Vs Bankruptcy
|Basis for Comparison||Bankruptcy||Insolvency|
|Meaning||An individual/company is unable to pay off its outstanding debts and files an application with a court to get himself declared as an insolvent or the creditor can file an application in the court against the insolvent.||An individual/company is not able to pay off its debts, called as cash insolvency or not able to set off its financial obligations due to the excess of liabilities over assets, called as balance sheet insolvency.|
|Nature||Permanent, resulting in wind up of an individual or entity's assets.||Temporary and amount can be recoverable.|
|Related to||Legal Concept||Financial state|
|Credit rating||Severely affected.||Not much affected.|
Definition of Insolvency
Insolvency is a situation which arises due to the inability to pay off the outstanding debts on time to the creditors because the assets are not enough to cover up the liabilities.
In the case of a company, this condition is caused due to the continuous fall in sales, and it doesn’t have enough cash to meet out its day to day expenses of the business, for which it takes loans from the creditors or banks or any other financial institution. This results in the insolvency of the company in the form of liquidation, voluntary administration, and receivership.
Definition of Bankruptcy
Bankruptcy is a situation in which an individual/organization sends an application to the relevant court; wherein he declares himself as insolvent due to his inability to pay off debts and expenses, seeking to be declared as a bankrupt. Now, the court may decide the appropriation of the personal property of the insolvent among his various creditors. It is the last stage of insolvency and gives a new lease to the insolvent to start a fresh, i.e. it relieves the individual or a company from all the debts and other disadvantages of insolvency.
Key Differences Between Insolvency and Bankruptcy
The points presented to you, explains the difference between insolvency and bankruptcy in a detailed way:
- The Bankruptcy refers to a legal state in which an individual/company becomes bankrupt, whereas the Insolvency relates to a financial state where an individual/company becomes insolvent.
- Bankruptcy is caused due to the inability of paying off the outstanding debts while the Insolvency arises due to the non-payment of financial obligations.
- The Insolvency may not necessarily lead to bankruptcy while all bankrupt individual/company are insolvent.
- In Bankruptcy, the person/company goes to the court and voluntarily declares himself as an insolvent.
- Bankruptcy is initiated by the individual himself, wherein the person/company goes to the court and declares himself as an insolvent, therefore, the process is voluntary. On the other hand, insolvency is involuntary.
- Bankruptcy is the final stage of insolvency, resulting in wind up of an individual or entity’s assets. Conversely, Insolvency is for a particular time period only, until the business reaches a stage where it is ready to pay off outstanding debts.
- Bankruptcy severely affects the credit score of the individual or entity whereas Insolvency does not affect the credit score of the individual.
- Arises due to the non-payment of debts.
- Liabilities exceed assets.
These two terms discussed above are very closely interrelated as one leads to another i.e. where insolvency ends the bankruptcy starts. But it doesn’t mean that every individual/company who is insolvent is bankrupt, as the conditions may be temporary or fixable without any legal interventions.