Bankruptcy and insolvency are two narrowly connected financial terms. In many cases, insolvency can lead directly to bankruptcy, either voluntarily or involuntarily. The similarities of the terms can often be confusing, as they both deal with credit, finance and debt (especially resulting from excessive debt). However, bankruptcy and insolvency are not necessarily the same thing:
Personal or business insolvency typically arises when the party is unable to satisfy creditors or discharge liabilities, either because liabilities exceed assets or because of an inability to pay debts as they mature. Assets can comprise of any property (real or personal) holdings of value including land, homes, stock holdings, insurance policies, and bank accounts.
In business, insolvency can arise when the total sum of all credits, or revenue loss, exceeds the total sum of the company’s debits, or current gains in revenue. A company that is insolvent might not have the sufficient funds available to pay debts, meet business expenditures or pay their employees.
Personal or business bankruptcy typically arises through the filing of a bankruptcy petition (voluntarily or involuntarily) resulting in an order of relief that declares the business or individual bankrupt. Being bankrupt is a legal determination that declares that the party is unable to pay off some or all debts that are owed to creditors.
In bankruptcy, the assets of the bankrupt party are, conceptually at least, gathered into the bankruptcy estate. Typically, non-exempt (i.e. unprotected) property of the bankruptcy estate is liquidated in an effort to generate funds to pay the creditors of the individual or business. There are various chapters of bankruptcy in the US that include: Chapter 7 – where non-exempt assets are liquidated, and, Chapters 11, 12 & 13 – where income or future earnings are pledged in some sort of repayment plan of the party’s debts. Click here to learn more about the different types of bankruptcy.
Bankruptcy and insolvency are two different financial instruments. Individuals and companies can be insolvent without the insolvency being legally recognized. Alternatively, bankruptcy can only be declared through a court of law. Additionally, bankruptcy requires a liquidation or future capital to pay off debts, which is not legally true with insolvency.
Insolvency leads into Bankruptcy
In specific cases, insolvency can easily lead to bankruptcy. If the individual or business can be proven to be insolvent to the creditor, the creditor can force the individual or business into bankruptcy. In the US, the filing of the bankruptcy petition itself acts as a declaration of legal bankruptcy. There is not always a direct path that exists to transform insolvency into bankruptcy, but the inability of an insolvent individual or business to satisfy creditors or pay bills as they mature often leads to bankruptcy. Lastly, bankruptcy is a common tool employed by an insolvent individual or business to stop collection lawsuits, garnishments or foreclosures.
The information provided in this article is intended to provide an overview of this topic. To speak to attorney about your specific situation, please contact us today.
You can also find out more about these topics by downloading our Free E-Book “Bankruptcy 101” by clicking here.