What is the difference between Insolvency and Bankruptcy?

Law
18-Oct-2022
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The aim of the Insolvency and Bankruptcy Code is to organize the laws relating to insolvency resolution. An insufficient amount of assets characterizes the state of Insolvency to meet liabilities. If untreated, Insolvency will lead to Bankruptcy or liquidation.

The term insolvency is used to express the inability of a party to pay his debts. Bankruptcy is a condition of Insolvency. It is a legal status of a person or an entity that cannot repay debts to creditors. The significant difference between Insolvency and Bankruptcy is of stages; Insolvency is the initial stage leading to Bankruptcy.  

What is Insolvency? 

Insolvency is the inability of debtors to repay their debts to their creditors or any other financial institution. It describes a situation where the debtor cannot meet his obligations, and Bankruptcy occurs when a court determines Insolvency and gives legal orders for it to be resolved. The term insolvency is used for individuals as well as organizations/companies. If Insolvency is not resolved, it leads to Bankruptcy in the case of individuals and liquidation in the case of corporations.

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What is Bankruptcy?

Bankruptcy is a legal proceeding that states that a person or business cannot pay their debts or loans. In this case, the court order states how an insolvent person or business must pay off its debts by selling assets or properties. It begins by filing a petition by the corporate debtor. It is a way to offer an individual or business a new chance to revive its business and for creditors to get repayment of money through liquidation.

Liquidation means the winding up of a corporation or an incorporated entity because of its inability to meet its obligations or pay its debts. A competent liquidator sells the assets to clear the indebtedness. 

Quick difference between insolvency and bankruptcy:

  Insolvency Bankruptcy
Meaning Insolvency is the economic state where an individual or an institution is incapable to cover the debt due to a lack of funds or a financial crisis. Bankruptcy is a legal condition when the court declares an individual going bankrupt as they failed to settle their debt.
Time Period Temporary and a time to recover the amount. The final result is when the assets are redeemed.
Held An individual or an institution. Only an individual.
Nature Involuntary process. Voluntary process.
Defense Individuals or an institution can escape from insolvency after clearing debt. There is no chance for reversal.

Relationship between Insolvency, Bankruptcy, and Liquidation

Insolvency 

Insolvency describes the financial status of a person or a business in financial trouble and the inability to pay their debts and is generally preceded by Bankruptcy or liquidation. Both an individual (who may become bankrupt) and a business (who may enter liquidation) can be insolvent. The word 'Insolvency' can be used for everyone unable to pay their dues, whether it is a corporate body, company, limited liability partnership, partnership firm, individual, HUF, or body of individuals. As mentioned above, there are two consequences of Insolvency, 

Bankruptcy 

The words "Insolvency" and "Bankruptcy" are generally used interchangeably, but there is a difference between Insolvency and Bankruptcy. The term "insolvency" is the state where assets are insufficient to pay debts or the general inability to pay debts. When individuals, companies, or other organizations cannot meet their financial obligations for paying their debts as they become due, they become insolvent. Bankruptcy is a determination of Insolvency and is a legal scheme in which an insolvent debtor seeks relief. It is a formal declaration of Insolvency and can be used only for individuals and partnership firms. Thereby, we can state that Insolvency is a state and Bankruptcy is a conclusion.

Liquidation 

As already mentioned, Insolvency results in Bankruptcy or liquidation. Liquidation is the process of winding up a company. Suppose the Insolvency of the corporate debtor does not get resolved through the Corporate Insolvency Resolution Process. In that case, the corporate debtor must go through the liquidation process for winding up and realizing the assets. 

Conclusion

The above article implies that bankruptcy, insolvency, and liquidation are all related processes that follow one another. Insolvency is the stage where a business cannot pay its debts, and Bankruptcy is the stage of the legal proceeding initiated to recover the money Liquidation is the sale of assets of the business to recover money to pay off the debts of the creditors.