What is the Difference between Insolvency & Bankruptcy?

You may often hear the terms “ insolvency” and “ bankruptcy” used interchangeably, but they have different meanings. Insolvency is a financial state where a person cannot meet debt payments on time. Bankruptcy is a legal process that happens when the individual declares he or she can no longer pay back his or her debts to creditors.

What is Insolvency?

Simply speaking Insolvency is the financial state of a being where the Individual Company or family has lost the capability to pay off their debts to the creditors. When any individual or entity is not able to pay back the debts to the creditors on time and does not have the financial viability of discharging oneself from the liability then the individual or entity is known as insolvent. In the case of a company when the inflow of cash is less than the outflow of cash i.e. the sum invested by the company into the business is more than what the company is earning from the business of the Company, also when the value of assets along with the money flow into the company is less than the liabilities and money outflow from the company. For example: When a company is involved in some business of manufacturing certain products which are to be supplied to various distributors, now initially the demand of that particular product in the market was at a high rate but somehow in the later stage of the business the demand of those products suddenly fell due to which the Company is not able to generate the revenue which was earned earlier by the company but the expense instead of the production remains same i.e. high. Therefore, this decline in the revenue of the company consequently leads to the situation of financial inability of the company as the liabilities keep on exceeding the assets or the debts exceeding the company and make the company insolvent.

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What is Bankruptcy?

Bankruptcy is termed as a legal declaration of insolvency i.e. one's inability to pay off debts. Insolvency is just the state where the financial inability is reached whereas bankruptcy is the realization and announcement of the state of being insolvent.

What is the benefit of being declared insolvent or undergoing bankruptcy?

When an individual or a company is financially incapable of paying off its debts in time or the value of assets stands less than the value of the liabilities, then by undergoing the process of bankruptcy debtors figure out a plan or restructure their payment plans to be easily met with the help of government or adjudicating authority. There are mainly two forms of bankruptcy:-

Resolution bankruptcy process As the name suggests this type of bankruptcy takes place to reorganize or find a resolution to pay off the debts in a timely manner. This is also called Corporate Insolvency Resolution Process as per the Insolvency and Bankruptcy Code, 2016 wherein the business of the company is run afresh with some new plans under which the whole company is under the control of an Insolvency Professional who finds the best feasible way out to discharge the liabilities of the company.

Liquidation bankruptcy process If the resolution process does not work properly and no viable resolution to discharge the liabilities has been reached then the liquidation takes place pursuant to which all the assets of the company are sold or disposed of in the best possible manner, thereafter, the sale proceeds are utilized to pay off the debts owed by the company to the creditors.

Relationship between bankruptcy, insolvency, and liquidation

The correlation between bankruptcy, insolvency, and liquidation is as follows:

1. “ Bankruptcy” is a legal proceeding involving a person or business that is unable to repay outstanding debts.

2. The bankruptcy process begins with a petition filed by the debtor, or by the creditors.

3. All of the debtor's assets are measured and evaluated, and then these assets may be used to repay a portion of the outstanding debt.

4. In lucid language, if any person or entity is unable to pay off the debts, it owes to its creditors, on time or as and when they became due and payable, then such person or entity is regarded as “ insolvent” .

5. “ Liquidation” is the winding up of a corporation or incorporated entity. Many entities can initiate proceedings that will lead to Liquidation, those being:- (a) The Regulatory Bodies (b) The Directors of a Company (c) The Shareholders of a Company and (d) An Unpaid Creditor of a Company

6. In a nutshell, insolvency is common to both bankruptcy and liquidation. Not being able to pay debts as and when they became due and payable is the leading cause for Liquidation and is the only way that can cause a natural person to become bankrupt.

Advocate Chikirsha Mohanty

Greater Kailash - 1, Delhi
5 years

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