What Is the Difference Between Insolvency and Bankruptcy?
If your business is starting to encounter financial difficulties, you may become aware of technical terms such as bankruptcy or insolvency.
Unless you’re a financial wizard, it’s likely these two terms might cause some confusion. Insolvency and bankruptcy are often seen as the same thing. But while they might at first appear similar, they are in fact very different. To make matters more confusing, different laws and applications are applied in the United Kingdom and the United States when it comes to bankruptcy and insolvency.
In these tough economic times, in the wake of Covid-19 and other external factors outside of our control, it’s more important than ever to be financially astute. That’s why we asked our expert team at Irwin Insolvency to explain the technical differences between insolvency and bankruptcy.
What Is Insolvency?
Insolvency is the term used to describe the state of being insolvent. Being insolvent is defined as not being able to pay off debts. Outgoings equal more than income, and a deficit is created when creditors can’t be paid on time.
Importantly, both individuals and companies are liable to become insolvent. In both the UK and the US, this principle is the same although different specific laws apply in both countries.
There are two primary types of insolvency, which are termed cash flow insolvency and balance sheet insolvency, and both can happen to individuals and businesses.
Cash flow insolvency occurs when a company or individual is in debt. But while they do not have enough cash reserves to pay their debt, they have assets that, if sold, would cover their debts. This form of insolvency can be rectified simply by converting those assets to cash and paying off the debts. This might not be an ideal solution however, due to the potential loss of important assets, especially if they’re integral to a business.
Balance sheet insolvency occurs when a company or person has incurred debt and has neither the cash nor the assets to pay their debts off.
Importantly, while cash flow insolvency can be rectified quickly with the sale of assets, balance sheet insolvency can quickly lead to further financial problems and is seen as a worse state of insolvency.
Depending on the situation and whether it’s individuals or companies involved, different action can be taken with the onset of insolvency.
What Is Bankruptcy?
Bankruptcy is not simply a state of being, as insolvency is, but a legal process. Bankruptcy can be filed for as a way to manage or clear debts and, in effect, provides a second chance.
Importantly, there are different geographical distinctions to make here. In the UK, only individuals can file for bankruptcy. UK companies can be declared insolvent, but they cannot be put through the legal proceedings of bankruptcy.
In the US, individuals and businesses can file for bankruptcy after becoming insolvent. The legal proceedings can be applied to both entities.
Still wondering what is bankruptcy? Read our extensive guide on bankruptcy
What Are the Differences Between the UK and the US?
Aside from the difference between companies and individuals applying for bankruptcy, there are other fundamental differences between the UK and the US when it comes to these financial issues.
In the UK, an individual must have debts in excess of £5,000 to declare bankruptcy. In the US, the thresholds aren’t quite so simple and are based on different median incomes for individuals. However professional expertise is imperative, regardless of where you’re looking to file for bankruptcy.
In the UK, if a company declares insolvency, rather than being taken through the bankruptcy process as would happen in the US, the company is often liquidated. These legal processes essentially remove the company from the Companies House Register, effectively rendering it void. It can’t trade or continue as an entity. There are various forms of liquidation that can result from insolvency, with common routes being administration or a company voluntary arrangement.
In both countries, different rules and laws apply that state how any debt is paid off, if it’s paid off using personal assets or only company assets, and what time frames are imposed. Insolvency and bankruptcy both have strong implications for future finances, so these are not processes that should be taken lightly.
In the UK, being bankrupt will affect your ability to apply for credit cards or mortgages, you’ll often have to declare your bankruptcy, and you might be stopped from becoming the director of a company.
If you need to know more about the differences between insolvency and bankruptcy or discuss either process with a professional, our team of insolvency practitioners are ready to help you. Contact Irwin Insolvency today for more information.