What’s The Difference Between Insolvency & Bankruptcy?

Whilst both terms are associated with debt and financial insecurity, there is a crucial difference between insolvency and bankruptcy. This article looks at what that difference is, why it’s important, and the situations in which a company might find themselves insolvent or bankrupt. So, without further ado, let’s take a look at what each of these terms mean before we consider the difference between insolvency and bankruptcy. 

What Is Insolvency?

Insolvency is an umbrella term used to describe a state of financial distress, referring to when a company or individual is unable to pay their debts on time. There are two main types of insolvency for a company that you’ll often hear people talk about. These are:

Cash-flow insolvency: When a company does not have cash resources to pay its debts as they fall due, they are facing cash-flow insolvency. 

Balance-sheet insolvency: When a company’s debts are greater than the total value of assets they own, this is known as balance sheet insolvency. In this instance however, the company may still have sufficient cash flow to keep paying their bills as they fall due.

At this point it’s important to emphasise that when a company is facing insolvency, this doesn’t necessarily mean that they will be unable to recover financially. Companies that are declared insolvent may be able to recover the company via a business rescue plan. Alternatively they may place the company into Creditors Voluntary Liquidation (CVL), or sell the business on via a company administration.

Whilst insolvent companies have options to help them recover and return to profitability, any reference to a ‘bankrupt’ company implies that it has ceased to trade and will almost always need to liquidate. This highlights the main difference between insolvency and ‘bankruptcy’ as regards companies.  With this in mind, let’s take a closer look at what exactly bankruptcy entails. 

What Is Bankruptcy?

In the UK, the term ‘bankruptcy’ refers to a legal process in which an insolvent individual either applies for their own bankruptcy, or a court makes a bankruptcy order based on the petition of the individual’s creditors.

However the Americanised use of the term often extends to companies and not just individuals. It’s important to note that the American use of the word ‘bankruptcy’ differs from the English understanding of the term, even though you might see the Americanised terminology used interchangeably. In America, bankruptcy can apply to both businesses and individuals, while in the UK, bankruptcy only applies to individuals being declared bankrupt. The UK version of bankruptcy for a company is liquidation. 

Bankruptcy (or liquidation) refers to when companies find themselves in a terminal financial situation where they are unable to recover their debts and the only option is to liquidate their assets. 

Insolvency Vs Bankruptcy – What’s The Difference?

The main difference between insolvency and bankruptcy is that bankruptcy is a formal, terminal event, whilst insolvency is a specific financial state at a given point in time which may be recoverable. For companies that are bankrupt, liquidation is the only resort. A company that is insolvent, on the other hand, has more options. They may choose to liquidate the company, however they also have the option to implement a business rescue plan or put the company into administration.

Another important difference to note is that whilst bankruptcy refers to a formal, terminal event, ‘insolvency’ is an umbrella term. When a company is insolvent they may enter formal insolvency proceedings such as a CVL, however the term ‘insolvency’ itself does not refer to a terminal event, but rather a state of financial insecurity. 

It’s crucial to remember that a company that is bankrupt is insolvent, however a company that is insolvent is not necessarily bankrupt. This is a crucial difference between insolvency and bankruptcy that highlights how both involve financial instability, however insolvency, as an umbrella term, is not always a terminal situation for companies. 

What Are The Options For My Company?

As we’ve mentioned through looking at the difference between insolvency and bankruptcy, bankruptcy is a terminal position for a company to find themselves in. In order to prevent bankruptcy, you should consult the advice of a licensed insolvency practitioner at the first signs of insolvency. Whilst insolvency is never a favourable position to be in, insolvent companies do still have options. Where it is realistic to do so, this may involve restructuring and returning the business to profitability. Alternatively, the best option may be to liquidate the company in order to remove creditor pressure, and wind up the companies’ debts correctly. A third option may be administration, in which the company is protected from creditor pressure, to facilitate the sale of the business, or to allow for restructuring. 

To discuss the options that are available to your business, please don’t hesitate to contact our experienced team of licensed insolvency practitioners for confidential advice.