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What is the Difference Between Insolvency and Bankruptcy?
IMPORTANT LINKS
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GS Paper |
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Topics for UPSC Prelims |
Bankruptcy, Insolvency, Insolvency and Bankruptcy Code (IBC) |
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Topics for UPSC Mains |
Comparison of Bankruptcy and Insolvency Laws, Economic Impact of Bankruptcy, Role of IBC in Financial Recovery |
What is Insolvency?
The situation where an individual or a body fails to pay the debts when and as they fall due is known as insolvency. Generalizing this would simply point out that liabilities surpass assets. It is among the very first symptoms of distress over one's finances, and there may either be a cause of insufficiency in the management of cash or due to an escalation of inflowing cash, or because of some unbudgeted expenditure. Insolvency can be either transient or chronic; if not treated at the right time, it can further become bankruptcy.
The signs of insolvency include:
- Cash Flow insolvency: The individual is not able to pay back the debts when they become due and payable even though assets are more than liabilities.
- Balance Sheet insolvency: Liabilities are greater than the assets, thus it has a negative net worth.
Read the article on the Insolvency and Bankruptcy Board of India (IBBI)!
What is Bankruptcy?
Bankruptcy is a status conferred by a court. It refers to a process in which an insolvent individual or legal entity takes the initiative to declare the inability to pay debts. The process in a bankruptcy case involves inspection by the court and quite often it forms the basis of fair and equitable distribution of debt to be paid among the creditors. In the majority of countries, speaking generally, bankruptcy laws finally result in either liquidating or rehabilitating the business.
Major steps carried out in bankruptcy include:
- Voluntary Bankruptcy: The debtor initiates the process and seeks relief from debt.
- Involuntary Bankruptcy: The creditors start the process by filing a petition against the debtor.
- Bankruptcy Decision: This could either be in the liquidation of assets to pay debt or reorganizing debt obligations to ensure continuation of business.
Read the article on the Insolvency and Bankruptcy Code (Amendment) Bill, 2020!
What is the Difference Between Insolvency and Bankruptcy?
To understand these terms clearly, it becomes important to distinguish between the two concepts. The following table captures the significant differences:
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Difference Between Insolvency and Bankruptcy |
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Aspect |
Insolvency |
Bankruptcy |
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Definition |
Situation when liabilities surpass the value of assets. It is a condition that is usually transient. |
Legal proceeding wherein a court declares a company or business entity unable to pay debts. |
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Nature |
Financial position or standing |
Court granted legal proceeding and status |
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Indicative Factors |
Inability to meet debt obligations, negative cash flow, or negative net worth. |
Formal order or judgment by court after due process. |
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Resolution |
It can be settled through compromise, refinancing, or liquidation of assets. |
Legal proceedings end in liquidation or reorganization. |
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Process Initiation |
Identified by management, creditors, or balance sheet. |
Initiated by debtor or creditors through legal filing. |
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Outcome |
Regain financial health with or without judicial procedure |
Results in discharge or restructuring of debts through court intervention. |
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Scope |
General applicability to persons, businesses, or firms which need not file court procedures |
Applicable to specific persons or business enterprises that seek formal debt relief through the courts. |
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Duration |
Can be temporary or continuing depending on the recovery measures taken to reassert financial health. |
Duration defined by legal proceedings, can be extended and complex. |
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Legislation in India |
Partially covered under the general financial regulations and corporate law, for example, Companies Act. |
Governed by Insolvency and Bankruptcy Code (IBC) 2016. |
Read the article on the Changes in Insolvency Act!
Conclusion
This distinction between insolvency and bankruptcy will act as a premise of understanding financial distress and how the law steps into action. Financial bankruptcy refers to the first stage, a state of insolvency whereby liabilities outweigh the assets. Bankruptcy is a judicial process intended to obtain debt relief by liquidating some of a debtor's assets or readjusting obligations that a creditor has against the debtor. It plays a very central role in the prevention of economic bankruptcy and to facilitate creditors and debtors' management during financial collapse.
Read the article on NBFCs & IBC!
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Key Takeaways for UPSC Aspirants
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What is the Difference Between Insolvency and Bankruptcy UPSC FAQs
What happens to debt in insolvency?
In case of insolvency, the debts are still payable, but it cannot be paid out because there is no fund or asset to cover up against it. Debtors are free to negotiate terms on creditors or seek legal relief upon application for the insolvency resolution process.
What is the punishment for insolvency?
Insolvency itself is not punishable; however, mismanagement or fraudulent activity causing insolvency could attract the consequences and penalization through corporate laws.
Am I eligible to get a loan after I am insolvent?
It is pretty difficult to get a loan after a person becomes insolvent as the lender always considers those who were earlier insolvent as a higher risk individual or business, but time and the consequent healthy financial situation may help a person.
What role does the Insolvency and Bankruptcy Code (IBC) 2016 play in India?
The IBC 2016 provides an integrated approach, which includes dealing with insolvencies, mechanisms in resolving financial distress, as well as maximum recovery by the creditors.
What is the difference between bankruptcy and insolvency?
The term insolvency can be defined as the financial situation in which an individual or an organization is incapable of paying his or her debt. Bankruptcy, however, is the judicial declaration of the court that declares an insolvent person or business bankrupt.
What is the impact of declaring insolvency?
Whenever there is the mention of insolvency, it implies that the individual cannot pay the debts. The debtor can negotiate with creditors or refinance and can be compelled to court if the situation persists.