Insolvency and bankruptcy – what’s the difference?

When an individual experiences final hardship, the prospects of personal insolvency and bankruptcy are front of mind.  Insolvency and bankruptcy are often terms that are referred to and used interchangeably, however these are two independent concepts with differing circumstances and legal consequences.

This article seeks to explain the differences between insolvency and bankruptcy and the implications of each for individuals experiencing financial difficulty.

What is personal insolvency?

Personal insolvency is a financial state in which an individual is considered unable to pay their debts as and when they fall due.  Determining whether an individual is insolvent can be complex and often requires analysis and assessment of a number of varying factors.

If insolvency is not dealt with promptly, it can have drastic consequences for individuals.

What is bankruptcy?

Bankruptcy is a legal option available to individuals who are experiencing prolonged personal insolvency.

It is a legal process in which an individual is declared ‘unable to pay their debts’ by the Australian Financial Security Authority.  A trustee is appointed to manage the bankruptcy by controlling the individual’s property and financial affairs with a view to releasing them from most of their debts and allowing them to make a fresh start.

What are the differences between insolvency and bankruptcy?

The key distinction between personal insolvency and bankruptcy lies in their nature.  Whilst personal insolvency refers to an individual’s financial state, bankruptcy refers to an individual’s legal status.  When a person is insolvent, they are unable to meet their debt obligations as and when they fall due.  In these circumstances, it is crucial to explore available options to address their insolvency, one of which is declaring bankruptcy before a creditor applies to the court for an order to have them declared bankrupt.

What are the consequences of personal insolvency and bankruptcy?

The consequences of personal insolvency vary depending on the seriousness of the individual’s financial difficulties and the action taken by the insolvent individual. For example, overdue payments can be recorded on an individual’s credit file and can have a negative impact on their credit score.

Bankruptcy, however, carries far more significant consequences for insolvent individuals.  These can include compulsory payments to a trustee if income exceeds a set threshold, restrictions on employment or business activities, the need for trustee approval to travel overseas, permanent listing on the National Personal Insolvency Index (NPII), reduced access to future credit, potential sale of assets by the trustee, and loss of the right to commence or continue legal proceedings.

How we can help

If you find yourself in financial difficulty or facing insolvency, it is important to know your options and seek advice at an early stage.  Upon determining that you may be insolvent, you should get in touch with your financial and legal advisors.  By acting early, you will maximise your prospects of a better outcome.

The Coulter Legal Litigation & Dispute Resolution team have significant experience acting for insolvent individuals and both for and against bankruptcy trustees.