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WHAT IS THE DIFFERENCE BETWEEN INSOLVENCY AND BANKRUPTCY?

September 5, 2017

Many people and companies are or can be insolvent without being bankrupt.  One of the criteria for becoming bankrupt is being insolvent.  We might use the analogy that all apples come from trees but not all trees produce apples.

Liquidity is a word that we hear bantered around – back in 2008/9 Canadian banks were having “liquidity issues” meaning they did not have any money on a day to day basis to be positioned to lend.  You might think about it this way:  You got paid on Friday and you paid your bills with your pay cheque – now you have nothing left except overdraft facilities on your account and that has been maxed out – you are lacking liquidity.  When your spouse’s paycheque is deposited on Thursday and your overdraft is paid down you return to liquidity.

It is the lack of liquidity that we refer to as “insolvent” – so in that sense the Canadian banks were “insolvent”.  The government purchased a whole lot of questionable mortgages ($114 billion worth) through CMHC which returned the banks to “liquidity”.  They were put back in a position where they had “liquid assets” (cash) that they could lend in order to continue business.

People and most businesses do not get “liquidity loans” from the government, as a result when they become insolvent they often turn to a trustee in bankruptcy to try to restructure the debt and hopefully return to a position of “solvency” or “liquidity”.  In some cases this can be done without actually declaring bankruptcy, by using some form of proposal or structured settlement, in others the debtor makes an assignment into bankruptcy.

Becoming bankrupt is a process that is typically initiated by the individual seeking relief but it can be started by a creditor who is frustrated and wants to see an orderly winding up of the company’s (or individual’s) assets.  The creditor has to spend money to get a court order declaring the company (rarely used for individuals) bankrupt.  The debtor voluntarily enters into the process making a declaration of bankruptcy – assigning their assets, such as they may be, to a trustee to see if there is anything that can be sold (liquidated) to make some form of restitution to the creditors.

At the end of the process an individual is “discharged” or released from bankruptcy and returned to liquidity.  Companies do not get discharged – they may get sold off to generate money to repay creditors and in some cases carry on business under new ownership again restored to liquidity by the bankruptcy process.

So at bottom all bankrupts are insolvent but not all insolvents are bankrupt.  For more information about how all of this relates to your situation call the office for a free consultation.