Answer to the Question: “Is Insolvency and Bankruptcy the Same Thing?”
People use the terms insolvency and bankruptcy interchangeably to refer to a state of financial distress. However, before using bankruptcy as a synonym for the term insolvency, one has to ask: “Is insolvency and bankruptcy the same thing?” We provide an answer to the question and clarify other issues as well, helping you to make an informed decision regarding an application for voluntary sequestration in South Africa.
Are Insolvency and Bankruptcy the Same Thing?
First, let us consider what the terms have in common. Both terms refer to a state where the natural person or business entity struggles to pay debts when due. In addition, both refer to the issue of liabilities that exceed assets.
Considering the above, it is only natural to ask if insolvency and bankruptcy are the same thing. Here is the main difference: bankruptcy is a legal concept and insolvency refers to the financial state of the business entity or the natural person. It is not a legal concept and not the same thing as bankruptcy.
What Does the Insolvency Act State?
It defines insolvency as a financial state where the legal entity’s debts are more than the entity’s assets. This legal entity can be a business or person. This financial state refers to the balance sheet of the person or entity. If one would list assets on the one side of the balance sheet and liabilities on the other, the total of the liabilities is then more than the value of the assets.
Insolvency is also defined as a financial situation in which the legal entity, whether it be a business or natural person, is unable to pay debts on time as the debts become due. This type of insolvency refers to the cash-flow problem. If the person is able to pay their debts when due, the person’s assets can be less than the liabilities and the person can still function financially. Many people are thus in a state of balance sheet insolvency, but they still manage to pay the debts as and when due. The problem comes in when the liabilities exceed the assets and the legal entity is unable to meet debt obligations when due.
In the instance of being cash-flow insolvent, the entity must take immediate action to rectify the problem in order to avoid becoming bankrupt. In terms of a business entity, the directors can cut on overheads, restructure the company, reduce the number of employees, and follow up on debts due by clients to generate cash in order to return to a solvent state.
The natural person can cut on overheads. Such a person can, for instance, cancel subscriptions to Internet channels, stop their gym membership, cancel insurance policies, down-grade their phone contracts, and generate extra cash through selling goods on markets over the weekends. They can sell their vehicles to pay off debts or sell one of their immovable properties to eliminate having to pay rates and taxes on the property and monthly bond instalments.
The person can apply for a debt consolidation loan to cover all the debts and then only pay the particular debt. They can borrow money from a family member to pay off credit and store cards.
In both instances of a business or natural person, it is possible to negotiate the restructuring of the debts to lower monthly instalments. This is best done with the help of attorneys, as such an act can be taken as an act of insolvency, giving the creditors the right to apply for the liquidation of the business or sequestration of the natural person.
As to the question of whether insolvency is the same thing as bankruptcy, we can already answer no. They are not the same thing. Let us investigate further. The term “bankruptcy” is defined as the outcome of a legal procedure in which the legal entity, such as a business or a natural person has applied to court to be declared bankrupt.
The above is a voluntary application. A creditor can also bring the application to have the business or person declared bankrupt. In this instance, it is a hostile or compulsory liquidation or sequestration. Liquidation is relevant to a business, whereas sequestration is relevant to a natural person. When it comes to a business, the board of directors or members of the close corporation can, by means of a special resolution that is filed with the Registrar of Companies, have the business entity declared bankrupt.
The insolvent state can thus be temporary, but bankruptcy only results after the Court or Registrar of Companies has awarded the status of bankrupt to the legal entity. As to the question of insolvency and bankruptcy being the same thing, we can thus answer that, although the terms have some factors in common, they do differ in meaning. Contact our attorneys for legal assistance to apply for voluntary sequestration or liquidation in South Africa.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Call on our attorneys rather than relying on the information herein to make any decisions. The information is relevant to the date of publishing.