How Does Insolvency Differ From Bankruptcy?

Though no company plans to face financial struggles, even the most established companies are not immune. In 2024 alone, 23,872 businesses in England and Wales entered insolvency, highlighting how financial difficulties can affect companies of all sizes. 

During these challenging times, businesses may encounter terms like insolvency and bankruptcy. Though often mistaken for each other, these terms refer to distinct concepts. 

Understanding the difference between insolvency and bankruptcy is crucial for business owners, creditors and shareholders, as each carries different legal implications.

So, how does insolvency differ from bankruptcy?

In short, insolvency is a financial state where a business cannot pay its debts on time, while bankruptcy is a formal legal process which typically follows insolvency, notably only for individuals.

We’ll break down the key differences between insolvency and bankruptcy below, including how a solicitor can help businesses through insolvency cases. 

What Does Filing For Insolvency Mean?

Filing for insolvency signals that a business or individual can no longer meet their financial commitments as they become due. 

For businesses, insolvency may lead to restructuring options or agreements with creditors to regain financial stability. However, if a company cannot recover, insolvency can result in liquidation, where the company’s assets are sold off to repay creditors.

Insolvency can be classified in two ways:

• Cash Flow Insolvency: When an individual or business has assets of value, but lacks accessible funds to pay debts on time. Often, negotiating a repayment plan with creditors can help stabilise this situation.
• Balance Sheet Insolvency: When total debts outweigh total assets, meaning that even if everything was sold, the debts still couldn’t be fully repaid.

Insolvency requires careful legal management, especially for businesses that are facing complex creditor negotiations or other options like restructuring or liquidation. 

What Does Filing For Bankruptcy Mean?

Bankruptcy is a legal process available to individuals who can no longer repay their debts. It offers a structured way to handle financial failure, either by a personal choice or through action taken by creditors owed £5,000 or more. 

Unlike insolvency, which can apply to both individuals and businesses, bankruptcy is strictly for individuals. Companies must go through separate insolvency procedures tailored to their needs. 

Once a bankruptcy order is made, the individual’s assets, including their property, bank accounts, and valuable possessions, are assessed and, where possible, used to repay creditors. 

After the bankruptcy period ends, any remaining debts may be written off, offering a fresh start to those who were in financial difficulty.

How Insolvency and Bankruptcy Impact Creditors and Shareholders

While insolvency and bankruptcy both deal with financial distress, their effects on creditors and shareholders differ significantly.

Impact on Creditors

If a company is declared insolvent, creditors have a legal right to pursue repayment. The appointed insolvency practitioner will manage the distribution of any available funds from asset sales, but not all creditors may be paid in full. 

Secured creditors (those with collateral) generally have priority over unsecured creditors, and if assets are insufficient, shareholders may lose their investment entirely. 

For individual bankruptcy, creditors are no longer able to take further action or pursue the debtor after the bankruptcy period ends. 

Once discharged, any remaining debts are typically written off, giving the individual a fresh financial start. However, creditors must cease all legal actions during the bankruptcy process, with an official receiver handling all interactions. 

Impact on Shareholders

Since bankruptcy is a legal process that applies to individuals who are unable to repay their debts, shareholders are not directly impacted by an individual’s bankruptcy. 

However, shareholders can be affected by insolvency, as they may lose their investment if a company’s assets are insufficient to cover its debts.

Shareholder agreements can provide some level of protection and can prevent disputes between shareholders and directors, particularly regarding debt management. 

These agreements may also protect minority shareholders, who might otherwise have limited influence in critical decisions like liquidation or restructuring. However, some risks may not be covered in these agreements, such as family disputes or conflicts over company assets.

In the case of insolvency, businesses must prioritise the interests of creditors, often resulting in the cessation of trading. The protection offered to shareholders through agreements can help ensure that the company’s assets are handled properly, but in severe cases, it may not prevent total financial loss. 

Shareholders should review and update their shareholder agreements to adapt to any changes in the company’s financial situation or ownership structure. 

How Commercial Insolvency Dispute Solicitors Can Help

If your business is facing insolvency, it’s crucial to have expert legal support to manage the issues and disputes that arise. 

Insolvency dispute solicitors offer tailored solutions to protect your business, resolve disputes, and facilitate recovery. 

Insolvency often involves multiple stakeholders, including creditors, insolvency practitioners, and financial institutions, which requires careful legal management. Solicitors can guide these parties through challenging financial situations, encouraging collaboration towards a more successful outcome. 

Insolvency dispute solicitors can assist with a wide range of issues, including: 

• Liquidation and Receivership: Providing expert advice on the liquidation process or administrative receivership.
• Debt Restructuring and Recovery: Offering strategies to recover debts and reschedule financial obligations.
• Corporate Restructuring and Turnaround: Advising businesses on reorganisation strategies to avoid liquidation and return to profitability.
• Litigation and Dispute Resolution: Representing office holders in insolvency-related litigation, ensuring disputes are resolved efficiently.

Insolvency dispute solicitors use diverse expertise across areas such as employment law, debt recovery, and dispute resolution. 

This comprehensive knowledge enables them to handle every aspect of your business’s insolvency, whether you’re facing financial difficulty or working towards recovery.

How Can We Help

At Harding Evans, our insolvency dispute solicitors work with businesses to resolve disputes, negotiate with creditors and offer tailored solutions to protect your interests. 

Our extensive approach covers everything from corporate restructuring to debt recovery, so your business is positioned for the best possible outcome. 

Get in touch with us today to find out more.