Definition Insolvency vs Bankruptcy
Written by Rohan Lamprecht   

The term insolvency is commonly confused with bankruptcy and is often used incorrectly as a synonym for bankruptcy. Although both insolvency and bankruptcy deal with liabilities exceeding assets, insolvency refers to a financial state and bankruptcy to a distinct legal concept, a matter of law.

Insolvency is defined as a financial condition or state experienced when:

  1. A legal entity* or a person’s liabilities (debts) exceeds their assets, commonly referred to as 'balance-sheet' insolvency; or

  2. When a legal entity* or person can no longer meet their debt obligations on time as they become due, commonly referred to as 'cash-flow' insolvency.

Upon becoming insolvent immediate action must be taken to rectify the situation as soon as possible in order to avoid possible bankruptcy, by generating cash, minimizing overhead costs, cutting back on living expenses and settling or renegotiating current debts and debt repayments.

Bankruptcy is defined as a successful legal procedure that resulted from:

  1. An application to the relevant court by a legal entity* or a person in order to have themselves declared bankrupt; or

  2. An application to the relevant court by a creditor of a legal entity* or a person in order to have the legal entity* or person declared bankrupt; or

  3. A special resolution which a legal entity* files with the Registrar of Companies in order to be declared bankrupt.

(* legal entity: Close Corporation or Company )

A state of insolvency can lead to bankruptcy but the condition may also be temporary and fixable without legal protection from creditors. Insolvency does not necessarily lead to bankruptcy, but all bankrupt debtors are considered insolvent.