What is the Difference Between Bankruptcy & Insolvency?
Understanding the difference between bankruptcy and insolvency is crucial for anyone grappling with financial distress. In this comprehensive guide, we delve into the nuances of these financial states, how they impact individuals and businesses, and the legal implications in the Canadian context.
Financial Distress: Understanding Bankruptcy, Insolvency, and Default
Often, the terms bankruptcy, insolvency, and default are used interchangeably, leading to confusion. Though all three terms are related to debt, their meanings are distinct.
Insolvency represents a state of monetary hardship where an entity is unable to meet its debt obligations. Bankruptcy, on the other hand, is the legal process that an insolvent debtor can opt for, wherein they surrender assets in exchange for relief from debts.
Interestingly, one can be insolvent without being bankrupt. However, to declare bankruptcy, one must be insolvent, as mandated by law. Understanding these differences is crucial as it determines whether an individual or entity is eligible for filing bankruptcy in Canada or if they need to declare bankruptcy at all. It also aids in selecting the appropriate consumer insolvency solution – bankruptcy or consumer proposal.
Criteria for Bankruptcy: Deciphering the Solvency Test
Bankruptcy is a legal procedure where the debtor assigns their assets for their creditors’ benefit, following which the debts are discharged.
To qualify for bankruptcy, one must be insolvent, meaning they cannot meet their debt obligations as they become due. This may occur due to shortage of funds when bills are due, or if the amount owed to creditors exceeds the debtor’s assets.
Insolvency, as per the Bankruptcy & Insolvency Act, is defined as the financial state of being unable to fulfill debt obligations as they become due. Essentially, it is a snapshot of your current financial status. Are your debts more than your assets? Is your cash flow so poor that you can’t pay your bills?
It’s crucial to note that defaulting on your loans doesn’t necessarily mean you’re insolvent. Default is a state that occurs when you miss payments. People miss payments for various reasons – sometimes by accident, other times due to a shortage of cash. Struggling to pay monthly bills or missing a payment or two doesn’t automatically make you insolvent or a prospective bankruptcy candidate.
Contrary to common perception, you can’t file for bankruptcy to eliminate debts if you possess sufficient money or assets to settle those debts independently.
The solvency test, which determines eligibility for bankruptcy, differs from the means test used in U.S. bankruptcy law, where eligibility is based on income. In the U.S., your income must be below the median income limit for a household of your size to declare bankruptcy. In contrast, in Canada, there is no means test. Here, you qualify if you owe more than $1,000 in debts and are insolvent.
Insolvency Proceedings in Canada: An Overview
In Canada, bankruptcy trustees are now referred to as Licensed Insolvency Trustees. The legislation that governs bankruptcy law in Canada is the Bankruptcy & Insolvency Act.
Canada offers two government-administered insolvency options to manage your debts: personal bankruptcy and consumer proposal. Both these options provide debt relief and protection from legal action by creditors and can only be administered by a Licensed Insolvency Trustee.
Evaluating the Need for Insolvency
To assess if you are insolvent and a potential candidate for insolvency, consider the following queries:
- Are you consistently overdue on your bill payments?
- Does your debt exceed the worth of your assets?
- Are you perpetually using credit to meet basic living expenses like rent and groceries?
- Do you regularly run out of money by the month’s end and can’t recover without debt?
- Are your debt balances increasing every month because you use debt to offset other debts?
- Is your debt so extensive that you can’t possibly repay it?
If most of your answers are affirmative, you might benefit from consulting with a Licensed Insolvency Trustee to determine if bankruptcy or a consumer proposal is the right insolvency solution for you.
