There is an important difference between declaring bankruptcy and insolvency. Declaring bankruptcy occurs when a debtor voluntarily or involuntarily goes through the legal process of bankruptcy. Insolvency is a financial state that can be defined in one of two ways: As the inability to pay debts as they come due or having liabilities in excess of assets. A state of insolvency might cause a debtor to eventually file bankruptcy.
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In the past, most bankruptcies were involuntary, but now they are usually voluntary. In early days of English law, an insolvent entity, defined in this instance as inability to pay debts as they came due, was forced into bankruptcy by creditors.
Individuals and businesses can become insolvent and both can file for bankruptcy.
A company can cure insolvency by increasing assets, selling assets, being acquired or opening a line of credit. An insolvent individual can take actions such as budgeting, debt settlement, credit counselling or obtaining additional income through a part-time job to cure insolvency.
When a person or business files for bankruptcy, they are protected by the automatic stay from any attempts by creditors to obtain payment. An insolvent individual is not protected by the automatic stay and will face attempts by creditors to collect money owed. Collection attempts range from phone calls to lawsuits.
Filing for bankruptcy has a negative impact on an individual’s credit rating but allows a filer to discharge his debts. The solvency of individuals and companies can fluctuate so temporary insolvency is not as detrimental to an entity's credit rating as bankruptcy. But insolvency will impact a credit rating indirectly by influencing factors such as ability to pay and amount of credit used.