If you have unmanageable debt, you may resort to insolvency or bankruptcy. Both are legal avenues to help you regain control of your finances and get a fresh start. 

While both insolvency and bankruptcy offer relief from overwhelming debt, they are not interchangeable terms. Each has its own implications and can significantly impact your financial future, so understanding the differences between these two concepts is a must.

Below, we’ll break down the key differences between insolvency and bankruptcy in Australia, including their definitions, scope of application, eligibility requirements, step-by-step processes, and potential consequences.

Bankruptcy vs Insolvency: Definition

Bankruptcy refers to a formal legal status governed by the Bankruptcy Act and overseen by the Australian Financial Security Authority (AFSA). If you’re declared bankrupt, it means you are unable to repay your debts and require legal intervention to manage your financial affairs. 

Bankruptcy can be initiated in two ways:

• Voluntary bankruptcy is initiated by the debtor (you) when you realise you cannot meet your financial obligations.
• Involuntary bankruptcy is initiated by your creditor through a court order when you fail to repay your debts.

On the other hand, personal insolvency (sometimes referred to as “part 9” or “part 10” debt agreements) is a legally binding agreement between a debtor and their creditors. This agreement outlines a plan to repay debts over a specified period, often at a reduced amount or interest. 

If you’re experiencing temporary financial difficulties or when your total liabilities exceed your total assets, personal insolvency can be a suitable option.

Both bankruptcy and personal insolvency can encompass:

• Secured debts or debts tied to specific assets, such as a mortgage on a house or a loan on a car.
• Unsecured debts or debts not tied to any particular asset, such as credit card debt or personal loans.
• Joint debts 
• Tax debts

Insolvency vs Bankruptcy: Eligibility

There are no strict debt or income limits to be considered insolvent in Australia. The determination of insolvency is based on a case-by-case assessment of your financial situation. Factors considered include your assets, liabilities, income, and expenses. If your debts exceed your assets and you cannot meet your financial obligations, you may be considered insolvent.

In contrast, to be eligible for bankruptcy in Australia, you must meet the following criteria:

• Inability to pay debts. You must be unable to pay your debts when they are due. This means your liabilities exceed your assets, and you have no realistic prospect of repaying your debts.
• Connection to Australia. You must be physically present in Australia or have a residential or business connection to Australia. This ensures that the Australian legal system has jurisdiction over your bankruptcy proceedings.

There are no minimum or maximum debt amounts to be eligible for bankruptcy. However, if you owe less than $10,000, your creditors cannot force you into bankruptcy.

Insolvency vs Bankruptcy: Processes

You can deal with insolvency through either informal or formal options. You can try to resolve your insolvency informally by negotiating directly with your creditors, proposing a revised payment plan, requesting a temporary reduction in payments, or exploring debt consolidation options.

If informal arrangements are unsuccessful or unsuitable, you can opt for formal insolvency administrations, such as a Debt Agreement (Part IX) or Personal Insolvency Agreement (Part X), which are legally binding agreements administered by an insolvency practitioner.

Bankruptcy, being a formal legal process, follows a more structured approach. For voluntary bankruptcy, the process begins with you voluntarily filing a debtor’s petition through AFSA. A creditor can also file a petition with the Federal Court, seeking a sequestration order to declare you bankrupt.

Once bankruptcy is declared, AFSA appoints a bankruptcy trustee to manage your assets and debts. The trustee’s responsibilities include:

• Assessing your assets and selling them (if needed) to generate funds for your creditors
• Distributing the proceeds from asset sales to your creditors according to a priority order
• Investigating your financial affairs to ensure all assets are identified and any voidable transactions are reversed

Insolvency vs Bankruptcy: Consequences

The consequences of personal insolvency depend largely on the specific debt management solution you choose. For example, formal debt agreements like Part IX or Part X will be listed on your credit report for five years and can make it harder to obtain credit in the future. Your name will also be listed on the National Personal Insolvency Index (NPII).

If you are a business owner, insolvency can lead to business closure if you cannot negotiate a viable solution with your creditors.

The effects of bankruptcy can be more severe and long-lasting. They can include:

• Travel restrictions. You may need to seek permission from your trustee to travel overseas during your bankruptcy.
• Forced income contributions. If your income exceeds a certain threshold, you may be required to make mandatory contributions towards your debts.
• Asset sale. Your assets, including your home, car, and investments, may be sold to repay your creditors.
• Poor credit report. Bankruptcy will be listed on your credit report for five years (or longer in some cases), making it difficult to obtain credit and potentially impacting your ability to rent a property or secure certain services.
• Negative employment impact. Bankruptcy may affect your current or future employment in certain industries, such as finance or law.

Explore your debt solutions with Debt Negotiators

If you’re unsure which debt solution is best for your circumstances, contact us or start with a free debt assessment. Our team of experienced financial advisors can provide personalised guidance and support. 

We help you understand your options, assess your eligibility for insolvency or bankruptcy, and create a plan to regain control of your finances.