Insolvency vs. Bankruptcy: Expert Answers

Knowing the difference between insolvency and bankruptcy is crucial, as both have different legal and financial implications. In short, insolvency means that you can’t pay your debts as they fall due, which can lead to bankruptcy, also called sequestration. Insolvency is a state of financial distress, whereas bankruptcy is a legal process.

This post discusses the differences between sequestration and insolvency and how to address them.

Key Differences between Insolvency and Bankruptcy

Insolvency is a financial state of distress and bankruptcy is a legal process.

Insolvency

A person is insolvent when they can’t pay their debts as they fall due or their liabilities exceed their assets. Not all insolvent people are bankrupt, but all bankrupt people are insolvent.

Unlike bankruptcy, insolvency can be short-lived, fixed through debt restructuring (such as debt mediation or debt review) or repaying debts.

Bankruptcy

Bankruptcy, or sequestration, usually follows in the wake of insolvency. In South Africa, people declared bankrupt (either by themselves or by creditors) have their assets repossessed to cover at least 20% of their debts. The rest of the debt is written off.

Being declared sequestrated can last for several years unless you get a rehabilitation order. After a rehabilitation order, you could be released from sequestration in four years or less. Without one, you would have to wait 10 years for the flag to fall off your credit profile.

Declaring yourself bankrupt automatically relieves you of your debts (after due process), whereas merely being insolvent doesn’t relieve you of anything, it’s just a state of financial distress.

How to Combat Insolvency

Since insolvency is a state of financial distress where you can’t pay your debts or your liabilities exceed your assets, you can combat it with a simple solution: reducing your debts or liabilities. There are three ways of doing this: debt review, repaying your debts, or debt mediation.

Debt Review

Debt review is a legal process wherein a debt counsellor negotiates for cut interest rates and reduced repayments. Under debt review, you’ll be protected from legal action from creditors, since under the National Credit Act (NCA), creditors may not take action against you once you’ve notified them you’ve begun restructuring your debts.

First, your debt counsellor submits a proposal to your creditors. If unsatisfied, your debt counsellor and creditors will negotiate the repayment plan until it’s ready to be submitted to the Magistrate’s court.

Once the Magistrate’s court has approved it, you make a monthly payment to a PDA (payment distribution agency), which will fairly distribute your payments among your creditors. Typically, the process lasts three to five years but can last longer if you have increased or decreased repayment capacity (money you have to repay your debts).

Once you’ve finished paying everyone back, your debt counsellor will issue you a clearance certificate, which states you are no longer over-indebted. You can submit this to the credit bureaus, which must expunge all records of the debts leading up to debt review and the flag itself.

Repay Your Debts

If you’re struggling to pay your debts, you might tackle them from a different angle. There are two expert-approved ways to tackle debt: the snowball and avalanche methods.

The snowball method works by tackling your smallest debt first. Once you’ve paid that off, you pay off a larger one, then a larger one, and so on until all your debts are paid off. People like this method because it provides a sense of accomplishment. However, this method isn’t always sustainable in the long run, as the debts with more interest will keep accruing debt, enlarging your overall balance.

This is why we typically suggest the avalanche method. When using the avalanche method, you tackle the debt with the largest interest rate first, then the second largest, and so on. This method is more effective because you eliminate debts that accrue more debt first, reducing your overall debt amount in the long run.

Use a Debt Mediator

Debt mediators also negotiate for reduced interest rates and repayments, but can’t offer you legal protection as debt review does. If you default on a payment, you’ll face the same ensuing legal consequences you would have had you not used a debt mediator.

Debt mediators are best for people who are only slightly over-indebted – can still afford living expenses, but have little to no disposable income. In contrast, debt review is best for grossly over-indebted people. This could look like taking out loans to cover living expenses or loan repayments, being unable to afford essentials such as school fees because of repayments, or receiving a letter of demand (S129) after defaulting.

How to Combat Bankruptcy

If you’re bankrupt, you’ve probably been sequestered. You can only remove sequestration after applying for a rehabilitation order. You can do this under three conditions:

• Your trustee isn’t paying your creditors as often as you could (for instance, if you could pay them monthly, but your trustee pays them once every three months).
• If you can offer your creditors 50 cents for every rand you owe them, either as a deposit or monthly payment
• If it’s been four years since the date you were sequestered (or less, but this is at the discretion of the High Court).

There’s a certain court process you must follow to apply for a rehabilitation order.

After you’ve applied for a rehabilitation order, you must submit it to the bureaus. Once rehabilitated, you’ll be able to apply for credit as normal, all debts that you accrued during and before sequestration will be written off, and you’ll be able to act as a company director again.

How Can Credit Rehab Help?

We’re experts in debt mediation, debt review, voluntary sequestration, and rehabilitation orders. Our legal experts have years of experience helping people fight their debt, be that through declaring bankruptcy, debt review, rehabilitation orders, or debt mediation.

Let our experts help you – contact Credit Rehab now.