Insolvency vs. Bankruptcy: What’s the Difference?

Struggling with debt can be overwhelming and leave you unsure about what comes next. During these stressful financial times, terms like insolvency and bankruptcy often arise, but what do they actually mean? And are they different?

In this blog, we’ll explore what insolvency and bankruptcy are, how they differ and the options available under Australian law so that you can navigate these difficult times with clarity and the right legal guidance.

What is insolvency?

Insolvency is a financial state where a person or company can no longer pay their debts, including amounts owed to creditors, meaning you owe more than you can currently pay. 

This can arise for many reasons, including:

• losing key clients or contracts, which can quickly dry up income;
• poor cash flow management that leaves you unable to meet payment deadlines;
• bad investment decisions that don’t generate returns;
• rising costs from suppliers, pushing expenses above income; and
• unexpected expenses such as legal fees or repair costs after natural disasters.

While insolvency signals serious trouble, it’s not always the end. With the right advice, individuals and companies can explore paths to manage debts, protect assets, and sometimes rebuild. 

The main Australian insolvency law regulation includes:

• Corporations Act 2001 (Cth): Covers directors’ duties, the roles of administrators and liquidators, and outlines corporate insolvency processes.
• Bankruptcy Act 1966 (Cth): Sets the rules for personal bankruptcy, including trustee appointments, asset handling, and individual obligations.
• ASIC’s Role: ASIC regulates insolvency professionals, ensures compliance with the Corporations Act, and investigates director or administrator misconduct.

What is bankruptcy?

Bankruptcy is a legal process designed for individuals who can’t repay their debts, handing control of most of their assets and income to a trustee. The trustee’s job is to manage what’s left and repay creditors as fairly as possible.

Australian bankruptcy law is governed by the Bankruptcy Act 1966, and some important facts  to consider if you are facing potential bankruptcy include: 

• you can go bankrupt by applying yourself or through a creditor’s court action;
• a trustee takes control of your assets and income during bankruptcy to repay debts;
• bankruptcy lasts three years and one day from when your financial details are lodged;
• you have 28 days (up from 21) to respond to a bankruptcy notice;
• the threshold for forced bankruptcy has increased from $10,000 to $20,000; with annual indexation requiring creditors to meet this higher debt amount to file;
• you’ll be listed on the insolvency index and face limits on borrowing, directorships, and certain jobs;
• a discharged bankruptcy stays on the National Personal Insolvency Index (NPII) for seven years; and 
• most unsecured debts are cleared, but some (like child support or fines) still need to be paid. 

Bankruptcy vs insolvency: Key differences 

People often mix up these terms, but they’re not interchangeable. Let’s compare the two:

Insolvency options in Australia

If insolvency strikes, there are options designed to help manage the financial distress: 

Liquidation

Liquidation is the process of closing a company by selling its assets to repay creditors, and it ends the company’s operations. There are 3 types: 

• Creditors’ voluntary liquidation (CVL) → Directors and shareholders agree to wind up an insolvent company.
• Court-ordered liquidation → A creditor applies to the court to liquidate a company with unpaid debts.
• Members’ voluntary liquidation (MVL) → A solvent company chooses to close, often for tax or structural reasons.

Small business restructuring

This option helps businesses with under $1 million in debt to restructure and repay creditors without full administration. A practitioner guides the process and creditors must approve the plan.

Voluntary administration

Gives a struggling company a short pause to assess its future. An independent administrator reviews the situation and may return the business to directors, propose a Deed of Company Arrangement (DOCA) or recommend liquidation.

Receivership

A secured creditor appoints a receiver to sell specific assets and recover money owed. The business may keep operating if other parts aren’t affected.

Bankruptcy options and consequences

Individuals facing bankruptcy have several debt solutions in Australia:

• Voluntary bankruptcy → applying to be declared bankrupt when debts are unmanageable. This process lasts at least three years and one day, after which most unsecured debts are wiped.
• Debt agreement → a legal deal is made to repay a portion of debts over time, avoiding full bankruptcy. Suitable for those with a steady income but limited means to repay in full.
• Personal insolvency agreement → a flexible formal agreement, often for those with higher debts or assets, which may involve lump sum payments or asset sales.
• Temporary debt protection (TDP) → provides 21 days’ relief from creditor action to consider options before committing to bankruptcy or agreements.

Consequences of bankruptcy include:

• loss of assets (except basic personal) that may be sold to repay creditors;
• limitations on borrowing, acting as a company director and professional licences;
• income contributions may be required if income exceeds thresholds;
• bankruptcy stays on your record for five years or longer; and
• you must cooperate with your trustee and report changes in financial circumstances.

Which one is for you? 

Choosing between insolvency options and bankruptcy depends on your situation:

• If your assets are few and debts are overwhelming → voluntary bankruptcy might be the practical reset, despite long-term effects.
• If you have regular income and can pay some debts → a debt agreement may offer a less harsh path.
• If you have larger assets or debts → a personal insolvency agreement could provide flexibility.
• If you need time to assess your finances and options → temporary debt protection gives breathing space.

Because of the sensitive nature of this situation, we always recommend seeking legal advice. This helps you understand the implications, navigate the process and protect your future.

The role of insolvency and bankruptcy lawyers

Insolvency lawyers provide the right support to navigate these challenging processes, advising on obligations and opportunities. They can assist you with: 

• assessing your rights, risks and options before you take steps;
• handling petitions, notices and necessary legal paperwork with courts or authorities;
• advocating for you in disputes or discussions with creditors;
• ensuring your interests are protected during asset management and distribution;
• helping directors understand their duties and reduce personal liability; and
• representing clients in court challenges over bankruptcy or insolvency actions.

Read about “What do lawyers do in insolvency?”.

Struggling with debt? You’re not alone. H+A Legal can help.

Insolvency and bankruptcy can be overwhelming, but it doesn’t have to be faced alone. With the right support, you can understand your options and what would work best for you. 

At H+A Legal, we provide experienced, practical legal support tailored to your needs. Our team specialises in business law, assisting with bankruptcy and insolvency, debt recovery, commercial disputes and more. 

If you or someone you know is struggling with debt, don’t wait. Reach out for trusted advice and contact us!