Insolvency vs Bankruptcy – What’s the Difference?

A common misperception is that insolvency and bankruptcy are the same thing. This is not necessarily the case. The two terms can be related, but they’re not interchangeable. 

In this “insolvency vs bankruptcy” article, we’ll get into the definition of each term, how they relate to each other, and how each term may relate to you.

Note – For the purpose of this article, we’re going to be discussing personal insolvency vs bankruptcy. For information relating to corporate bankruptcy, please check out this blog on the topic.

Insolvency vs Bankruptcy – A Quick Definition of Each Term

The main difference between insolvency vs bankruptcy is as follows:

• Insolvency – when someone is facing insolvency, it means they are unable to meet their monthly or total financial obligations.

• Bankruptcy – is one of three different legal processes available to people that are insolvent and unable to pay their financial obligations.

When a person is unable to meet their financial obligations, a Licensed Insolvency Trustee can work with them to initiate an insolvency proceeding under the Bankruptcy and Insolvency Act (the “BIA”). This proceeding could be a bankruptcy, a Division 1 proposal, or a consumer proposal. 

Let’s take a more detailed look at some of these terms.

Insolvency vs Bankruptcy – What is Insolvency?

In Canada, according to the Bankruptcy and Insolvency Act, insolvency, or being insolvent, simply means that you are unable to pay all of your debt. This could manifest itself in a couple of different ways:

• Monthly Obligations – If for any reason you are unable to meet your monthly obligations as they become due, or you have ceased to meet your monthly obligations as they have come due, you would be considered insolvent.

• Total Obligations – If you were to convert all of your assets into cash at a fair market value, and that cash is unable to pay off your total obligations, you would be considered insolvent.

In addition to being unable to pay their monthly or total obligations, to be considered insolvent, a person must live in, have business in, or have property in Canada and also owe at least $1000 to creditors they can’t repay. 

What Isn’t Considered Insolvency?

It’s possible that you may be struggling to pay bills every now and again, yet not be insolvent. Examples of this may be:

• higher credit card bills just after Christmas or a vacation
• an unexpected expense that sets you back a couple of months
• a temporary reduction in income
• accidentally or intentionally missing monthly payments you can afford to make

If you’re having a few hard months, yet your income and/or assets can pay your debts, you may not be considered insolvent. 

A Few Signs Insolvency is on the Horizon

Now that we understand what insolvency means, how do you know if you’re at risk of becoming insolvent? If any of the following apply to you, you may be on the path to insolvency.

• You are in danger of defaulting on one or more of your monthly payments.
• Making the minimum monthly payments on your debt is becoming a burden.
• You consistently try to decide which bills get paid in full and which don’t.
• You take on new debt to pay down other debt.
• You regularly use credit to pay for necessities (gas, food, living arrangements).
• You pay bank overdraft fees on a regular basis.
• A creditor is threatening legal action.

If you think you may be insolvent or are on the path to becoming so, a Licensed Insolvency Trustee can take a look at your situation and advise you on your options.

Insolvency vs Bankruptcy – What is Bankruptcy?

Personal bankruptcy is a legal proceeding a person can enter into for debt relief. In Canada, if you owe more than $1000 in unsecured debt and you are unable to pay this debt, you are considered insolvent and eligible to file for bankruptcy. 

Bankruptcy is an insolvency proceeding that will:

• discharge most of your unsecured debt
• protect your wages from being garnished
• give you a fresh start and a chance to rebuild your credit
• protect some of your assets

After entering into a personal bankruptcy with a Licensed Insolvency Trustee, you will make reduced payments on your unsecured debt for anywhere between 9-3621 months. After this time, you will be released from bankruptcy, and your unsecured debts will be forgiven.

While there is some stigma attached to bankruptcy, this proceeding has helped protect thousands of Canadians from creditors. In 2022 alone, over 100,000 Canadians entered into an insolvency proceeding. Nearly a full quarter of those proceedings were bankruptcies. 

Bankruptcy, though, isn’t the only insolvency proceeding available to Canadians who are unable to pay their bills. There are a couple of bankruptcy alternatives that can also help.

Bankruptcy Alternatives

There are three different personal insolvency proceedings available to Canadians who can’t pay their debts:

• Bankruptcy
• Consumer Proposal
• Division 1 Proposal

We’ve already covered bankruptcy as an option for insolvency, let’s take a quick look at two bankruptcy alternatives.

Consumer Proposal

A consumer proposal is another insolvency proceeding designed to protect people who are unable to pay their bills. People who enter a consumer proposal can have up to 80% of their unsecured debt forgiven. The remainder of the unsecured debt will be renegotiated into one easy monthly payment.

After making reduced monthly payments for 36-60 months under a consumer proposal, your unsecured debts will be paid, giving you a chance to start over financially. If you’re unsure whether a bankruptcy or consumer proposal is right for you, feel free to reach out to us, and we can go over the advantages and disadvantages of a consumer proposal vs bankruptcy.

Division 1 Proposal

The difference between a consumer proposal and a Division 1 proposal comes down to how much unsecured debt you owe. A consumer proposal is intended for people who are insolvent and owe less than $250,000 in unsecured debt.

A Division 1 proposal is basically the same, but for insolvent people who owe more than $250,000 in unsecured debt. Since your house and car loans are considered secured debt, neither is included in a consumer proposal or a Division 1 proposal unless you wish to surrender the underlying asset.

Insolvency vs Bankruptcy – How to Proceed

Let’s finish off with a quick recap of insolvency vs bankruptcy.

Anyone who cannot make their financial obligations is considered insolvent. For debt reduction or forgiveness and protection from their creditors, an insolvent person can enter into one of three insolvency proceedings: 

1. Bankruptcy
2. Consumer Proposal
3. Division 1 Proposal

After successfully completing the terms of one of the above insolvency proceedings, all unsecured debts will be paid off or forgiven. Once this occurs, the person is no longer considered insolvent. 

If you think you may be considered insolvent, or it looks like you may be heading in that direction, the best thing you can do is to schedule an appointment with a Licensed Insolvency Trustee to go over your options.