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What’s the difference between bankruptcy and insolvency?

Learn the difference between bankruptcy and insolvency and what they mean for your financial future.

If you’re struggling to pay your bills or your personal loan repayments on time, you might have started hearing and reading a lot of confusing and scary-sounding words. Bankruptcy and insolvency are two terms with negative connotations that are often taken to mean the same thing, but they are actually completely different.

This article examines the difference between insolvency vs bankruptcy and what being in each state means for your personal finances.

What is personal insolvency?

Insolvency is an inability to pay your debts when they are due. In other words, while insolvency might sound complicated and intimidating on the surface, it’s actually a state many of us have been in at one time or another.

Insolvency has many causes, such as if you have a major bill crop up unexpectedly or if you’re made redundant and unable to find work for a temporary period. However, while it can be a temporary situation for some people, insolvency can soon lead you into much deeper financial trouble if it isn’t quickly addressed.

What is bankruptcy?

Bankruptcy is a legal process for people who are unable to pay their debts. If you apply for bankruptcy, you’re absolved from paying your debts.

However, being declared bankrupt has serious consequences for your financial future and bankruptcy remains on your credit file for five years.

What are the main differences between bankruptcy and insolvency?

The biggest difference between bankruptcy and insolvency is that while insolvency refers to a personal financial situation, bankruptcy refers to a legal state. If you’re insolvent, you’re simply unable to pay your debts on time. If this is the case, it’s important to look at the actions available to address your insolvency – and bankruptcy is one of those options.

Bankruptcy is often referred to as an act of insolvency and declaring bankruptcy releases you from your debts. There are two ways you can be legally classified as bankrupt – you can declare yourself bankrupt, or one of your creditors may apply to the court to have you declared bankrupt.

However, bankruptcy is not a “get out of jail free” card and can have a significant impact on your ability to access credit for the rest of your life.

What are my options if I can’t pay my debts?

If you can’t pay your debts on time (you’re insolvent), there are several options you can choose from to help get your finances back on track.

  • Summary Instalment Order (SIO). An SIO is a legally binding arrangement made by the Official Assignee. It allows you to pay back some or all of the debts to your creditors over a period of up to three years.
  • Debt agreement. A debt agreement is a formal arrangement to pay back your creditors that is approved by the court but doesn’t involve the Official Assignee like an SIO.
  • Bankruptcy. You can enter into voluntary bankruptcy by debtor’s petition, or a creditor can apply to the court to have you declared bankrupt. Bankruptcy absolves you from most debts and lasts for three years, with a trustee appointed to manage your bankruptcy.

You also have the option of contacting your creditors directly to try to come to some sort of informal arrangement for the repayment of your debts. This could involve requesting more time to pay, negotiating a smaller lump sum payment to settle your debt, or setting up a more flexible payment arrangement.

How do you declare bankruptcy?

To be eligible for bankruptcy you need to:

  • Be insolvent. That is, be unable to pay your debts when they are due.
  • Be present in New Zealand or have a residential or business connection to New Zealand.

You don’t need to have a certain amount of debt to be eligible for bankruptcy. Once you’ve done your due diligence to decide if bankruptcy is right for you (i.e. you have explored all other options), you need to head to the New Zealand Insolvency and Trustee Services (ITS) website and download an application form. If your application is accepted, the ITS will send your creditors confirmation.

Does bankruptcy clear all debts?

While bankruptcy is often viewed as a “clean slate”, a common misconception is that it clears all of your debts. Declaring bankruptcy does mean that the large majority of your debts will be cleared so you won’t have to pay them after your bankruptcy ends, but there are a few debts that are not included in this.

The following tables show what debts are and aren’t included so you can make an informed choice about whether it’s right for you.

Unsecured loan debt

DebtWill my debt be cleared by bankruptcy?Conditions
Credit cardYes
Store cardYes
Unsecured personal loanYes
Unsecured business loanYes
Trade creditorYes
Payday loanYes
Pawn shop loanYes

You won’t get your pawned item/s back.

Overdrawn accountYes

Secured loan debt

DebtWill my debt be cleared by bankruptcy?Conditions
House mortgageYesYour house is likely to be sold though.
Motor vehicle securityYesYou will have to surrender your vehicle if the account falls into arrears or if the vehicle equity is worth more than the indexed amount.
Secured business loansYesNoYou need to repay the debt or the secured asset may be sold.
Chattel mortgageYesNoYou need to repay the debt or the secured asset may be sold.

Household debt

DebtWill my debt be cleared by bankruptcy?Conditions
Gas, electricity, phone, broadband, pay TVYes

The supplier may choose to no longer supply you or may require a bond.

Outstanding rent where you liveYes

Check local laws to see your tenancy rights – your landlord may be able to terminate your tenancy agreement.

Outstanding rent at a place where you used to liveYes
Debts from a property you damaged as a tenantYes

WINZ, tax, fines, fees and court debts

DebtWill my debt be cleared by bankruptcy?Conditions
Legal feesYes
Medical feesYes
Accounting feesYes
Court finesNo
Non-court finesNo
Court-ordered restitution amountsYesOnly if the amount was fixed before your bankruptcy.

Your wage deductions may continue.

Child supportNo

Doesn’t apply if WINZ was incurred by fraud.

Student loan debtYes

Other debts

DebtWill my debt be cleared by bankruptcy?Conditions
Victims of crimeYesNoIt depends when or if the debt was registered.
Liquidated debts/liquidated damagesYes
Unliquidated debts/unliquidated damagesNo

This is unless the debt is incurred by reason of a contract, promise or breach of trust.

Debts incurred after you enter bankruptcyNo
Provable debts incurred by fraudNo

What are the consequences of bankruptcy?

There are several consequences and ways that your life is affected when you become bankrupt. You should seriously consider each one before you apply.

  • Length of bankruptcy. You will be considered “currently bankrupt” for three years from the day you file your statement of affairs.
  • Income. If you earn over a certain amount you will need to make compulsory payments to your trustees. This amount changes depending on how many dependents you have.
  • Employment. You need to inform your trustee if you change jobs, receive a higher or lower income or stop working. New employers may be hesitant to employ you if you are bankrupt and you’ll need to get permission if you want to be employed by a family member or start your own business.
  • Savings. You can usually save money while you are considered bankrupt but you must keep this money in a normal savings account. If you move these funds to a term deposit or purchase an asset, your trustee can claim it to repay your debts.
  • IRD and tax. Your IRD number will be cancelled and a new one issued. You will need to keep filing tax returns while you are bankrupt.
  • Credit rating. Bankruptcy affects your credit rating, so you will find it difficult to buy things like a car or a house, or be approved for a rental application. Bankruptcy is listed on your credit report for the three years you are declared bankrupt and the two years following.
  • Assets. Your trustee is able to sell your assets such as real estate, vehicles, bank balances, tools and lottery winnings. You also need to declare any money you receive during bankruptcy.
  • Overseas travel. If you want to travel overseas while you’re bankrupt you need to submit an application to the Official Assignee. The Official Assignee doesn’t have to approve your travel and can place restrictions on your travel.

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