Difference Between Bankruptcy and Liquidation

Edited by Diffzy | Updated on: July 03, 2023

       

Difference Between Bankruptcy and Liquidation

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Introduction 

The business is said to be a going concern concept. In this concept, we take the scenario that our business will continue to flourish in the future. But in reality, business goes through many ups and down during the life cycle of the business. The situation of lack of money may result in two possible outcomes which are bankruptcy and liquidation. Insolvency plays a very critical role in both liquidation and bankruptcy. So here we will witness some of the prominent differences between them. One must be aware of the key distinctions between bankruptcies and liquidation to comprehend a company’s rehabilitation.

Bankruptcy vs Liquidation

Selling a company's assets to settle debts is the process of liquidation. When a business can no longer function as there is no chance of things getting better, this is often done. The liquidation marks the end of a firm's operations, in contrast to bankruptcy, which can let a corporation reorganize its debt and carry on with operations. For struggling companies, it's frequently a final resort, although it might be required as a last resort to pay off debts that are still owed and move on. In contrast to liquidation, which is a process of completely closing an entity's business, bankruptcy is nothing more than a legal strategy through which an insolvent or bankrupt person seeks relief. Liquidation is something that can only be done by businesses; it cannot be done by an individual. Contrarily, bankruptcy can be covered for both businesses and people. Insolvency of the person or the company is the sole reason behind the bankruptcy but it is not the case for the liquidation. The case is different for liquidation as there may be some internal things going on in the company which may lead to liquidation.

Difference Between Bankruptcy And Liquidation In Tabular Form

Parameters of comparisonBankruptcyLiquidation
MeaningThe official declaration of incapacity to pay one's debts and other obligations is stated to be the scenario that eventually results in bankruptcy.When a corporation is finally shut down or wound up, it goes through a process which is known as the liquidation process.
Coverage It covers individuals and companies.It covers only the companies.
ReasonThe sole reason behind the bankruptcy is the company’s or the person’s insolvency.The reason may be financial or any other internal reason.
NatureBankruptcy is not permanent as the person or the company can recover the losses.The liquidation is permanent as the company is shut down completely.
Mode It is involuntary.The mode is mandatory or voluntary.

What is Bankruptcy?

When a person or corporation is unable to pay back their debts or obligations, a legal process called bankruptcy is started. It provides a new beginning for those who cannot pay their debts anymore.

A petition is filed either on behalf of unsecured creditors, which is less common or by the debtor, depending on the circumstances, to start the bankruptcy process. All of the debtor's possessions are counted and assessed, and a portion of the debt can potentially be paid off with the help of the assets.

Process of Bankruptcy

Further, we will discuss the procedure or process of bankruptcy which is as follows:

By wiping out unmanageable debts, bankruptcy allows a person or corporation to start again. The assets that the person or business has available for liquidation allow creditors to receive some payback in the interim. Debtors must initially file a petition with the nearby federal bankruptcy court to seek bankruptcy protection. To file, the debtor must provide numerous pieces of paperwork and a wealth of information regarding their financial situation, such as tax returns, income documentation, mortgage records, and bank account information. A pre-discharge debtor training course and a pre-bankruptcy credit counseling course from recognized providers are also required of filers.

After submitting, the borrower meets with lenders and a trustee appointed by the court to discuss their capacity to collect their obligations. The debtor is questioned under oath about this ability. Because Section 341 of the Bankruptcy Code requires it, this is known as a 341 meeting.  According to the bankruptcy type and agreement selected, the discharge is finally granted after a time that can range from a few months to many years.

When you file for bankruptcy, creditors can no longer contact you by phone, mail, or in any other way to try and collect most of your debts. It is crucial to keep in mind that not all debts may be eliminated through bankruptcy and that declaring bankruptcy may have long-term effects like harming your credit score. Before making a choice, it is crucial to speak with a bankruptcy lawyer to completely comprehend your alternatives and the possible results.

Depending on the chapter, the bankruptcy procedure varies. Knowing your alternatives and goals will help you select the appropriate chapter. Here, the chapter refers to the types, and the three primary types of bankruptcy are described in detail below which is as follows:

Chapter 7 Bankruptcy

In essence, selling off your assets to pay off debt is what Chapter 7 bankruptcy entails. People who solely own exempt property, such as clothing, home items, equipment for their professions, and an automobile up to a specific value, may find themselves unable to make any payments on their unsecured debt. Such individuals may not have any valuable assets at all.

Chapter 13 Bankruptcy

A wage earner's plan is another name for a Chapter 13 filing. In exchange for paying off debts over a longer length of time, usually three to five years, it allows a debtor to keep more property.

Chapter 11 Bankruptcy

Business entities and partnerships are frequently linked with Chapter 11, also known as reorganizing bankruptcy. A Chapter 11 filing can, however, also be used by business owners such as single proprietors. Chapter 11 also entails a payment schedule, just like Chapter 13.

What is Liquidation?

In terms of finance and economics, liquidation refers to the process of closing down a business and allocating its assets among claimants. It is a situation that typically arises when a business is insolvent, or unable to make its debt payments on time. As business operations come to a final stage, assets that remain are distributed to owners and creditors by the order of precedence of their claims. While technically speaking, dissolution refers to the final stage of liquidation, liquidation is sometimes known as winding up or dissolution.

Liquidation usually occurs during the bankruptcy process under Chapter 7.

To liquidate is to turn assets into cash. For instance, a person might sell their house, car, or another item and get cash in return. Liquidation is the term used for this. The liquidity of a variety of assets is taken into account while valuing them. A house, for instance, is not highly liquid since selling one requires time-consuming steps such as preparing it for sale, determining its value, advertising it, and locating a buyer. Stocks, on the other hand, are more liquid since they can be quickly sold and the proceeds are paid out if their value rises over time.

When a business ceases to operate and is deregistered, it has completed its liquidation. At the same time, its assets are sold. Various claimants, including shareholders and creditors, are reimbursed through the sale of the assets. When a business becomes insolvent—that is, when it is unable to pay its debts—the liquidation process begins. The company's assets are liquidated in this process so that the claims can be paid when the accounts are finally closed. A liquidator is chosen by the court to dissolve the company for these reasons. The remaining funds are divided among the company's shareholders after paying creditors. The corporate debtor's operation may be sold as a going concern by the liquidator during the liquidation process.

Liquidator

After the adjudicating authority issues a liquidation order, the resolution specialist who was selected to handle the corporate insolvency resolution procedure may take on the role of liquidator. Additionally, he may be replaced by the IBC's adjudicating authority. The liquidator must fulfill their obligations up until the liquidation is finished, and they must be qualified under the code.

Further, we will discuss the liquidation order

Liquidation Order

In the following cases, the Adjudicating Authority (AA) may issue the liquidation order:

  • If a resolution plan is not received by the deadline
  • When the resolution plan filed is rejected by the adjudicating authority (NCLT)
  • when the corporate debtor's liquidation is accepted by the committee of creditors
  • When a corporate debtor deviates from an established resolution plan

Following is the major order in which claims are resolved during the liquidation process:

Secured: The company first pays its secured creditors, including the bank that issued the mortgage loan, and then reimburses all preferential secured creditors, including employees and landlords. Finally, the company pays the insolvency attorney appointed to handle the liquidation.

Unsecured: Suppliers, HMRC, contractors, holders of debentures, credit card firms, and any additional lenders or creditors without a guarantee of repayment are next in line.

Stakeholders: Shareholders, investors, and owners are then given a part of the leftover money.

Types of Liquidation

Further, we will discuss some of the types of liquidation which are as follows:

Voluntarily Liquidation 

When a business voluntarily resolves to liquidate its assets and business operations to write off its creditors, this is known as voluntary liquidation. The 2013 Companies Act's requirements control how this procedure is carried out.

Compulsory Liquidation

The creditors of a firm might compel the liquidation of their debts through a judicial process. When a business is unable to pay its bills and cannot reach an arrangement with its creditors regarding a repayment schedule, this occurs. In such situations, the creditors may apply to the National Company Law Tribunal (NCLT) and ask for the dissolution of the business. The assets are subsequently liquidated to cover the liabilities. After paying out all claimants, any remaining monies are allocated to the shareholders, owners, and investors.

Creditors Voluntary Liquidation

When a company's creditors elect to sell off its assets to settle their debts, this process is known as a creditors' voluntary liquidation or CVL. The directors of the business initiate it voluntarily. It must be approved by the majority of the company's creditors for the liquidation to proceed.

Difference Between Bankruptcy And Liquidation In Points 

  • The legal situation that occurs when a person or business proclaims bankruptcy is known as bankruptcy, whereas the process through which a company's operations are finally ended is known as liquidation.
  • The liquidation can be carried out either freely (petition submitted by shareholders) or compulsorily (petition submitted by creditors). The bankruptcy can be carried out either willingly with the aid of a petition submitted by the person or company itself or unwillingly (petition filed by creditors).
  • Bankruptcy results from financial problems or bankruptcy, whereas liquidation may be the result of financial instability or for other reasons, which is a key distinction between the two.
  • If a debtor cannot afford to pay their obligations back, they can file for bankruptcy to get legal protection from their creditors.  Contrarily, liquidation is a procedure where a corporation sells off its assets to settle its debts.
  • In a bankruptcy, the assets of the debtor are taken over by a trustee, who then distributes them to the creditors. As opposed to this, liquidation can be either voluntary or involuntary, and the sale's revenues are then divided up amongst the company's creditors.
  • In contrast to bankruptcy, which is not just for businesses but also individuals, liquidation is only applicable to companies.

Conclusion

In light of everything that has been discussed above it can be concluded that bankruptcy and liquidation both are important aspects when we talk about economics and finance. The most catastrophic sort of circumstance that can occur is either bankruptcy or liquidation. However, when someone is declared bankrupt, they are allowed a fresh start; in contrast, when someone is liquidated, there are no such possibilities. Not every firm that is liquidated must be insolvent because the liquidation is only applicable to companies. Nevertheless, there are many situations where a corporation is financially stable but is still liquidated at the direction of its stockholders.

References

  • https://www.forbes.com/advisor/debt-relief/types-of-bankruptcies/
  • https://www.wallstreetmojo.com/liquidation/

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"Difference Between Bankruptcy and Liquidation." Diffzy.com, 2024. Sat. 02 Mar. 2024. <https://www.diffzy.com/article/difference-between-bankruptcy-and-liquidation>.



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