Bankrupt or insolvent?

If a company is bankrupt, does that mean it is insolvent? If so, does the same logic apply the other way round? In other words, if a company is insolvent, does that mean it is bankrupt? In this column, I will explore the meaning of these terms, in English and Chinese. I will also consider when bankruptcy (or insolvency) proceedings against companies may be initiated, under English law and Chinese law.

The meaning of the words in English

Let’s start with “insolvent”. The word insolvent means that a person or entity is unable to repay his, her or its debts. The opposite word, solvent, is based on the Latin word solvere, meaning “to loosen” or “to dissolve”. In the context of debts, it means to dissolve one’s debts, or to free oneself from one’s debts.

In general, the word “bankrupt” has a more limited meaning than insolvent and is used to describe the situation where an insolvent person or entity is declared bankrupt pursuant to formal legal proceedings. In the case of an individual, the consequences of being declared bankrupt are serious. For example, a trustee is appointed to manage the individual’s assets and, except for certain personal assets, all of the assets must be converted into cash to repay creditors. The individual must make regular payments from his or her income for the benefit of creditors and this arrangement usually continues for a period of up to three years before the individual is “discharged from bankruptcy”. In addition, in common law jurisdictions, a bankrupt person cannot be a director of a company without the approval of the court.

In the case of a company, the consequences of bankruptcy are that the assets of the company are liquidated to repay creditors and the company is ultimately dissolved or wound-up. In other words, it ceases to exist.

Somewhat confusingly, different jurisdictions within the English-speaking, common law world use these words in different ways. For example, in jurisdictions such as England and Australia, the use of the word bankrupt is limited to describing individuals who are unable to repay their debts as they fall due. The word insolvent is used to describe companies that are unable to repay their debts as they fall due. In the US, on the other hand, bankruptcy is also used in relation to companies.

The word bankrupt in English has an interesting derivation or etymology, which has been the subject of some debate. Most people believe that it comes from the Italian, banca rotta, meaning “broken bench”. In the Medieval period, money lenders operated in public marketplaces and transacted their business on a bench. If the money lender became insolvent and was unable to meet his debts, the bench would be broken to indicate to the public that the money lender was no longer in business. This phrase was subsequently adopted in England in the form of the word bankrupt, which was a combination of “bank” and “rupt”, which was based on the Latin word meaning “broken”.

Interestingly, the “rupt” part is also found in other English words, including the word “interrupt” and “corrupt” [see China Business Law Journal volume 2 issue 10, page 90: Bribery and corruption].

A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at law.asia.