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Understanding insolvency: Find out what these terms really mean...

by , 25 October 2013
When it comes to insolvency, the terms 'insolvent, 'insolvency, 'liquidation', 'sequestration and 'winding up' are used interchangeably. This causes great confusion because they're NOT the same thing. Read on to find out what these terms really mean so you can understand insolvency better.

'Insolvency, sequestration and liquidation, are terms that people hear about frequently, but rarely have they paid attention to them,' says The Financial Gazette.

The website adds that 'in these harsh economic times where to fall into debt can be a curse, people need to understand better the subject of insolvency so as to avoid embarrassment of being publicly declared insolvent.'

The different terms around insolvency can be explained as follows:

Insolvency: According to the Practical Tax Loose Leaf Service, being declared insolvent means that the person or entity concerned (the debtor) is unable to meet their obligations in respect of money owed to third parties (the creditors).

But, as we explain here, insolvency can also refer to the process where a debtor reaches a point where obligations can't be met in the normal course of business, or from ordinary regular earnings.

It's the point at which the debtor's assets are handed over to an administrator appointed by the Court with the aim of selling the assets to meet claims lodged by one or more creditors.

These assets, once under the curatorship of the administrator are referred to as the insolvent estate.

So that's insolvency out the way, but what do those other terms means?

Liquidation and sequestration: A corporate entity is placed in liquidation, while an individual is sequestrated.

Both terms mean the same thing. And that's to say a creditor has taken action against the debtor to recover amounts due and the debtor needs to liquidate their assets to partially or fully settle the amount owed.

In both cases, the liquidation or sequestration can be compulsory, where the creditor takes action to have a debtor declared insolvent. Or voluntary, where the debtor sees no other way to settle their obligations other than to declare themselves insolvent.

Winding up: The judicial process of realising assets for cash and partially or fully settling claims raised by creditors is referred to as the winding up of the insolvent estate, says the Loose Leaf Service

This process applies to both corporate and individual estates. It's completed once the administrator has lodged the final liquidation and distribution account and settled all claims in accordance with this account.

Now that you know what these terms mean, find out more about insolvency and tax here.

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