Insolvency refers to the inability of a person or corporate to pay up his debt /bills as and when they become due. He may be able to pay at a later date some amount or even in full, but at the promised date of payment, he is unable to make the payment. Insolvency leads to the state of default. Bereft of outright fraud, the default can happen due to financial failure (as evidenced by “cash flow test”) or business failure (as determined by “balance sheet test”).
Resolution refers to a plan proposed by any authorised person/entity for enabling the overdue payments of a corporate debtor through restructuring or through part payments, while allowing the corporate debtor to continue as a going concern.
Bankruptcy is the next state of insolvency where an individual and partnership firm is declared by the relevant authority under a specified law for the purpose, as incapable of paying up his debt / bills at any time in present as well as in the foreseeable future. Generally, failure of resolution process leads to bankruptcy.
Liquidation is the winding up of a corporation or incorporated entity under the supervision of a person or “liquidator”, empowered under law for such operation and for distribution of proceeds to the various creditors as per an agreed formula. Only firms can be liquidated. Defaulting individuals cannot be liquidated.
Insolvency is the trigger that causes a bankruptcy or liquidation. For some, the right answer after default is to take the firm straight into liquidation. But there may be many situations in which a viable mechanism can be found through which the firm can be protected as a going concern. To the extent that this can be done, the costs imposed upon society go down, as liquidation involves the destruction of the organisational capital of the firm. The ideal insolvency and bankruptcy regime may provide for early determination of economic viability or otherwise of an entity, management of the conflicts between the interests of creditors and debtors and provide for predictable, equitable and fair loss allocation to all concerned in economic difficulties and reduce the time taken in resolution, then recoveries would be faster and the capital would be preserved for better allocation.