Insolvency is the inability of a debtor to
pay their debt. In many sources, the definition also includes
the phrase “or the state of having liabilities that exceed assets” or some similar phrase. Cash flow insolvency involves a lack of liquidity
to pay debts as they fall due. Balance sheet insolvency involves having negative
net assets—where liabilities exceed assets. Insolvency is not a synonym for bankruptcy,
which is a determination of insolvency made by a court of law with resulting legal orders
intended to resolve the insolvency. A business can be cash-flow insolvent but
balance-sheet solvent if it holds market liquidity assets, particularly against short term debt
that it cannot immediately realize if called upon to do so. Conversely, a business can have negative net
assets showing on its balance sheet, making it balance-sheet insolvent, but still be cash-flow
solvent if ongoing revenue is able to meet debt obligations, and thus avoid default:
for instance, if it holds long term debt. Some large companies operate permanently in
this state. Considering the first definition of insolvency,
this situation of ongoing balance-sheet insolvency with cash-flow solvency obviously does not
qualify as “insolvency” defined that way. It has been suggested that the speaker or
writer should either say technical insolvency or actual insolvency in order to always be
clear – where technical insolvency is a synonym for balance sheet insolvency, which means
that its liabilities are greater than its assets, and actual insolvency is a synonym
for the first definition of insolvency. This avoids any confusion over which of the
two definitions of “insolvency” are being used. If it is known that the second definition
of insolvency is being used, then it avoids any confusion over which of the two possible
required situations is manifest. While technical insolvency is a synonym for
balance-sheet insolvency, cash-flow insolvency and actual insolvency are not synonyms. The term “cash-flow insolvent” carries a strong
connotation that the debtor is balance-sheet solvent, whereas the term “actually insolvent”
does not. Definition
Insolvency is defined both in terms of cash flow and in terms of balance sheet in the
UK Insolvency Act 1986, Section 123, which reads in part: 123.-(1) A company is deemed unable to pay
its debts — (a) if a creditor to whom the company is indebted
in a sum exceeding £750 then due has served on the company, by leaving it at the company’s
registered office, a written demand requiring the company to pay the sum so due and the
company has for 3 weeks thereafter neglected to pay the sum or to secure or compound for
it to the reasonable satisfaction of the creditor,… Consequences
The principal focus of modern insolvency legislation and business debt restructuring practices
no longer rests on the liquidation and elimination of insolvent entities but on the remodeling
of the financial and organizational structure of debtors experiencing financial distress
so as to permit the rehabilitation and continuation of their business. This is known as business turnaround or business
recovery. In some jurisdictions, it is an offence under
the insolvency laws for a corporation to continue in business while insolvent. In others, the business may continue under
a declared protective arrangement while alternative options to achieve recovery are worked out. Increasingly, legislatures have favored alternatives
to winding up companies for good. It can be grounds for a civil action, or even
an offence, to continue to pay some creditors in preference to other creditors once a state
of insolvency is reached. Debt restructuring
Debt restructurings are typically handled by professional insolvency and restructuring
practitioners, and are usually less expensive and a preferable alternative to bankruptcy. Debt restructuring is a process that allows
a private or public company – or a sovereign entity – facing cash flow problems and financial
distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity
and rehabilitate so that it can continue its operations. Government debt
Although the term “bankrupt” may be used referring to a government, sovereign states do not go
bankrupt. This is so because bankruptcy is governed
by national law; there exists no entity to take over such a government and distribute
assets to creditors. Governments can be insolvent in terms of not
having money to pay obligations when they are due. If a government does not meet an obligation,
it is in “default”. As governments are sovereign entities, persons
who hold debt of the government cannot seize the assets of the government to re-pay the
debt. The recourse for the creditor is to ask nicely
to be repaid at least some of what is owed. However, in most cases, debt in default is
refinanced by further borrowing or monetized by issuing more currency. Law
Insolvency regimes around the world have evolved in very different ways, with laws focusing
on different strategies for dealing with the insolvent corporate. The outcome of an insolvent restructuring
can be very different depending on the laws of the state in which the insolvency proceeding
is run, and in many cases different stakeholders in a company may hold the advantage in different
jurisdictions. Australia
In Australia Corporate insolvency is governed by the Corporations Act 2001. Companies can be put into Voluntary Administration,
Creditors Voluntary Liquidation & Court Liquidation. Secured creditors with registered charges
are able to appoint Receivers and Receivers & Managers depending on their charge. Canada In Canada, bankruptcy and insolvency are generally
regulated by the Bankruptcy and Insolvency Act. An alternative regime is available to larger
companies under the Companies’ Creditors Arrangements Act, where total debts exceed $5 million. South Africa
In South Africa, owners of businesses that had at any stage traded insolvently become
personally liable for the business’ debts. Trading insolvently is often regarded as normal
business practice in South Africa, as long as the business is able to fulfill its debt
obligations when they fall due. Switzerland Under Swiss law, insolvency or foreclosure
may lead to the seizure and auctioning off of assets or to bankruptcy proceedings. Turkey
Turkish insolvency law is regulated by Enforcement And Bankruptcy Law. Main concept of the insolvency law is very
similar to Swiss and German insolvency laws. Enforcement methods are realizing pledged
property, seizure of assets and bankruptcy. United Kingdom In the United Kingdom, the term bankruptcy
is reserved for individuals. A company which is insolvent may be put into
liquidation. The directors and shareholders can instigate
the liquidation process without court involvement by a shareholder resolution and the appointment
of a licensed Insolvency Practitioner as liquidator. However, the liquidation will not be effective
legally without the convening of a meeting of creditors who have the opportunity to appoint
a liquidator of their own choice. This process is known as creditors voluntary
liquidation, as opposed to members voluntary liquidation which is for solvent companies. Alternatively, a creditor can petition the
court for a winding-up order which, if granted, will place the company into what is called
compulsory liquidation or winding up by the court. The liquidator realises the assets of the
company and distributes funds realised to creditors according to their priorities, after
the deduction of costs. In the case of Sole Trader Insolvency, the
insolvency options include Individual Voluntary Arrangements and Bankruptcy. It can be a civil and even a criminal offence
for directors to allow a company to continue to trade whilst insolvent. However, two new insolvency procedures were
introduced by the Insolvency Act 1986 which aim to provide time for the rescue of a company
or, at least, its business. These are Administration and Company Voluntary
Arrangement: Administration is a procedure to protect a
company from its creditors in order for it to be able to make significant operational
changes or restructuring so that it could continue as a going concern, or at least in
order to achieve a better outcome for creditors than via liquidation. In contrast to Chapter 11 in the US where
the directors remain in control throughout that restructuring process, in the UK an Administrator
is appointed who must be a licensed Insolvency Practitioner to manage the company’s affairs
to protect the creditors of the insolvent company and balance their respective interests. Unless the company itself is saved by this
process, the company is subsequently put into liquidation to distribute the remaining funds. A Company Voluntary Arrangement is a legal
agreement between the company and its creditors, based on paying a fixed amount lower than
the outstanding actual debt. These are normally based on a monthly payment,
and at the end of the agreed term the remaining debt is written-off. The CVA is managed by a Supervisor who must
be a licensed Insolvency Practitioner. If the CVA fails, the company is usually put
into liquidation. One particular type of Administration that
is becoming more common is called pre pack administration). In this process, immediately after appointment
the administrator completes a pre-arranged sale of the company’s business, often to its
directors or owners. The process can be seen as controversial because
the creditors do not have the opportunity to vote against the sale. The rationale behind the device is that the
swift sale of the business may be necessary or of benefit to enable a best price to be
achieved. If the sale was delayed, creditors would ultimately
lose out because the price obtainable for the assets would be reduced. In addition to the above-mentioned corporate
insolvency procedures, a creditor holding security over an asset of the company may
have the power to appoint an insolvency practitioner as administrative receiver or, in Scotland,
receiver. The process, latterly known as administrative
receivership or, in Scotland, receivership, has existed for many years and has often resulted
in a successful rescue of a company’s business via a sale, but not of the company itself. Since the introduction of the collective insolvency
procedure of Administration in 1986, the legislators have decided to set a shelf life on the administrative
receivership or, in Scotland, receivership procedure and it is no longer possible to
appoint an administrative receiver or, in Scotland, receiver under security created
after 15 September 2003. In individual cases the bankruptcy estate
is dealt by an official receiver, appointed by the court. In some cases the file is transferred to RTLU
that will assess your assets and income to see if you can contribute towards paying costs
of bankruptcy or even discharge part of your debts. United States
Under the Uniform Commercial Code, a person is considered to be insolvent when the party
has ceased to pay its debts in the ordinary course of business, or cannot pay its debts
as they become due, or is insolvent within the meaning of the Bankruptcy Code. This is important because certain rights under
the code may be invoked against an insolvent party which are otherwise unavailable. The United States has established insolvency
regimes which aim to protect the insolvent individual or company from the creditors,
and balance their respective interests. For example, see Chapter 11, Title 11, United
States Code. However, some state courts have begun to find
individual corporate officers and directors liable for driving a company deeper into bankruptcy,
under the legal theory of “deepening insolvency.” In determining whether a gift or a payment
to a creditor is an unlawful preference, the date of the insolvency, rather than the date
of the legally declared bankruptcy, will usually be the primary consideration. References External links
Glossary of Insolvency Terms Further reading
Mańko, Rafał. “Cross-border insolvency law in the EU”. Library Briefing. Library of the European Parliament. Retrieved 21 February 2013.