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.