Insolvency

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In accounting, insolvency is the state of being unable to pay the debts, by a person or company (debtor), at maturity; those in a state of insolvency are said to be insolvent. There are two forms: cash-flow insolvency and balance-sheet insolvency.

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Cash-flow insolvency is when a person or company has enough assets to pay what is owed, but does not have the appropriate form of payment. For example, a person may own a large house and a valuable car, but not have enough liquid assets to pay a debt when it falls due. Cash-flow insolvency can usually be resolved by negotiation. For example, the bill collector may wait until the car is sold and the debtor agrees to pay a penalty.

Balance-sheet insolvency is when a person or company does not have enough assets to pay all of their debts. The person or company might enter bankruptcy, but not necessarily. Once a loss is accepted by all parties, negotiation is often able to resolve the situation without bankruptcy. A company that is balance-sheet insolvent may still have enough cash to pay its next bill on time. However, most laws will not let the company pay that bill unless it will directly help all their creditors. For example, an insolvent farmer may be allowed to hire people to help harvest the crop, because not harvesting and selling the crop would be even worse for his creditors.

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 ("Insolvency is the inability of a debtor to pay their debt."). [1] 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 (but perhaps not absolute) connotation that the debtor is balance-sheet solvent, whereas the term "actually insolvent" does not.

Technical definitions

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.

Accounting insolvency happens when total liabilities exceed total assets (negative net worth). [2] [3] [4] [5]

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. Implementing a business turnaround may take many forms, including keep and restructure, sale as a going concern, or wind-down and exit. In some jurisdictions, it is an offence under the insolvency laws for a corporation to continue in business while insolvent. In others (like the United States with its Chapter 11 provisions), 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, in several jurisdictions, 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. [6]

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, creditors who hold debt of the government cannot easily seize the assets of the government to re-pay the debt (though "Vulture funds" often find ways to do so). The recourse for the creditor is to request 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 (which typically results in inflation or hyperinflation).[ citation needed ]

Law

Insolvency regimes around the world have evolved in very different ways, with laws focusing on different strategies for dealing with the insolvent. 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. [7]

Anguilla

In Anguilla, the insolvency of individuals is regulated under the Bankruptcy Act (Cap B.15) and corporate insolvency is governed by the Bankruptcy Act (Cap B.15) or the Companies Act (Cap C.65).

Australia

In Australia, corporate insolvency is governed by the Corporations Act 2001 (Cth). Companies can be put into Voluntary Administration, Creditors Voluntary Liquidation, and Court Liquidation. Secured creditors with registered charges are able to appoint Receivers and Receivers & Managers depending on their charge.

British Virgin Islands

In the British Virgin Islands, insolvency law is primarily codified in the Insolvency Act, 2003 and the Insolvency Rules, 2005.

Canada

In Canada, bankruptcy and insolvency are generally regulated by the Bankruptcy and Insolvency Act. An alternative regime is available to larger companies (or affiliated groups) under the Companies' Creditors Arrangements Act, where total debts exceed $5 million. [8]

Germany

In Germany, insolvency proceedings, both for companies and for natural persons, are regulated by the Insolvency Act (Insolvenzordnung), in effect since 1999 but with significant changes in 2012. [9] The goal of insolvency law is the equal and best satisfaction of creditors.

If the interests of creditors are respected, insolvent companies are offered different ways to restructure their businesses, for example by implementing an 'insolvency plan' (Insolvenzplan). While regular insolvency proceedings are led by a court-appointed insolvency administrator, 'debtor-in-possession' proceedings are common since the legislative changes in 2012.

For natural persons, the Verbraucherinsolvenzverfahren (literally "insolvency proceeding for individual consumers") allows discharge of all debts after three years, if certain conditions are met.

Hong Kong

In Hong Kong, insolvency is primarily governed by the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) and the Companies (Winding Up) Rules (Cap 32H).

India

In India, bankruptcy and insolvency are generally regulated by the Insolvency and Bankruptcy Code 2016. The Insolvency and Bankruptcy Board of India (IBBI) is the regulator for overseeing insolvency proceedings and entities like Insolvency Professional Agencies (IPA), Insolvency Professionals (IP) and Information Utilities (IU) in India.

Insolvent citizens may not contest/be appointed for any public office, nor may they participate in govt exams. They are also not allowed to emigrate out.

Iran

Iranian government Tax, finance and bankruptcy administration handles corporations . First insolvency law was adopted 1935. Those who claim inability are temporary exempt from debt payment. [10] [11]

Ireland

In Ireland, insolvency is governed by the Companies Act 2014.

Russia

In Russia, insolvency law is governed by Federal Law No. 127-FZ "On Insolvency (Bankruptcy)" and Federal Law No. 40-FZ "On Insolvency (Bankruptcy) of Credit Institutions".

South Africa

In South Africa, owners of businesses that had at any stage traded insolvently (i.e. that had a balance-sheet insolvency) become personally liable for the business's 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 (generally in the case of private individuals) or to bankruptcy proceedings (generally in the case of registered commercial entities).

Turkey

Turkish insolvency law is regulated by Enforcement and Bankruptcy Law (Code No: 2004, Original Name: İcra ve İflas Kanunu). The 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

Insolvency Act 1986

In the United Kingdom, the term bankruptcy is reserved for individuals. 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 (by assignment or otherwise) 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 (in the prescribed form) 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,... (2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities...

—  Insolvency Act 1986, Section 123 (Part IV, Chapter VI), p. 68.

A company which is insolvent may be put into liquidation (sometimes referred to as winding-up). 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 (CVL), as opposed to members voluntary liquidation (MVL) 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.

Procedures

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 (CVA) 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 (more information under administration (law)). 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.

Receivership

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 (OR Regional Trustee Liquidator Unit) 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 [ citation needed ] 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". [12]

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.

See also

Related Research Articles

Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor.

<span class="mw-page-title-main">Liquidation</span> Winding-up of a company

Liquidation is the process in accounting by which a company is brought to an end. The assets and property of the business are redistributed. When a firm has been liquidated, it is sometimes referred to as wound-up or dissolved, although dissolution technically refers to the last stage of liquidation. The process of liquidation also arises when customs, an authority or agency in a country responsible for collecting and safeguarding customs duties, determines the final computation or ascertainment of the duties or drawback accruing on an entry.

An officer of the Insolvency Service of the United Kingdom, an official receiver (OR) is an officer of the court to which they are attached. The OR is answerable to the courts for carrying out the courts' orders and for fulfilling their duties under law. They also act on directions, instructions and guidance from the service's Inspector General or, less often, from the Secretary of State for Business, Energy and Industrial Strategy.

<span class="mw-page-title-main">Insolvency Act 1986</span> United Kingdom legislation

The Insolvency Act 1986 is an act of the Parliament of the United Kingdom that provides the legal platform for all matters relating to personal and corporate insolvency in the UK.

Wrongful trading is a type of civil wrong found in UK insolvency law, under Section 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the insolvent company. Under Australian insolvency law the equivalent concept is called "insolvent trading".

An unfair preference is a legal term arising in bankruptcy law where a person or company transfers assets or pays a debt to a creditor shortly before going into bankruptcy, that payment or transfer can be set aside on the application of the liquidator or trustee in bankruptcy as an unfair preference or simply a preference.

An undervalue transaction is a transaction entered into by a company who subsequently goes into bankruptcy which the court orders be set aside, usually upon the application of a liquidator for the benefit of the debtor's creditors. This can occur where the transaction was seriously disadvantageous to the company and the company was insolvent or in immediate risk of becoming insolvent.

In law, a liquidator is the officer appointed when a company goes into winding-up or liquidation who has responsibility for collecting in all of the assets under such circumstances of the company and settling all claims against the company before putting the company into dissolution. Liquidator is a person officially appointed to 'liquidate' a company or firm. Their duty is to ascertain and settle the liabilities of a company or a firm. If there are any surplus, then those are distributed to the contributories.

As a legal concept, administration is a procedure under the insolvency laws of a number of common law jurisdictions, similar to bankruptcy in the United States. It functions as a rescue mechanism for insolvent entities and allows them to carry on running their business. The process – in the United Kingdom colloquially called being "under administration" – is an alternative to liquidation or may be a precursor to it. Administration is commenced by an administration order.

<span class="mw-page-title-main">United Kingdom insolvency law</span> Law in the United Kingdom of Great Britain and Northern Ireland

United Kingdom insolvency law regulates companies in the United Kingdom which are unable to repay their debts. While UK bankruptcy law concerns the rules for natural persons, the term insolvency is generally used for companies formed under the Companies Act 2006. Insolvency means being unable to pay debts. Since the Cork Report of 1982, the modern policy of UK insolvency law has been to attempt to rescue a company that is in difficulty, to minimise losses and fairly distribute the burdens between the community, employees, creditors and other stakeholders that result from enterprise failure. If a company cannot be saved it is liquidated, meaning that the assets are sold off to repay creditors according to their priority. The main sources of law include the Insolvency Act 1986, the Insolvency Rules 1986, the Company Directors Disqualification Act 1986, the Employment Rights Act 1996 Part XII, the EU Insolvency Regulation, and case law. Numerous other Acts, statutory instruments and cases relating to labour, banking, property and conflicts of laws also shape the subject.

<i>Winding-up and Restructuring Act</i>

The Winding-up and Restructuring Act is a statute of the Parliament of Canada that provides for the winding up of certain corporations and the restructuring of financial institutions. It was passed in 1985, and has been amended since. Predecessors of the act date back to 1882.

<span class="mw-page-title-main">British Virgin Islands company law</span>

The British Virgin Islands company law is the law that governs businesses registered in the British Virgin Islands. It is primarily codified through the BVI Business Companies Act, 2004, and to a lesser extent by the Insolvency Act, 2003 and by the Securities and Investment Business Act, 2010. The British Virgin Islands has approximately 30 registered companies per head of population, which is likely the highest ratio of any country in the world. Annual company registration fees provide a significant part of Government revenue in the British Virgin Islands, which accounts for the comparative lack of other taxation. This might explain why company law forms a much more prominent part of the law of the British Virgin Islands when compared to countries of similar size.

<span class="mw-page-title-main">British Virgin Islands bankruptcy law</span>

British Virgin Islands bankruptcy law is principally codified in the Insolvency Act, 2003, and to a lesser degree in the Insolvency Rules, 2005. Most of the emphasis of bankruptcy law in the British Virgin Islands relates to corporate insolvency rather than personal bankruptcy. As an offshore financial centre, the British Virgin Islands has many times more resident companies than citizens, and accordingly the courts spend more time dealing with corporate insolvency and reorganisation.

<span class="mw-page-title-main">Cayman Islands company law</span> National economic law

Cayman Islands company law is primarily codified in the Companies Law and the Limited Liability Companies Law, 2016, and to a lesser extent in the Securities and Investment Business Law. The Cayman Islands is a leading offshore financial centre, and financial services form a significant part of the economy of the Cayman Islands. Accordingly company law forms a much more prominent part of the law of the Cayman Islands than might otherwise be expected.

<span class="mw-page-title-main">Cayman Islands bankruptcy law</span>

Cayman Islands bankruptcy law is principally codified in five statutes and statutory instruments:

Anguillan bankruptcy law regulates the position of individuals and companies who are unable to meet their financial obligations.

Australian insolvency law regulates the position of companies which are in financial distress and are unable to pay or provide for all of their debts or other obligations, and matters ancillary to and arising from financial distress. The law in this area is principally governed by the Corporations Act 2001. Under Australian law, the term insolvency is usually used with reference to companies, and bankruptcy is used in relation to individuals. Insolvency law in Australia tries to seek an equitable balance between the competing interests of debtors, creditors and the wider community when debtors are unable to meet their financial obligations. The aim of the legislative provisions is to provide:

Provisional liquidation is a process which exists as part of the corporate insolvency laws of a number of common law jurisdictions whereby after the lodging of a petition for the winding-up of a company by the court, but before the court hears and determines the petition, the court may appoint a liquidator on a "provisional" basis. Unlike a conventional liquidator, a provisional liquidator does not assess claims against the company or try to distribute the company's assets to creditors, as the power to realise the assets comes after the court orders a liquidation.

<span class="mw-page-title-main">Hong Kong insolvency law</span> Financial regulation in Hong Kong

Hong Kong insolvency law regulates the position of companies which are in financial distress and are unable to pay or provide for all of their debts or other obligations, and matters ancillary to and arising from financial distress. The law in this area is now primarily governed by the Companies Ordinance and the Companies Rules. Prior to 2012 Cap 32 was called the Companies Ordinance, but when the Companies Ordinance came into force in 2014, most of the provisions of Cap 32 were repealed except for the provisions relating to insolvency, which were retained and the statute was renamed to reflect its new principal focus.

<i>Brooks v Armstrong</i>

Brooks v Armstrong[2016] EWHC 2289 (Ch), [2016] All ER (D) 117 (Nov) is a UK insolvency law case on wrongful trading under section 214 of the Insolvency Act 1986.

References

  1. ↑ Graeme Pietersz. "Moneyterms Investment Definitions". Archived from the original on 2017-07-05. Retrieved 2013-12-27.
  2. ↑ Fundamentals of Corporate Finance, Ross-Westerfield-Jordan, 10th e, p.549
  3. ↑ Graeme Pietersz. "Moneyterms Investment Definitions". Archived from the original on 2017-03-17. Retrieved 2013-12-27.
  4. ↑ Downes, John, and Jordan Elliot. Goodman. Dictionary of Finance and Investment Terms. Hauppauge, NY: Barron's Educational Series, 2003. Print.
  5. ↑ UK Insolvency Act 1986, Section 123
  6. ↑ Enterprise Bankruptcy Law of the People's Republic of China (August 27, 2006), Chapter 2, Section 2, Article 16.
  7. ↑ Joseph Swanson and Peter Marshall, Houlihan Lokey and Lyndon Norley, Kirkland & Ellis International LLP (2008). A Practitioner's Guide to Corporate Restructuring. City & Financial Publishing, 1st edition ISBN   978-1-905121-31-1
  8. ↑ "Restructure your business through the Companies' Creditors Arrangement Act". Office of the Superintendent of Bankruptcy Canada. Archived from the original on 10 December 2014. Retrieved 11 December 2014.
  9. ↑ Insolvency Statute Archived 2019-03-11 at the Wayback Machine Bundesamt für Justiz
  10. ↑ https://rc.majlis.ir/fa/law/show/92296 Archived 2020-02-02 at the Wayback Machine
  11. ↑ "اعسار چيست و معسر كيست؟". ایرنا (in Persian). 2013-08-24. Retrieved 2024-05-15.
  12. ↑ Thompson, David (2007). "A Critique of 'Deepening Insolvency,' a New Bankruptcy Tort Theory". Stanford Journal of Law, Business & Finance. 12 (2): 536. SSRN   1377375.

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