insolvency
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In
accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
, insolvency is the state of being unable to pay the
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
s, by a
person A person (plural, : people) is a being that has certain capacities or attributes such as reason, morality, consciousness or self-consciousness, and being a part of a culturally established form of social relations such as kinship, ownership of pr ...
or
company A company, abbreviated as co., is a legal entity representing an association of people, whether natural, legal or a mixture of both, with a specific objective. Company members share a common purpose and unite to achieve specific, declared ...
(
debtor A debtor or debitor is a legal entity, legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counter ...
), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet insolvency. Cash-flow insolvency is when a person or company has enough
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s 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 A liquid is a nearly Compressibility, incompressible fluid that conforms to the shape of its container but retains a (nearly) constant volume independent of pressure. As such, it is one of State of matter#Four fundamental states, the four fund ...
assets to pay a debt when it falls due. Cash-flow insolvency can usually be resolved by
negotiation Negotiation is a dialogue between two or more people or parties to reach the desired outcome regarding one or more issues of conflict. It is an interaction between entities who aspire to agree on matters of The Impact of Religion on Interna ...
. 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 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 debt ...
, 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 A synonym is a word, morpheme, or phrase In syntax and grammar, a phrase is a group of words or singular word acting as a grammatical unit. For instance, the English language, English expression "the very happy squirrel" is a noun phrase whi ...
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."). 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 Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liqui ...
to pay debts as they fall due. Balance sheet insolvency involves having negative net assets—where liabilities exceed assets. Insolvency is not a
synonym A synonym is a word, morpheme, or phrase In syntax and grammar, a phrase is a group of words or singular word acting as a grammatical unit. For instance, the English language, English expression "the very happy squirrel" is a noun phrase whi ...
for
bankruptcy 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 debt ...
, which is a determination of insolvency made by a
court of law A court is any person or institution, often as a government institution, with the authority to Adjudication, adjudicate legal disputes between Party (law), parties and carry out the administration of justice in Civil law (common law), civil, C ...
with resulting legal orders intended to resolve the insolvency. Accounting insolvency happens when total liabilities exceed total assets (negative
net worth Net worth is the value of all the non-financial and financial assets owned by an individual or institution minus the value of all its outstanding Liability (financial accounting), liabilities. Since financial assets minus outstanding liabilitie ...
).


Consequences

The principal focus of modern insolvency
legislation Legislation is the process or result of enrolling, enacting, or promulgating laws by a legislature A legislature is an deliberative assembly, assembly with the authority to make laws for a Polity, political entity such as a Sovereign st ...
and business
debt restructuring 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 to improve or restore accounting liquidity, liquidity so ...
practices no longer rests on the
liquidation Liquidation is the process in accounting by which a company (law), company is brought to an end in Canada, United Kingdom, United States, Republic of Ireland, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and p ...
and elimination of insolvent entities but on the remodeling of the financial and organizational structure of debtors experiencing
financial distress Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are Default (finance), broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. ...
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 A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...
to continue in business while insolvent. In others (like the United States with its
Chapter 11 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code Title 11 of the United States Code, also known as the United States Bankruptcy Code, is the source of Bankruptcy in the United States, bankruptcy law in the Uni ...
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
creditor A creditor or lender is a Party (law), party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided s ...
s 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 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 to improve or restore accounting liquidity, liquidity so ...
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 Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance), failure to satisfy the terms of a loan obligation or failure to pay back a loan ** Default judgment, a binding judgment in favor of eit ...
". As governments are
sovereign ''Sovereign'' is a title which can be applied to the highest leader in various categories. The word is borrowed from Old French , which is ultimately derived from the Latin , meaning 'above'. The roles of a sovereign vary from monarch, ruler or ...
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 A currency, "in circulation", from la, Wikt:currens, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or currency in circulation, circulation as a medium of exchange, for example ba ...
(which typically results in
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
or
hyperinflation In economics, hyperinflation is a very high and typically accelerating inflation. It quickly erodes the real versus nominal value (economics), real value of the local currency, as the prices of all goods increase. This causes people to minimiz ...
).


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 Jurisdiction (from Latin 'law' + 'declaration') is the legal term for the legal authority granted to a legal entity to enact justice. In federations like the United States, areas of jurisdiction apply to local, state, and federal levels. J ...
.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


Anguilla

In
Anguilla Anguilla ( ) is a British Overseas Territory in the Caribbean The Caribbean (, ) ( es, El Caribe; french: la Caraïbe; ht, Karayib; nl, De Caraïben) is a region of the Americas that consists of the Caribbean Sea, its islands (som ...
, 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 Australia, officially the Commonwealth of Australia, is a sovereign country comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands. With an area of , Australia is the largest country by ...
, corporate insolvency is governed by the
Corporations Act 2001 The ''Corporations Act 2001'' (Cth) is an Act of Parliament, Act of the Parliament of Australia, which sets out the laws dealing with business entity, business entities in the Commonwealth of Australia. The company is the Act's primary focus, b ...
(Cth). Companies can be put into
Voluntary Administration 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 ...
, 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 ) , anthem = "God Save the King" , song_type = Territorial song , song = "Oh, Beautiful Virgin Islands" , image_map = File:British Virgin Islands on the globe (Americas centered).svg , map_caption = , mapsize = 290px , image_map2 = Brit ...
, insolvency law is primarily codified in the Insolvency Act, 2003 and the Insolvency Rules, 2005.


Canada

In
Canada Canada is a country in North America. Its Provinces and territories of Canada, ten provinces and three territories extend from the Atlantic Ocean to the Pacific Ocean and northward into the Arctic Ocean, covering over , making it the world ...
, bankruptcy and insolvency are generally regulated by the
Bankruptcy and Insolvency Act The ''Bankruptcy and Insolvency Act'' (BIA; french: Loi sur la faillite et l'insolvabilité) (the ''Act'') is one of the statutes that regulates the law on bankruptcy Bankruptcy is a legal process through which people or other entities who can ...
. An alternative regime is available to larger companies (or affiliated groups) under the Companies' Creditors Arrangements Act, where total debts exceed $5 million.


Germany

In
Germany Germany,, officially the Federal Republic of Germany, is a country in Central Europe. It is the second most populous country in Europe after Russia, and the most populous member state of the European Union. Germany is situated between ...
, 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. 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 Hong Kong ( (US) or (UK); , ), officially the Hong Kong Special Administrative Region of the People's Republic of China (abbr. Hong Kong SAR or HKSAR), is a List of cities in China, city and Special administrative regions of China, special ...
, 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 India, officially the Republic of India (Hindi: ), is a country in South Asia. It is the List of countries and dependencies by area, seventh-largest country by area, the List of countries and dependencies by population, second-most populous ...
, 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 India, officially the Republic of India (Hindi: ), is a country in South Asia. It is the List of countries and dependencies by area, seventh-largest country by area, the List of countries and dependencies by population, second-most populous ...
.


Ireland

In
Ireland Ireland ( ; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the Atlantic Ocean, North Atlantic Ocean, in Northwestern Europe, north-western Europe. It is separated from Great Britain to its east by the North Channel (Grea ...
, insolvency is governed by the
Companies Act 2014 The Companies Act 2014 (No. 38 of 2014) was signed into law by President Michael D. Higgins on 23 December 2014 to regulate company, companies under law of the Republic of Ireland, Irish law. It was a consolidation bill, consolidating and reformi ...
.


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 South Africa, officially the Republic of South Africa (RSA), is the Southern Africa, southernmost country in Africa. It is bounded to the south by of coastline that stretch along the Atlantic Ocean, South Atlantic and Indian Oceans; to the ...
, 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 Swiss may refer to: * the adjectival form of Switzerland *Swiss people Places *Swiss, Missouri *Swiss, North Carolina *Swiss, West Virginia *Swiss, Wisconsin Other uses *Swiss-system tournament, in various games and sports *Swiss International A ...
law, insolvency or
foreclosure Foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset In financial accounting, an asset is any resource ...
may lead to the seizure and auctioning off of assets (generally in the case of private individuals) or to
bankruptcy 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 debt ...
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 United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
, the term
bankruptcy 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 debt ...
is reserved for individuals. Insolvency is defined both in terms of
cash flow A cash flow is a real or virtual movement of cash, money: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are exp ...
and in terms of
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
in the UK
Insolvency Act 1986 The Insolvency Act 1986c 45 is an Act of Parliament, 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. History The Insolvency Act 1986 followed t ...
, Section 123, which reads in part: A company which is insolvent may be put into
liquidation Liquidation is the process in accounting by which a company (law), company is brought to an end in Canada, United Kingdom, United States, Republic of Ireland, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and p ...
(sometimes referred to as winding-up). The directors and
shareholders A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
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 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 debt ...
.


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 The Insolvency Act 1986c 45 is an Act of Parliament, 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. History The Insolvency Act 1986 followed t ...
which aim to provide time for the rescue of a company or, at least, its business. These are Administration and
Company Voluntary Arrangement Under UK insolvency law United Kingdom insolvency law regulates companies in the United Kingdom which are unable to repay their debts. While Bankruptcy in the United Kingdom, UK bankruptcy law concerns the rules for natural persons, the ter ...
: *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) 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 ...
). 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 Scotland (, ) is a Countries of the United Kingdom, country that is part of the United Kingdom. Covering the northern third of the island of Great Britain, mainland Scotland has a Anglo-Scottish border, border with England to the southeast ...
, receiver. The process, latterly known as
administrative receivership In law, receivership is a situation in which an institution or enterprise is held by a receiver—a person "placed in the custodial responsibility for the property of others, including tangible and intangible assets and rights"—especially in ca ...
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 In law, receivership is a situation in which an institution or enterprise is held by a receiver—a person "placed in the custodial responsibility for the property of others, including tangible and intangible assets and rights"—especially in ca ...
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 The Uniform Commercial Code (UCC), first published in 1952, is one of a number of Uniform Acts that have been established as law with the goal of harmonizing the laws of sales and other commercial transactions across the United States through U ...
, 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 The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
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 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, wheth ...
. 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.


See also

*
Solvency Solvency, in finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and C ...


References


Further reading

*


External links


Infographic Insolvency Risk Map Q2 2018 - Euler Hermes forecast
{{Authority control Debt Bankruptcy law legal terminology Insolvency law