Condition in which liabilities exceed assets so that creditors cannot be paid. It is a financial condition that often precedes bankruptcy. In the context of equity, insolvency is the inability to pay debts as they become due; insolvency under the balance-sheet approach means that total liabilities exceed total assets.
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Insolvency means the inability to pay one's debts.
This is defined in two different ways:Cash flow insolvency: unable to pay debts as they fall due;Balance sheet insolvency: having negative net assets: liabilities exceed assets.
A business may be cash flow insolvent but balance sheet solvent if it holds illiquid assets, particularly against short term debt. Conversely, a business can have negative net assets showing on their balance sheet 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.
123. Definition of inability to pay debts
(1) A company is deemed unable to pay its debts - ...
(e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.
(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.
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. 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 favoured 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 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 deliquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations.
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.
When determining whether a gift or a payment to a creditor is an unlawful preference, both the date of the insolvency and the date of the bankruptcy – the liquidator or administrator will be able to recover money paid to a creditor as a preference if paid within six months (or two years if the creditor is a person connected to the company) preceding the date of liquidation and the company was insolvent at the time. In addition to unlawful preferences, liquidators and administrators in the UK may also challenge transactions at an undervalue, extortionate credit transactions, some floating charges and transactions defrauding creditors.
In the UK, the term bankruptcy is reserved for individuals; a company which is insolvent may be put into liquidation (sometimes referred to as winding-up).
The United States has established insolvency regimes which aim to protect the creditors of the insolvent individual or company and balance their respective interests. For example, see Chapter 11, Title 11, United States Code.
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.