What is insolvency?
Author: Richard Fisher of Blake Dawson Waldron This is an extract from Lawbook Company’s Nutshell: Corporate Insolvency Law by Richard Fisher (Sydney: LBC, 2000, 1st ed). LBC Nutshells are the essential revision tool: they provide a concise outline of the principles for each of the major subject areas within undergraduate law. Written in clear, straightforward language, the authors clearly explain the principles, and highlight key cases and legislative provisions for each subject. Central, of course, to any consideration of the forms of external administration is the concept of insolvency. The Law defines “insolvency” by reference to a stipulation as to when a person is “solvent”; solvency being that financial condition which obtains if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable; s95A,Corporations Law. There is some debate as to whether such a test of insolvency involves a consideration of the debtor’s balance sheet or its ca
Insolvency is generally defined as a financial state in which a company can no longer pay its bills and other obligations on time. Insolvency occurs whenever liabilities, or debts, exceed assets and cash flow. Once a company becomes insolvent, it must take immediate action to generate cash and settle or renegotiate current debts. Companies which cannot successfully pull themselves out of insolvency often face bankruptcy proceedings, receivership, or liquidation of all assets. Insolvency is commonly confused with bankruptcy, and the two concepts are not dissimilar. Both insolvency and bankruptcy deal with liabilities exceeding assets, but insolvency is a state of being and bankruptcy is a matter of law. Companies can be insolvent but not legally bankrupt. Insolvency can lead to bankruptcy, but the condition may also be temporary and fixable without legal protection from creditors. Companies facing the possibility of insolvency can take steps to keep themselves financially solvent. Using
All businesses have revenues coming in from sales and money going out to pay for raw materials, staff, insurance, administration, advertising, loans and so on. The amount of money coming into the business, and when it comes in to the business, is crucial to allow a firm to be able to continue operating in the longer term. Expenditures tend to be fairly regular in occurrence – insurance, staff salaries, rent and rates, for example, have to be paid at least monthly and raw materials used will depend on the level of production. If a business faces an increase in demand for its products, it may have to order in more stock and it needs the funds available to be able to do that. If, for some reason, revenues are not coming in at the same rate then the business can start to experience problems. Without cash coming in, creditors (people who are owed money by the business) do not get paid and legally they can take steps to recover this money. If this happens then the business faces insolvency –
An insurance company is declared to be insolvent when it no longer meets the statutory definition of solvency. Even though the company may still have assets, the company is deemed to be “Unable to pay its outstanding lawful obligations as they mature in the regular course of business …” and the existing assets of the company are then preserved to allow for the settlement of outstanding claims and debts to creditors.
