May 22, 2020
Frequency Asked Questions about Insolvency
Q: WHAT IS INSOLVENCY?
A: Insolvency is a term to describe an inability to pay debts when they are due. A business, person or entity that is insolvent is called a "debtor." A "creditor" is the person or entity that is owed the money.
Q: IS THERE MORE THAN ONE KIND OF INSOLVENCY?
A: Yes. There is "cash-flow" insolvency and "balance-sheet" insolvency.
Q: WHAT IS THE DIFFERENCE BETWEEN "CASH FLOW" INSOLVENCY AND "BALANCE-SHEET" INSOLVENCY?
A: "Cash Flow" insolvency occurs when the debtor doesn't have enough cash to pay its debts when they become due. Balance-Sheet insolvency is when the debtor's debts exceed its assets.
Balance sheet insolvency is generally applied to businesses, as it takes into account the businesses non-liquid assets when comparing the debtor's assets to its debts. Balance sheet insolvency also addresses the longer term financial viability of a debtor by taking into account the debtor's contingent liabilities and prospective liabilities.
Q: CAN A DEBTOR BE CASH FLOW SOLVENT BUT BALANCE SHEET INSOLVENT, OR VICE VERSA?
A: Yes. A debtor is cash flow solvent and balance sheet insolvent when the debtor has the enough cash on hand to pay its debts that are currently due, but not have enough assets to cover its longer term liabilities.
A debtor is cash flow insolvent and balance sheet solvent, when the debtor doesn't have enough cash on hand to pay its immediate debts, but the debtor's has enough non-liquid assets to cover all its debts.
WHAT HAPPENS IF DEBTORS HAVE MULTIPLE CREDITORS?
If a debtor owes money to more than one creditor, creditors have legal options available to them to reserve a place in line to receive payment in proportion to the debts owed by the debtor.
If you are a business or entity facing cash flow challenges, or you are a creditor that is concerned about your legal rights to collect monies owed to you, it is important that you consult with a legal advisor to protect your interests. There are legal remedies available to both parties, but those remedies are time-sensitive.