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Insolvency in Bankruptcy
Under the Balance Sheet definition of insolvent found in the U.S. Bankruptcy Code, a debtor is insolvent when the value of a debtor's assets is exceeded by the debtor's liabilities. However, some bankruptcy courts disagree on how to determine whether a company is insolvent. The two competing tests are:
- The Balance Sheet Test, and
- The Cash Flow Test
The Balance Sheet test asks if the company's liabilities exceed its assets. The Cash Flow test asks whether or not the debtor company is able to pay its debts as they become due. Many bankruptcy courts seem to look at a variety of factors including both of the Tests listed above when considering a debtor's insolvency.
A debtor does not have to prove insolvency to be granted relief under the U.S. Bankruptcy Code. The test in an involuntary bankruptcy is slightly different. A debtor company may be forced into involuntary bankruptcy if the debtor is not able to pay its debts as they come due.
A debtor's insolvency shall be deemed to occur in any of the following cases:
1. The customer has been declared bankrupt
2. An order for the winding up of the customer's business affairs has been made on the ground that the entity is insolvent
3. An order for administration of the customer's business affairs has been made by a Court for the benefit of its creditors
4. In the course of execution of a judgment obtained against the customer, the levy of execution has not fully satisfied the debt
5. The customer has made a valid Assignment for the Benefit of Creditors, or a composition agreement or other arrangement
6. A receiver is appointed to manage the debtor company on behalf of debenture holders or other creditors
A note of caution: The fact that a company reports a deficit net worth [ a situation in which total liabilities exceed total assets ] does not necessarily mean that the company is going to file for bankruptcy protection. However, a customer or applicant reporting a deficit net worth is certainly worth reviewing and monitoring carefully and regularly.
Edited by Michael C. Dennis. Michael Dennis is a consultant and he can be reached by email at mcdennis13@yahoo.com