Insolvency

Under the Balance Sheet definition of insolvent 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.

Bankruptcy courts sometimes disagree on how to determine whether a company is insolvent. The two competing tests are:

• The Balance Sheet Test, and
• The Cash Flow Test

As mentioned above, 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 capable and 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 under the Bankruptcy Code does not have to show insolvency to be granted relief under the 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 paying 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 he is insolvent
3. an order for administration of the customer's business affairs has been made by a court for the benefit of his creditors
4. in the course of execution of a judgment obtained against the customer, the levy of execution has not satisfied the debt either in full or in part
5. the customer has made a valid assignment, or composition or other arrangement for the benefit of his creditors generally
6. a receiver is appointed on behalf of debenture holders or other creditors of the customer
   

A note of caution: The fact that a company reports a deficit net worth 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 evaluating carefully and monitoring carefully and regularly.

Edited by : Michael Dennis, author of "Credit and Collection Handbook" available at the NACM Bookstore.