What happens if a business that owes you money informs you that it’s insolvent or an insolvency order is issued by the court? What does that mean for your ability to collect what it owes you?
First, it’s important to know what insolvency means and to understand the two primary types. Further, contrary to popular belief, insolvency isn’t the same as bankruptcy. A business (or individual) can be insolvent without having to file for bankruptcy. However, when parties file for bankruptcy, they, by definition, have become insolvent.
Cash-flow vs. balance-sheet insolvency
Bankruptcy law defines insolvency as a “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at fair valuation.” Cash-flow (equitable) insolvency is when a debtor simply doesn’t have the money available to pay a debt – usually after exhausting all options for obtaining money to do so. Balance-sheet insolvency is when a business’s or person’s debts are greater than their assets.
If you’re a creditor, you likely have a better chance of getting paid by a business with balance-sheet insolvency because it may have the money at the moment to pay you. At some point, however, unless their assets increase, that business will likely end up in cash-flow insolvency.
Both types of insolvency are potentially reversible. For example, if a business understands its predicament and takes steps like selling off assets, cutting employees or possibly agreeing to some type of merger or partnership that will give it an influx of capital. It may try to negotiate down its debt with individual creditors.
It’s crucial as a creditor to recognize the signs of potential insolvency before you’re left with a sizable unpaid debt that can harm your bottom line. It’s critical to get legal guidance as early as possible to help you determine how best to go about collecting what you can from an insolvent or potentially insolvent debtor.