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What does it mean to file for insolvency?

Date Added 10.11.21

There is a lot of confusion about what the term “insolvency” actually means.  Terms such as bankruptcy, liquidation and administration are liberally referred to in the media but are often incorrectly applied or not adequately explained. So what is insolvency?

You can be insolvent as an individual or as a Company.  Insolvency occurs when an individual or company can no longer meet financial obligations.  As an individual that would mean that you cannot pay your debts when they are due.  So if you are unable to meet monthly obligations to institutions who have lent you money (for example a mortgage or credit card company) you may be insolvent by definition.

As a Company, there are two tests.  The first is cash flow insolvency.  This is similar to the individual test.  So a Company does not have enough liquid cash to pay its creditors when its invoices fall due even though it does have assets on its balance sheet (such as property or stock).

The second test for a company is balance sheet insolvency.  A company would be considered insolvent on a balance sheet basis if the company debts are greater than its total assets.  All assets are considered in the analysis, liquid or otherwise.

So what does it mean to file for Insolvency?  While Insolvency is the state of financial distress in respect of an individual or company based on these tests, filing for insolvency is the legal process pursued in Court in the form of proceedings with the purpose of liquidating the assets in order to pay off the outstanding debts.

This is where the terms bankruptcy, liquidation and administration come in.  These are the legal processes that follow on from insolvency.  Filing for Bankruptcy applies to individuals while Liquidation and Administration applies to companies.  Where companies are concerned, Liquidation is appropriate where the financial distress is so extreme that the only option is to close the business while Administration, by comparison, might be used where some parts of the distressed Company might be saved.

The individual or the Company may choose to file for insolvency themselves or a creditor who has lost patience may commence the legal process.  So being insolvent does not automatically mean that bankruptcy, liquidation or administration will follow.  These legal processes will only occur when someone takes the ultimate step to file for insolvency as a result of the financial distress experienced by the ‘insolvent’ individual or Company.

For further advice and guidance on insolvency and the legal processes that might follow from insolvency…Talk to Tollers on 01604 258558 and ask to speak to the specialists in our commercial services teams who will be happy to help.

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