If you’ve learned that a creditor is “insolvent,” that is certainly a troubling (if not unexpected) development. They may simply announce that they’re insolvent or they may receive a court-issued insolvency order.
People often assume that if an individual or business is insolvent, they’re on the verge of bankruptcy. That’s not necessarily the case.
What is insolvency?
Just about anyone who files for bankruptcy is insolvent. However, insolvency doesn’t always lead to a bankruptcy filing.
U.S. 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.” There are two primary types. Let’s take a brief look at them.
Balance-sheet insolvency
This is when debts exceed assets. It may be possible for a person or business to liquidate enough assets to pay their immediate debts. This can help them settle up with creditors in the short run. However, if it’s not enough to turn their financial situation around (or file for bankruptcy), they can end up with what’s called cash-flow insolvency.
Cash-flow insolvency
Also referred to as “equitable insolvency,” this is when a party doesn’t have enough cash coming in to keep up with their debts – even after they’ve sold off assets or taken other steps to get needed cash. as the name denotes, is a problem with not having enough cash flow to pay debts. Generally, debtors have exhausted all options for obtaining cash before insolvency.
Unless and until insolvency leads to bankruptcy, creditors don’t have to be notified. That’s just one reason why it’s crucial to keep in close touch with individuals and businesses that owe you money and be aware of the signs. For example, if a debtor asks you to restructure or negotiate their debt, that’s a clear indication that they can’t pay you what they owe. Having legal guidance can help protect your own business from being harmed by others’ financial challenges.
