Insolvency is a term often confused with bankruptcy. Insolvency is defined as not having access to enough cash to pay current bills and other financial obligations in the usual course of business. Insolvency will occur if total assets are greater than liabilities, if those assets cannot be readily sold for cash to meet debts become due.
While insolvency is similar to bankruptcy, the legal definition is important because under the Uniform Commercial Code, there are some additional rights which can be invoked by creditors if the debtor is deemed to be insolvent. Insolvency often leads to bankruptcy for companies. Bankruptcy is a matter of law which must be authorized in a court proceeding. Bankruptcy protects the debtor from their creditors while insolvency provides no safeguards for the debtor, therefore creditors may continue all legal methods to recover their money they are owed.
Insolvency can affect both individuals and corporations. If a business cannot solve their insolvency, they will usually be forced into bankruptcy, receivership or forced to liquidate all assets. If you find yourself in insolvency, you will need to either raise additional cash or find a way to refinance or renegotiate your debt.
Options for corporations include selling additional shares of stock, issuing bonds ("junk bonds" since they will have a poor credit rating), utilizing existing lines of credit or renegotiate loans More imaginative options for companies to raise immediate cash are selling assets (buildings or machinery) and then leasing back, or selling receivable (money owed such as fees billed but not collected) at a discount rate. Sometimes a larger company will be willing to buy your company even with financial troubles if you have a great product, local, reputation or customers.
Individuals trying to recover from insolvency can potentially refinance their home mortgage if they still have equity, transfer credit card balances to cards with lower interest rates or take out a personal loan. If you find cash alternatives or postpone debt, you will probably have to declare bankruptcy to protect yourself from your creditors.
You also need to be careful if you pay off some of your creditors if you are insolvent. This could lead to civil lawsuits from other creditors if they believe you are showing preference to certain specific creditors over other creditors, usually family members, friends or business partners. Insolvency is a definite warning signal of financial problems and without solving the problems, will eventually lead to either further financial difficulties or bankruptcy.
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