Do you know that without being a bankrupt, you can always be insolvent but you cannot become bankrupt unless you are insolvent? The statement may be a little confusing. Usually, people think that both means the same, but they are not.
When you are unable to pay all your debts then you become insolvent. However, you can try to resolve your insolvency either by borrowing money or by arranging money from different sources to payback your dues.
When all the attempts made by you fail to pay back your debt then the last alternate available with you to declare yourself as bankrupt when you declare voluntary liquidation of your assets.
Usually insolvency can be found in two different forms:
- Cash flow insolvency
- Balance sheet insolvency
In case of cash flow insolvency as a debtor you fail to make any payments as you may not have money. In case of balance sheet insolvency your debts will exceed your assets.
Types of insolvency
In the corporate sector, there are 3 common types of insolvency that generally occur. They are as follows:
1. Voluntary administration
In case of voluntary administration, the directors of any company which is financially troubled or a company that has secured creditor who has collateral of most of the assets of the company will appoint external administrator.
This external administrator will be called as ‘voluntary administrator’.
Basic role of this voluntary administrator will be to make detailed investigation about various affairs of the company, in order to report to all the creditors and also make recommendation to all the creditors.
Voluntary administrator will recommend whether the troubled company must enter into any legal deed to go into liquidation or all the assets be returned to their directors.
Company’s directors will generally appoint a voluntary administrator and after that they will take decision that the sick company is now insolvent or very soon going to become insolvent.
When all the affairs of the company wind up in a systematic manner then it will be called as liquidation which will involve selling of all assets of the company.
Thereafter all the proceeds of the assets will be distributed among the creditors and all other shareholders of the company. There can be following 3 types of liquidation:
- Through court order
- Creditors’ voluntary
- Members’ voluntary.
In case of court liquidation, it will start after obtaining order from the court for which necessary application will be made to the court. Normally, all the creditors of the sick company will make an appeal to the court.
As far as liquidation through creditors’ voluntary is concerned, this liquidation will be initiated by the company itself.
Most commonly a company will go into receivership after a receiver will be appointed by any secured creditor, who may be holding security or has charge over few or all the assets of the company.
The primary role of the receiver is to collect as well as sell most of the charged assets of the company for repaying the debt, which is owed to all the secured creditors.