There are various definitions of what constitutes insolvency for a corporation but it is generally when the corporation is unable to meet its obligations. In most cases, this means that the corporate liabilities now exceed its assets and there is no reasonable possibility that it can meet its future obligations or to pay its debts as they become due. In most cases, corporate bankruptcy under either Chapter 7, a liquidation, or a Chapter 11, reorganization, is filed.
There are also different degrees of corporate insolvency:
Zone of Insolvency
Any corporation meeting these definitions is at least within the zone of insolvency. Depending on where your corporation is incorporated, the directors’ duties remain to the shareholders only, or may include the creditors under Delaware’s corporate laws.
If the officers and the directors know, however, that the corporation is in this zone of insolvency, they must avoid any actions such as incurring more debt since they may be guilty of fraud.
This may include not paying its employees or vendors and laying off or furloughing workers. The management in this predicament may consider taking some of the following action:
- Determine prospects for fund-raising and a timeline
- Identify potential buyers
- Identify realistic cash flow projections
- Identify accounts receivables
- Determine the value of the company
- Assess the status of creditors–secured or unsecured, statutory, taxes
- List potential investors
- Possibility and practicality of a loan
- Convert assets into cash
- Consult legal and financial advisors
- Management should recuse themselves from any decisions where they have a personal interest or stake
- Practice good corporate governance and be aware of fiduciary duties
If insolvent and all other actions have failed to lift the corporation out of insolvency, corporate bankruptcy is usually the last but most practical resort.
Also, a corporation might consider a Company Voluntary Arrangement, if available, whereby an appointed administrator manages the company’s affairs and may restructure the corporation and work out a monthly payment schedule to creditors and keep the business operational, or simply liquidate it. This is similar to a a corporate bankruptcy under either Chapter 7 or Chapter 11, but these and all other options should be discussed with a legal professional.