What is Corporate Insolvency?

Malcolm Tatum

Corporate insolvency is a condition in which a business is unable to honor its debt obligations, often due to either a lack of sufficient investment capital on the front end or a negative change in cash flow. Once a company becomes insolvent, it is not unusual for the business to seek some type of bankruptcy protection as a means of restructuring the debt or beginning the process of liquidating assets as part of a company shutdown. The insolvency procedures that are utilized depend on whether the owners wish to attempt to salvage the business or dissolve the corporation after complying with the directives of the court overseeing the compulsory liquidation.

When a corporation becomes insolvent, it often seeks some type of bankruptcy protection.
When a corporation becomes insolvent, it often seeks some type of bankruptcy protection.

One of the most common reasons for corporate insolvency has to do with a lack of cash to adequately fund the business operation. With newly created firms, this may come about because projections of the amount of capital needed to fund the business during its startup phase fall short of the actual expenses. Unless investors are willing to contribute more money to the enterprise, the business will fail and whatever assets the company may own are sold to settle outstanding debts.

With established companies, corporate insolvency may come about due to changes in cash flow. This may happen because competitors are able to attract a significant number of the company’s clients, which in turn reduces the revenue stream. Unless the company can recapture those lost clients or attract new customers to replace those who left, the business will soon begin liquidating assets to augment the reduced revenue stream. Over time, the stockpile of assets is exhausted and the business has no choice but to go into bankruptcy.

Other issues may actually be the underlying cause of corporate insolvency. An inability to manage financial assets responsibly may undermine the strength of the business, even if there is more than enough revenue coming in to honor all debt obligations. This includes the mismanagement of lines of credit, or embarking on an expansion campaign without adequate preparation. A decline in product quality or support to customers may also erode the company’s reputation over time, making it impossible for the business to compete against other companies with better products and a more customer-centric culture.

While the reasons behind corporate insolvency vary, the end result is the same. A business that once had a great deal of promise is unable to pay creditors and lenders, and must seek protection in order to survive. Depending on laws related to business bankruptcy in the jurisdiction where the company is located, it may be possible to reorganize the debt and continue functioning. In other situations, liquidation and dissolution of the business is unavoidable, with those activities conducted under an administrative receivership created and monitored by the local court system.

Discuss this Article

Post your comments
Forgot password?