Essentially, the term insolvency refers to the inability to pay debt.
This means that as your bills become due and payable, you lack the funds to pay the amount owing.
Businesses are also subject to being insolvent.
In these situations, it means that your company is no longer capable of paying out debts per the scheduled agreement.
Insolvency proceedings are covered by bankruptcy law and a possible court order.
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Different Types of Insolvency
There are different ways to approach determining the state of being insolvent.
Depending on situational specifics, you may be experiencing one of these types.
Balance Sheet Insolvency
The first of the two, and the most optimistic and manageable, is a more technical determination of insolvency.
Often called Insolvency by Balance Sheet, this means that your assets represent less than your liabilities.
An example is if your company’s assets (accounts currently on file and free and clear property) are worth $1 million.
If your corporate liabilities (mortgage, loans, other overhead expenses) represent more than $1 million, you are in a state of balance sheet.
Cash Flow Insolvency
By far the more challenging of the two types, this is when you do not have the liquid assets required to pay your bills as they arrive.
Often, this is a result of a sales issue, where inflow of cash is more challenging to achieve due to a stopping point in sales revenue.
Both types of insolvency are applicable to both businesses and individuals in Canada.
During times of economic strain, it is far too easy to slip into a state of being insolvent.
Legal Terms & Legislation
Insolvency is a clear-cut, legally defined term whose specifics are outlined by several different pieces of legislation in Canada.
The federal government outlines all the important details related to the state of being insolvent.
According to the official Canadian Government website, being insolvent allows for debtors to get a “fresh start” by getting relief from debt.
Outlined by several different pieces of legislation, the insolvency law works together to detail the ethical and legal approaches to managing situations.
These regulations include:
- The Bankruptcy and Insolvency Act: Detailing the steps and guidelines for individuals or businesses to liquidate their assets during the state of insolvency, this also outlines the necessary steps to ethical distribution of these funds. It also sets out the steps necessary to avoid the state of bankruptcies by outlining the way that debtors and creditors can come to arrangements.
- The Companies’ Creditors Arrangement Act: This regulation offers an outline for how to properly reorganize corporate debtors who have become insolvent. It allows such companies to get an order of the court to stop creditors from pursuing actions against them during negotiations.
- The Winding-up and Restructuring Act: This act, governed by the Department of Finance Canada, offers an approach to avoid taking the route of the BIA. Applying mainly to major corporations like banks and insurance businesses, it enables the liquidation of assets for companies not covered under other legislation.
In addition to the multiple rules controlling management, there is an official board governing these matters, namely the Office of the Superintendent of Bankruptcy.
Situations Leading Up to Becoming Insolvent
Leading up to a state of being insolvent are many financial difficulties, generally the inability to pay amounts owing.
During historical times of economic hardship, there were many approaches to avoiding creditors – all of which are prohibited by law.
These methods included:
- Debtors Absconding: When a person or business owing flees the jurisdiction for the purpose of avoiding a creditor. This also applies if the company or person possesses any property (including funds) which is seizure-exempt.
- Unethical Bulk Sale: Though only true in some jurisdictions, this is when a business sells a major portion of its assets (usually in form of inventory) to another party. When this is not a part of routine business, and rather an attempt to circumvent creditor’s actions, this is illegal.
Of course, there are other ways to manage creditors during the situation leading up to being insolvent.
One such approach is to generate ‘security interests’ which is when a debtor gives a creditor the legal right for property to become collateral if a debtor defaults on their obligated debts.
Though the key example of this is a mortgage or car loan, there are ways to apply this approach to debt mitigation.
On the other hand, too many security interests can create a climate ready to develop into an insolvent state and restructuring.
Business Vs. Individual
Even though being insolvent is generally defined in the same manner, the difference between the two is both the acts governing the issue and the nature of the parties involved.
Consumers becoming insolvent is when an individual is no longer able to pay off debt as it becomes due.
Commercial states of insolvency are also different given that there are approaches to managing the situation inaccessible to consumers.
Whereas all three above-mentioned acts apply to corporations, only the BIA applies to consumers.
An insolvent person is unable to pay their debts as they become due.
The proceedings can lead to a financial state where you will be declaring bankruptcy or making a consumer debt proposal to creditors.
Insolvent companies are handled differently.
There are, naturally, other approaches to insolvency which do not lead to a state of bankruptcy.
The major approach is through restructuring your debt.
Essentially, this is the act of forming a proposal to creditors which outlines your approach to repaying debt on new terms.
Generally, it allows the payer to pay either a smaller amount, pay the same amount over a more substantial period of time, or a mix of both.
Often, making the proper financial maneuvers to handling the state of being insolvent can be very overwhelming – especially for individuals.
It can help to seek out the advice and guidance of a professional in the financial industry, especially when you want to create a consumer proposal to restructure debt.
A financial advisor can assist in the creation of these proposals, and in helping you recreate credit after you leave the state of insolvency.
There are many resources available to help you handle the matter.
Information on Consumer Proposals
Consumer Proposals in Canada – An Alternative to Bankruptcy
What is a Consumer Proposal?
What are the Benefits of a Consumer Proposal?
What are the Steps in a Proposal?
What Debts Are Erased in a Consumer Proposal?
Is There Life After a Proposal?
Consumer Proposal Eligibility
How to Amend a Consumer Proposal
How to File for Bankruptcy
What is Bankruptcy?
How Does Bankruptcy Work?
What is the Cost of Bankruptcy in Canada?
How to Rebuild Credit Following Bankruptcy
Personal Bankruptcy in Canada
What Debts are Erased in Bankruptcy?