What is the test for insolvency? Is there any obligation on directors or officers of the debtor to open insolvency procedures upon the debtor becoming distressed or insolvent? Are there any consequences for failure to do so?

Restructuring & Insolvency

Australia Small Flag Australia

In Australia, the definition of insolvency is contained in section 95A of the Corporations Act which states,

  1. A company is solvent if, and only if, the company is able to pay all the company’s debts, as and when they become due and payable.
  2. A company which is not solvent is insolvent.

Case law in Australia has indicated that the focus of the insolvency test for companies approaching financial distress is the ‘cash flow’ position of the business rather than its balance sheet.

Company directors are burdened by a positive duty to prevent insolvent trading. This duty prevents directors from incurring any debt on behalf of the company if the company is insolvent or the director has reasonable grounds for suspecting that it is likely to become insolvent. Directors will be personally liable for any debts that are incurred thereafter in these circumstances.

To guard against the risk of an insolvent trading claim, directors are required to consider the solvency of the company regularly and to place the company into voluntary administration if, in their opinion, the company is, or is likely to become, insolvent.

Cayman Islands Small Flag Cayman Islands

A company may be wound up on the ground of insolvency if it is unable to pay its debts as they fall due (i.e. the cash flow insolvency test). A company will be deemed to be unable to pay its debts if:

  1. It fails to satisfy a statutory demand (provided that the debt claimed in the demand is not disputed by the debtor company in good faith and on substantial grounds);
  2. Execution of a judgment is returned wholly or partly unsatisfied; or
  3. It is proved to the satisfaction of the Court that the company is unable to pay its debts.

There is no statutory obligation on a company's directors to commence liquidation proceedings. However, in circumstances in which the company is insolvent or of doubtful solvency, the directors' duty to act in the best interests of the company requires them to have regard to the interests of its creditors. Directors may incur personal liability to the company for any losses which they cause to the company if they act in breach of that duty, for example, by causing the company to incur further obligations when they knew or should have known that there was no reasonable prospect of the company avoiding an insolvent liquidation.

Switzerland Small Flag Switzerland

Under Swiss law, the following terms must be distinguished:

  • Illiquidity (Zahlungsunfähigkeit): A Swiss corporate is illiquid pursuant to Art. 191 of the Swiss Federal Act on Debt Enforcement and Bankruptcy (DEBA) if it is no longer in a position to pay its debts as and when they fall due. Hence, this test focuses on the solvency of the corporation.
  • Over-indebtedness (Überschuldung): A Swiss corporate is over-indebted within the meaning of Art. 725 par. 2 (CO) if its assets are no longer sufficient to cover its liabilities. This test is balance sheet based. That said, over-indebtedness may result from illiquidity where, as a result, the going concern assumption is no longer sustainable and, thus, accounting will have to be made at liquidation values.

The highest executive body of a Swiss corporate is generally obliged to file for bankruptcy proceedings in case of over-indebtedness within the meaning of Art. 725 DEBA. Certain exceptions apply where a deep subordination exists (cf. section 5 below) or where a restructuring can be implemented without delay. The general assembly of a Swiss corporate may further resolve to apply for the liquidation of the Swiss corporate through a bankruptcy proceeding if the company is illiquid pursuant to Art. 191 DEBA but no general obligation to initiate such proceedings in case of illiquidity currently exists under Swiss corporate law. Furthermore, a creditor may directly apply for the opening of bankruptcy proceedings if the corporation has ceased to make payments pursuant to article 190 DEBA.

There is no specific trigger event for a debtor to request the opening of composition proceedings although (looming) illiquidity and/or over-indebtedness will often exist. In addition, both creditors entitled to request the opening of bankruptcy proceedings and the bankruptcy court may request the opening of composition instead of bankruptcy proceedings.

It is currently being proposed within the context of a general revision of Swiss corporate law to extend the duties of the highest executive bodies of a Swiss corporate in case of (looming) illiquidity. Such rules are not currently expected to enter into force before 2019. It is not proposed to make (looming) illiquidity an automatic trigger for insolvency proceedings.

Please refer to section 11 below for the consequences of a breach of obligations by the highest executive body of a Swiss corporate.

Germany Small Flag Germany

There are three independent tests for insolvency:

  • Illiquidity (Zahlungsunfähigkeit) is the debtor's inability to meet its payment obligations as and when due. A debtor is generally assumed to be illiquid if he has ceased to make payments. Illiquidity cannot be presumed if there is only a temporary delay in payments. Only debt that is being seriously pursued by the creditor (ernstliches Einfordern) must be considered for the purposes of determining illiquidity.
  • A company is overindebted (überschuldet) if its assets (on market value basis) no longer cover its liabilities, unless the continuation of the company’s business is predominantly likely, which requires sufficient funds to carry on its business within the present and the following business year. If this prognosis is negative, overindebtedness is determined solely on the basis of a special balance sheet (Überschuldungsstatus).
  • Impending illiquidity (drohende Zahlungsunfähigkeit) which is defined as the debtor not being able to meet its payment obligations as and when they will become due in the future.

In case of illiquidity or overindebtedness, managing directors of limited liability companies, corporations and partnerships ultimately having limited liability must file for insolvency at the latest within three weeks. This three-week period, may only be fully used, if there is a well-founded expectation that within it illiquidity and overindebtedness can be cured. Managing directors who intentionally or negligently breach this duty face civil liability to the company and its creditors for any losses which these have incurred due to the delayed petition and criminal liability. These severe consequences are a serious threat for managing directors in distressed situations.

In case of impending illiquidity, management has a right, but not a duty, to file for insolvency.

Updated: March 14, 2017