Meaning
Legal definitions determine a firm’s failure to meet specific financial tests prescribed by national law. This statutory insolvency is the formal trigger for various legal remedies, including the right for creditors to petition for a winding up order. It is established through two primary tests that look at the balance sheet and the cash flow.
The status remains until a court discharges the entity or the debts are fully satisfied. Reaching this point changes the legal relationship between the directors and the parties who are owed money.
Balance Sheet
Liabilities that exceed the total value of assets indicate a state of negative equity. This test for statutory insolvency considers both present and contingent liabilities to determine the long term viability of the firm. A company might be solvent on a cash basis but still meet this definition if its future obligations are too high.
Cash Flow
Inability to pay debts as they fall due is the most immediate sign of financial failure. The cash flow test for statutory insolvency focuses on the liquidity available to meet current operational needs. Missing a single payment to a major supplier can be enough evidence to prove this condition in court.
Evidence Burden
Creditors must provide clear proof that one of the legal tests has been satisfied. The burden for statutory insolvency usually requires a formal demand for payment that remains unanswered for a set period. Once this evidence is presented the court can move to appoint a professional to manage the affairs of the company.
