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What’s the “zone of insolvency” in a business bankruptcy?

On Behalf of | Jun 2, 2023 | Business Bankruptcy

The “zone of insolvency” is a term used in bankruptcy law to describe a period when a company is in financial distress, generally when its liabilities exceed its assets. It refers to the point in time when insolvency and bankruptcy become a real possibility.

During this phase, your company may be facing significant challenges in meeting its financial obligations, such as maintaining its liquidity, fulfilling its contractual obligations and – of course – paying its debts.

Several key things you should consider during the zone of insolvency

Being in the zone of insolvency should trigger you to begin thinking about whether or not filing for bankruptcy protection for your company is appropriate. Bankruptcy can provide your company with the chance to restructure its debts and negotiate with creditors – and even continue operations if that’s judged to be a viable option.

Whether you may want to consider restructuring the company’s operations or look into sale options will likely depend on several factors, including your acceptance of personal risk, the ability you have to negotiate with your creditors or the chance to obtain additional financing and even the possibility of a merger with a more financially stable operation.

When a company is solvent, the owners and directors have a fiduciary obligation to continue to prioritize the interests of the shareholders, not its creditors. This duty does not generally shift to include creditors and other residual claimants until actual insolvency is reached. Therefore, this is a good time to be cautious about any transactions your company makes or any transfers of assets.

It’s also important to note that if your company does go into bankruptcy, asset transfers and financial transactions made during the zone of insolvency can be subject to scrutiny later by the bankruptcy trustee. If the trustee deems payments of your company’s debts to favor some creditors over others, they may exercise their clawback powers in the future and reclaim them.

It’s never wise to wait until your company hits an absolute crisis point to start exploring the possibility of bankruptcy. Seeking legal guidance to learn more about the benefits it offers (and the pitfalls you need to avoid as your business approaches insolvency) can help you make informed decisions about your situation.