What insolvency means
Insolvency is a financial state, not a legal process. The processes, winding up and administration, are what follow from it.
There are two tests and either can be satisfied on its own.
The cash flow test asks whether the company can pay its debts as they fall due. A business with valuable property but no cash to meet this month's obligations is insolvent on this test.
The balance sheet test asks whether liabilities exceed assets. A business paying its bills comfortably from new borrowing while its liabilities outrun its assets is insolvent on this test.
There is also a statutory route to establishing it. A creditor serves a statutory demand for a debt above the threshold set by CAMA, and if the company fails to pay or secure it within the statutory period, the company is deemed unable to pay its debts. That deeming is what founds most creditor petitions.
How it is used
The word matters most because of what it triggers for directors.
While a company is solvent, directors run it for the shareholders. As it approaches insolvency, creditor interests come to the fore, and decisions that were routine become risky. Continuing to take deposits or incur credit with no realistic prospect of paying is where personal liability starts.
The options at that point are not only closure. CAMA 2020 introduced administration, where an administrator takes control with the aim of rescuing the company or achieving a better outcome for creditors than immediate liquidation, with a moratorium on claims while that is attempted. It also introduced the company voluntary arrangement, a compromise proposed to creditors that binds them all if the required majority approves.
Winding up remains the endpoint where rescue is not realistic, either voluntarily or on a creditor's petition.
Key features
- Two tests: inability to pay debts as they fall due, and liabilities exceeding assets
- An unanswered statutory demand can deem a company unable to pay its debts
- Directors' duties shift towards creditors as insolvency approaches
- CAMA 2020 introduced administration and company voluntary arrangements as rescue routes
- Insolvency practitioners must be qualified and licensed
- Personal liability can follow for directors who trade improperly
How this works in Nigeria
CAMA 2020 was a genuine change and it is still under used. Before it, a Nigerian company in difficulty had very few options between struggling on and being wound up. Administration and voluntary arrangements give a viable business room to restructure, and the moratorium in administration stops creditors dismantling the business while a rescue is attempted.
The Act also brought insolvency practitioners under regulation, so administrators, liquidators and receivers must be qualified and licensed rather than simply appointed.
For small Nigerian companies the practical picture is different again. Many simply stop trading, stop filing and are eventually struck off, leaving creditors with nothing and directors with an unresolved history that surfaces when they try to register or bank elsewhere.
Directors should also remember that limited liability protects shareholders from company debts. It does not protect a director who signed a personal guarantee, and Nigerian banks take those routinely from directors of small companies.
Insolvency vs bankruptcy vs receivership
Three words used interchangeably in conversation and meaning different things in law.
Insolvency is the financial condition. Being unable to pay debts as they fall due, or owing more than you own. It applies to both individuals and companies.
Bankruptcy is the formal process for individuals under the Bankruptcy Act, not for companies. Calling a failed company bankrupt is common speech rather than accurate description.
Receivership is what happens when a secured creditor enforces. A receiver is appointed under a debenture to take charge of the charged assets and realise them for that creditor, rather than for creditors generally.
So an insolvent company might enter administration, go into receivership at the instance of its bank, or be wound up. Only an individual goes bankrupt.
Limits and risks
The rescue procedures depend on the business being worth rescuing. Administration buys time, it does not create customers or capital, and a company with no viable underlying business is delaying rather than surviving.
Cost is a real barrier. Administration and voluntary arrangements involve licensed practitioners and professional fees that a very small company cannot fund, which is why most small Nigerian insolvencies end informally.
Creditors also behave unpredictably. A voluntary arrangement needs the required majority, and a single large creditor who prefers enforcement can make rescue impossible.
And early warning is the thing most often missing. Directors who wait until the account is empty have removed the options that only exist while there is still something to work with.
Worth knowing
Take advice at the point the cash flow forecast stops working, not when the last payment bounces. The rescue options under CAMA 2020 need time and something left to restructure, and directors who keep incurring credit after the position is hopeless expose themselves personally.
Questions people ask
What does insolvency mean?
Being unable to pay debts as they fall due, or having liabilities that exceed assets. Either test on its own is enough, and it is a financial condition rather than a legal process.
What is the difference between insolvency and bankruptcy?
Insolvency is the financial condition and applies to both individuals and companies. Bankruptcy is a formal process for individuals under the Bankruptcy Act. Companies are wound up rather than made bankrupt.
What is a statutory demand?
A formal demand served by a creditor for a debt above the threshold set by CAMA. If the company fails to pay or secure it within the statutory period, it is deemed unable to pay its debts, which founds a winding up petition.
Can an insolvent Nigerian company be rescued?
Yes. CAMA 2020 introduced administration, where an administrator takes control with a moratorium on claims while a rescue is attempted, and the company voluntary arrangement, a compromise binding creditors if the required majority approves.
Are directors personally liable if their company becomes insolvent?
Not automatically. Directors who traded fraudulently or in other defined improper circumstances can be made personally liable, and a director who signed a personal guarantee is liable on that guarantee regardless of the company's position.
What should a director do when the company cannot pay?
Take advice immediately, stop incurring credit that cannot realistically be repaid, keep records of every decision and the reasons for it, and consider administration or a voluntary arrangement while there is still a business to save.