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Voluntary insolvency is when a business determines that it is unable to meet the full payment requirements to its creditors. Instead of being forced into bankruptcy, the company's officials or shareholders make the decision to file for a restructuring of the organization's debt. An insolvency agreement may involve the voluntary liquidation of some assets in order to satisfy creditors.
Essentially, a voluntary insolvency is equivalent to a bankruptcy. The business typically has financial obligations that exceed its income and it cannot successfully fulfill its obligations unless the payment terms are restructured. It is somewhat similar to when an individual participates in a consumer credit counseling program. These programs usually lower the monthly payment amounts and interest rates on unsecured debt. In the case of a business, however, the restructuring may involve the dissolution of company pension plans, a reduction in executive salaries, and the consolidation of company operations.
When a company files for voluntary insolvency, a formal agreement between the company and its creditors is reached. It is usually overseen by a court-appointed judge or arbitrator who mediates between the involved parties. Typically the company has funds available to pay its creditors, but does not have enough to pay all of the obligations in full by the due dates. As a part of a voluntary insolvency agreement, a company will need to find a way to reduce its expenses so that permanent insolvency is avoided and it can return to a state of profitability.
Some creditors may take priority over others in a voluntary insolvency. For example, those who are owed payments on a secured interest such as property or equipment may be entitled to repossession or sale proceeds. Certain shareholders in the company, such as preferred stock holders or employees who have funds invested in profit sharing plans, may receive payments from liquidation proceeds prior to investors who hold common stock.
Under a voluntary insolvency agreement, the time frame for repayment to creditors is often extended. The company is given a certain amount of time to emerge from bankruptcy and pay back its restructured debt. The amount that is due by a certain date may be reduced or it may be paid off by streamlining the company's operations. An agreement will typically outline the short-term and long-term steps that the company plans to take to ensure that its revenue exceeds its liabilities.
If a company is unable to successfully meet its obligations under the restructuring plan, it may eventually dissolve and liquidate its remaining assets. While the voluntary insolvency agreement protects the company from immediate repossession of property by creditors, it does not forgive the debts owned. In the event of a complete business failure, the creditors will receive any payments from full liquidation proceedings based on priority.