A company’s ability to pay debts when due: insolvency and the opening of proceedings

To open insolvency proceedings, the substantive conditions laid down in Articles 608, 625 and 631 of the Commerce Act must be met. An applicant with standing must petition the competent court. The trader must be unable to meet a monetary obligation that has fallen due, a public-law debt to the state or a municipality, or wage obligations to at least one third of the workforce that have remained unpaid for more than two months.

For insolvency under Article 608, the debtor’s difficulties must be lasting and irreversible rather than temporary. They must reflect the trader’s objective condition; the trader must lack sufficient assets to cover the debts.

As to standing, the court must determine whether Article 625 applies. A written petition may be filed by the debtor, the liquidator where applicable, a creditor under a commercial transaction with the debtor, or the National Revenue Agency in respect of public-law debts to the state or municipalities.

Under Article 608(1), an insolvent trader is one unable to meet a due monetary obligation established as to its legal basis and arising from or relating to a commercial transaction, or a public-law obligation to the state or municipalities. The first requirement is that the debtor have the status of a trader.

The existence of a due monetary debt must be established for the applicants to qualify as creditors. Only an outstanding monetary claim gives them standing in that capacity to seek the opening of insolvency proceedings.

Under Article 154(1) of the Code of Civil Procedure, the debtor bears the burden of proving discharge of the obligation. Article 608(2) of the Commerce Act presumes inability to meet a due debt if, before the insolvency petition was filed, the trader had not applied for publication in the Commercial Register of its annual financial statements for the last three years.

Under Article 608(3), insolvency is presumed if the debtor has stopped making payments. Cessation of payments can exist even if the debtor has paid selected creditors in full or in part. This is a rebuttable presumption. The focus is not only on the particular legal relationship and the rights and obligations arising from it, but also on whether the trader is capable of paying only certain creditors. Of primary importance are the relationship of debt to assets and the debtor’s other commercial debts, public-law debts or private-law debts to the state. Article 608 also presumes insolvency if enforcement of a final instrument obtained by a creditor leaves the claim wholly or partly unsatisfied within six months after receipt of the invitation or notice to comply voluntarily. Whether the trader can discharge a particular obligation arising from a commercial transaction requires the court to assess the debtor’s actual condition.

The court uses expert evidence to establish that condition. Profitability, liquidity and solvency matter because they are closely linked and directly reflect the company’s financial structure. Profitability and yield are economic measures used to assess and compare the trader’s ability to generate profit and income. Profitability is positive when there is a profit and negative when there is a loss. Liquidity is a quantitative measure of the ability to make current payments to creditors. It is sufficient when the resources equal or exceed the liabilities against which they are measured.

The current ratio compares current assets less prepaid expenses with current liabilities at the same date. The quick ratio shows the proportion of current liabilities that can be covered by readily liquid assets.

The immediate liquidity ratio uses short-term investments plus cash in relation to current liabilities. The absolute liquidity ratio compares cash alone with current liabilities. The financial autonomy indicator should be positive; its purpose is to show the percentage of own funds in total balance-sheet funding. In insolvency proceedings it is necessary to examine whether non-payment results from temporary difficulties and whether the trader has enough assets to cover its debts.

Difficulties may be temporary where income is expected from business operations, collection of receivables or new investment.

Under settled case law (Supreme Court of Cassation Decision No. 72 in civil case No. 953/95; Decision No. 795 of 4 April 2006 in commercial case No. 489/05, First Commercial Division; and Decision No. 988 of 10 March 2008 in commercial case No. 647/07, First Commercial Division), the debtor’s tangible fixed assets should not be included when assessing the assets available to meet current obligations. Selling them to pay current debts would frustrate or impede future trading and lead to its cessation. Selling fixed assets is also a liquidation measure to realise property and raise cash. In assessing the trader’s financial position for this purpose, only its current assets should be considered. The mere fact that book assets exceed book liabilities does not establish solvency.

The initial date of insolvency is the date of the earliest unpaid debt at which all the signs of insolvency under Article 608 were present. It must be determined in light of the company’s overall economic position and when it stopped servicing its obligations. This date is important for the proceedings, for bringing assets into the insolvency estate and for protecting both the debtor and its creditors.

This article is not a legal opinion or advice about a particular situation or person. The author makes no claim to cover corporate insolvency exhaustively. For assistance in a similar case, consult a commercial lawyer specialising in insolvency.