"C1. What does insolvency mean in law?
The short answer
There is no statutory definition of 'insolvent' although the Insolvency Act 1986, when referring to a state of insolvency, uses the phrase "unable to pay its debts". In practice there are two separate tests for insolvency and failure of either might be an indication of insolvency:
- the charity cannot pay its debts as they fall due for payment;
- the value of its liabilities exceeds the value of its assets.
An unincorporated charity cannot technically be insolvent as it has no legal identity separate to its members and trustees. This means that any liability of the charity is the liability of its trustees or members. However, the term 'insolvency' is used in this guidance to describe a situation where a charity's available assets are not sufficient to cover the liabilities of the trustees or members.
In more detail
Section 123 of the 1986 Act provides that a company is deemed to be unable to pay its debts where:
- the company has not paid, secured or settled a claim for a sum due to a creditor exceeding £750 within three months of having been served with a statutory demand;
- a creditor has attempted an enforcement process against the company in respect of a debt without success;
- it is proven to the satisfaction of the court that the company is unable to pay its debts as they fall due (cash flow test);
- it is proven to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities (balance sheet test).
Generally insolvency law aims to rescue or restructure a business rather than liquidate it. A rescue can maximise the return for creditors. A rescue often involves selling a business (free of its liabilities) to another party and using the proceeds of sale to pay its creditors. This is not usually relevant to charitable companies as it is unlikely that an insolvent charity's 'business' will be sold to another party to pay off its creditors."
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