Answers on Questions: What is the Legal Definition of Insolvency?

With so many misconceptions about insolvency, bankruptcy, liquidation, and sequestration, it is time to answer the question: “what is the legal definition of insolvency?”


So, What is the Legal Definition of Insolvency?

It is when a business entity or person is unable to meet their financial obligations to their creditors as and when the debts are due. This means that the person or company cannot pay the debts on the due date and according to the agreed payment terms. However, this is a cash-flow insolvency. When we consider the question of what a legal definition of insolvency is, then a person or entity can still borrow money or arrange for funding to pay the debts when due, but if the person or entity’s liabilities exceed their assets and they are unable to pay debts when due, then the person or entity is truly insolvent.

When we consider the question of what the legal definition of insolvency is, we need to clarify that bankruptcy and insolvency differ. A person can be insolvent and not yet bankrupt. The insolvent state can be changed if the person is able to sell their assets and pay off the debts. When the person does not have enough assets to sell to pay off the debts and their expenses exceed their income, the creditors can apply for their sequestration or the person can apply to court to be sequestrated. The court must declare the person or entity bankrupt.

In the case of a business entity, the legal process is called liquidation. Unlike with a natural person who must have enough assets to ensure the sale thereof on auction can bring about enough funds to pay for the sequestration and the minimum benefits to the creditors, the business entity does not need to have assets to liquidate. Indeed, according to the Company’s Act, the business, by law, must stop trading and must liquidate if its assets exceed its liabilities. However, the business can request business rescue assistance or be placed under business rescue if there is a chance that it can be brought back to a solvent state.

If a person is declared bankrupt, their legal status is diminished. This means they no longer have control over their financial estate. With voluntary sequestration, the person surrenders the estate and the court appoints a trustee/curator to oversee the sale of assets and distribution of benefits among the creditors.

The insolvent party cannot hold certain government positions during the time of sequestration and cannot be a director of a company or member of a close corporation. The person needs the permission of the appointed trustee/curator to enter into credit agreements. Their credit record shows that they are sequestrated.

But why, given the answer to “what is the legal definition of insolvency?”, would a person apply for voluntary sequestration? Though being declared bankrupt is certainly not the ideal, it is possible that the debt has become so huge and unmanageable that a person is unable to pay it when due. The only way out may be voluntary sequestration.


What If the Person Already Has Legal Problems with Debt?

The person may already be under debt review and may still find it impossible to pay the debts due in time, even at the lower consolidated monthly instalment. In such a situation, the bank may threaten to foreclose on property or the creditors may threaten with judgements. Time is of the essence and since the person is under debt review, they cannot apply for a consolidation loan to cover all the debt.

Even with a consolidation loan, they will still be in severe financial trouble because they cannot afford the debt review instalment. In such an instance, being declared bankrupt means being able to only pay 20 to 22 cents out of the rand and to be free of the other 80% of the debt. Immediately, cash-flow opens up and the person can rebuild their financial estate without the threat of judgements and constant fear of losing assets hanging over their head.


What to Do Next?

For a comprehensive answer to “what is the legal definition of insolvency?” and an explanation of the process to become debt free, get in touch with our lawyers. They will help you determine whether you qualify for sequestration and provide legal advice on how to proceed with your sequestration application.


Disclaimer: This article is for information purposes only and does not constitute legal advice. Call on our attorneys rather than relying on the information herein to make any decisions. The information is relevant to the date of publishing.

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