Insolvency: What Does It Mean for Your Business and How Can You Prepare?

Insolvency is a word that many business owners dread and may not want to hear or even think about, yet understanding it and being prepared for it can be the key to survival when financial challenges or difficulties arise. But what exactly does insolvency mean, and how can a business prepare for this potentially difficult situation? Let’s dive into the concept and what steps businesses can take to navigate through it.

What is Insolvency?

Insolvency occurs when a business can no longer meet its financial obligations—such as paying debts to creditors, employees, or suppliers—when they fall due. By virtue of Section 868 of the Companies and Allied Matters Act, 2020 (CAMA), a person is said to be insolvent in Nigeria when the person in respect of any judgment, Act or court order against him, is unable to satisfy execution or other process issued in favour of a creditor, and the execution or other process remains unsatisfied for not less than six weeks;

The chief consideration in insolvency is the debtors inability to pay a debt when it becomes due. For a company, it is regarded as being unable to pay its debt according to section 572 of CAMA if,

1. creditor, by assignment or otherwise, to whom the company is indebted in a sum exceeding N200,000, then due, has served on the company, by leaving it at its registered office or head office, a demand under his hand requiring the company to pay the sum due, and the company has for three weeks thereafter neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of the creditor;
2. execution or other process issued on a judgment, act or order of any Court in favour of a creditor of the company is returned unsatisfied in whole or in part; or
3. the Court, after taking into account any contingent or prospective liability of the company, is satisfied that the company is unable to pay its debts.

Insolvency can be identified in two primary forms:

1. Cash Flow Insolvency: This is when a business cannot pay its debts as they become due, even though its assets might exceed its liabilities on paper.
2. Balance Sheet Insolvency: This occurs when a company’s total liabilities exceed its total assets, meaning the business is technically bankrupt, even if it can still meet some immediate obligations.

Why Does Insolvency Happen?

Several factors could lead to insolvency, these include:?

1. Poor cash flow management.
2. Declining sales or revenue.
3. High levels of debt.
4. Inability to access new capital or financing.
5. Unforeseen crises (e.g., economic downturns, market changes) a recent example here is the covid-19 pandemic which caused some State relax their insolvency laws.
6. Mismanagement or lack of proper financial oversight

When left unchecked, these issues can grow, leading to insolvency, which may ultimately result in the closure of a business.

Legal Implications of Insolvency in Nigeria

CAMA is the principal legislation that governs insolvency in Nigeria. The Act provides a framework for identifying insolvency and allows companies to take certain steps to either recover or wind up their operations. Key provisions of the Act include the requirement for a licensed Insolvency Practitioner (IP) to oversee restructuring, liquidation, or administration.

Under CAMA, businesses facing insolvency have options such as company voluntary arrangements (Chapter 17), administration (Chapter 18), appointment of receiver/manager,? or liquidation. Each option comes with its legal processes and consequences, and businesses must comply with the provisions of the law to avoid additional penalties.

How to Prepare for Insolvency

While no business owner hopes to face insolvency, being proactive and prepared is crucial for sustainability. Here are key steps businesses can take to safeguard against insolvency:

1. Monitor Financial Health Regularly

Regularly assess your financial statements, including cash flow, balance sheet, and profit & loss accounts. Watch for early warning signs such as declining sales, increasing debt, or difficulty paying suppliers on time.

2. Implement Strong Cash Flow Management

Cash flow is the lifeblood of any business. Implementing strong cash flow forecasting can help predict future financial challenges and give you time to take corrective measures.

3. Reduce Debt Exposure

High debt levels can be a significant cause of insolvency. Work towards reducing debt by paying off high-interest loans and avoiding unnecessary borrowing.

4. Negotiate with Creditors

If you sense that your business may face insolvency, it’s crucial to negotiate with creditors early. This can include extending payment terms, negotiating lower interest rates, or setting up instalment payment plans.

5. Seek Professional Advice Early

The earlier you engage an Insolvency Practitioner or financial expert, the better. Insolvency Practitioners can help you explore restructuring options and negotiate with creditors, potentially saving your business from closure.

6. Consider Restructuring or Turnaround Strategies

Businesses that are struggling but not yet insolvent may benefit from restructuring. This could involve downsizing, changing your business model, renegotiating contracts, or selling non-core assets to regain financial stability.

7. Develop a Business Continuity Plan

A business continuity plan (BCP) prepares your business to survive crises. Whether it’s a market downturn, pandemic, or sudden loss of key clients, a BCP can ensure you’re ready to face challenges head-on and keep the business afloat.

What Happens When Insolvency Occurs?

If your business does fall into insolvency, the first step is to contact an Insolvency Practitioner who can guide you through the process. The options available include:

Restructuring or Administration: The business continues to operate, but under the control of an administrator who aims to turn the business around or achieve a better outcome for creditors than immediate liquidation.

Voluntary Arrangement: A formal agreement between the business and its creditors to settle debts over time while the business continues to trade.

Liquidation: The company’s assets are sold to pay off debts, and the business is dissolved.

Each of these routes has serious implications for your business and its future, so careful consideration and professional advice are essential.

Conclusion

Insolvency may feel like the end of the road, but with the right preparation and response, it can become an opportunity for a fresh start. Businesses that recognize the warning signs early, engage professional help, and are willing to restructure have a higher chance of surviving financial distress. By understanding the concept of insolvency and taking proactive steps, you can position your business to either avoid insolvency altogether or recover quickly when faced with it.

If your business is struggling, don’t wait until it’s too late. Consult an Insolvency Practitioner today and explore the options that could help your business bounce back.

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References?

1. Companies and Allied Matters Act (CAMA) 2020
2. Insolvency Regulations, 2022
3. Onyinye Oc-Chukwuocha, Scheme of Arrangement as a Rescue Device for Aliling Companies in Nigeria, The Bripan Law Review (Vol. 1)
4. O. M. Atoyebi, SAN FCIArb.(U.K), The Role of Insolvency Practitioners in Nigerian Corporate Restructuring; Legal and Ethical Considerations, (https://omaplex.com.ng/the-role-of-insolvency-practitioners-in-nigerian-corporate-restructuring-legal-and-ethical-considerations/)
5. Cameron Hashemi-Pour, What is a business continuity plan (BCP)?, https://www.techtarget.com/searchdisasterrecovery/definition/business-continuity-action-plan