A company is said to be insolvent when it is unable to pay its debts. This is a common occurrence within the construction industry and it can be attributed to many reasons. Some of which are as follows:
1.The ease with which construction businesses are created especially its initial low capital investment often results to very fragile arrangements. This can result into a structure that can be easily destabilised;
2.Competitive tendering practices used within the industry has resulted to a high incidence of insolvency among contractors;
3.The quality of management expertise within the industry is poor when compared to other allied industries. Many cases of contractor insolvency have occurred resulting from the mismanagement of a business as opposed to unfavourable external conditions.
The damage resulting from insolvency can be widespread.
1.It can have a resultant effect on the cost, quality of work and duration of a construction project.
2.The solvency of a contractor can also affect his sub-contractors and suppliers; thus insolvency can affect many projects. The insolvency of a developer can create financial difficulties for the contractors and, consequently, the sub-contractors and suppliers involved with this developments.
This refers to the winding-up of a company. Trading usually ceases upon liquidation; the assets of the company are collected and used to offset liabilities. There are two categories of liquidation
Voluntary liquidation can be either members’ or creditors’ voluntary liquidation.
Compulsory liquidation is the result of a court order for a company to be wound up. This is usually because the company is unable to pay its debts. There are two tests that can be used to determine if a company is unable to pay its debts. First, the going concern or cash flow test whereby a company is judged to be insolvent if it cannot pay debts as they become due. Secondly, the balance sheet test, which is a long-term test. The balance sheet test examines the value of a company’s assets in relation to the amount of its liabilities. If assets are less than liabilities, then the company will be deemed insolvent.
A party is considered to be insolvent where the following apply:
1. they enter into an arrangement, etc. in satisfaction of their debts (i.e. see voluntary arrangements above);
2. They pass a resolution for their company to be wound up, without making a declaration that the company is solvent. For example, where a solvent company wishes to cease trading and be wound up they would be in a position to make a formal declaration that sufficient assets exist to pay off any liabilities therefore creditors would not be too concerned about such a resolution;
3. a winding up order or bankruptcy order made against them;
4. an administrator or administrative receiver is appointed;
5.they are subject to similar insolvency proceedings outside the country
6.In the case of a partnership, all partners are subject to an individual arrangement or any of the above events.