Insolvency and Bankruptcy in Business: Tips for Overcoming Financial Difficulties

Insolvency and bankruptcy are challenges that many companies face during their operations. These situations can have serious consequences for the financial status of the company, but with appropriate legal advice and strategies, they can be overcome. That is why it is necessary to apply appropriate measures and advice during the course of business that will help you maintain the liquidity of the company, and therefore successfully develop your business. However, when you come to a situation where bankruptcy is inevitable, you should keep in mind that even then all is not lost and that there is still the possibility to repay the debts and continue doing business as before. Therefore, in this article we explain the meaning of the terms insolvency and liquidity, the steps you can take when an insolvency problem arises, but also an explanation of how the bankruptcy procedure works, the difference between bankruptcy and the liquidation procedure, as well as some useful tips, in order to companies facing financial challenges have overcome them in an efficient and legally correct manner.

What is insolvency and how it affects business

Insolvency is a situation in which a company is unable to meet its financial obligations or pay debts to creditors. This can result from various factors such as a lack of liquid assets, poor management of resources, non-regulation or inadequate legal regulation of our business and contractual obligations with other persons, as well as economic changes occurring in the world that are beyond our control. Insolvency can lead to the initiation of bankruptcy proceedings, which can have serious implications for the future of the company.

The difference in relation to the liquidity problem

What is often equated and which must not be the case are the concepts of insolvency and liquidity.

Liquidity refers to a firm’s ability to meet its short-term financial obligations without problems or losses. This includes the ability to easily convert existing assets (such as real estate, investments or inventory) into cash. High liquidity means the company has enough funds to pay bills, pay employees or deal with unexpected expenses, while low liquidity can lead to financial problems.

Liquidity is key to maintaining business stability. Companies that have good liquidity are more resistant to economic crises, can react more quickly to market opportunities and adapt more easily to changes in the business environment. This is particularly important for small and medium-sized enterprises, which may be more sensitive to a lack of liquidity.

On the other hand, insolvency occurs when a company or an individual is unable to meet its financial obligations, i.e. to pay debts or make payments to creditors. Insolvency may be the result of a lack of liquid assets or the fact that total liabilities exceed available assets.

Thus, liquidity refers to the current ability to pay obligations, while insolvency indicates that a company or individual is unable to meet its financial obligations in the long term or in total.

In financial planning, it is important to maintain good liquidity in order to avoid insolvency and ensure a stable business. Liquidity is key to short-term viability, while insolvency can have long-term implications for a company’s financial status.

Measures you can take to prevent financial difficulties

Financial difficulties can be a challenge for the business of a company or an individual, but with the right advice, strategies and the right approach, it is possible to overcome these difficulties. Before a company decides to file for bankruptcy, it is important to explore other options such as debt restructuring, refinancing or asset sales.

• Hiring expert legal advisors – consulting a lawyer specializing in bankruptcy law is key. They can provide expert guidance through legal processes and provide advice on reorganization or reaching an agreement with creditors.
• Transparent communication with creditors – open communication with creditors can help in negotiations on debt rescheduling or finding alternative solutions, given that the goal of creditors is for the company to continue operating in order to repay existing debts.
• Monitoring deadlines and obligations – regular monitoring of deadlines and obligations related to your business can significantly affect the volume of working capital available to you, that is, the liquidity of your company, which significantly affects the stability of your business.
• Planning a strategy in case bankruptcy is inevitable – if bankruptcy becomes inevitable, it is important to have a plan, considering that bankruptcy does not necessarily lead to bankruptcy and the cessation of business of your company.

Legal regulation of bankruptcy

The legislation governing bankruptcy and insolvency varies from country to country. In Serbia, for example, there is a special Law on Bankruptcy that defines the processes, rights and obligations for both debtors and creditors during bankruptcy proceedings. Understanding this law and complying with legal requirements is key to successfully navigating these processes.

As a rule, bankruptcy is defined as a collective way of settling creditors that can lead to the reorganization of the bankrupt debtor or to bankruptcy and the termination of the debtor as a legal entity. In the case of reorganization, the goal is to establish the debtor’s business in such a way that it continues its business in an efficient manner and pays creditors. On the other hand, bankruptcy is carried out with the aim of ensuring the most favorable collective settlement of creditors by achieving the highest possible value of the bankrupt debtor, i.e. his property. Therefore, bankruptcy can be implemented through bankruptcy or reorganization.

Difference between liquidation and bankruptcy

Liquidation and bankruptcy are ways of terminating a company’s operations, but with important differences.

Liquidation is a way of terminating a legal entity that is characterized by full settlement of creditors, while the rule in bankruptcy is proportional settlement. Therefore, given that bankruptcy focuses on the protection of creditors and their, as much as possible, settlement, bankruptcy provides more options, i.e. reorganization with the survival of the bankrupt debtor and the regulation of his obligations, while liquidation, as a rule, leads to the settlement of creditors and the cessation of existence of the liquidation debtor.

Bearing in mind the mentioned difference between the mentioned two procedures, it is prescribed that the liquidation administrator is obliged to submit a proposal to the competent court for the initiation of bankruptcy proceedings if he determines that the debtor is over-indebted. Therefore, the opening of bankruptcy is an obstacle to the initiation of liquidation, while the reverse is not the case. Bankruptcy is an absolute priority over liquidation when the debtor is over-indebted, while in other situations bankruptcy and liquidation are mutual alternatives.

Bankrupt debtor

A bankrupt debtor is a subject of law against whom bankruptcy proceedings can be conducted, i.e. a person who has bankruptcy capacity. For the sake of easier understanding, bankruptcy debtors cannot be natural persons for the time being, as well as some legal entities, namely:

1. Republic of Serbia, autonomous province, local self-government unit
2. Compulsory social insurance funds – PIO, RFZO and NES
3. National Bank of Serbia
4. Central Registry of Securities
5. Public agencies
6. Legal entities whose founder is a person under item 1, and which are exclusively or predominantly financed from the budget

Founders, that is, owners as members or shareholders, are jointly and severally liable for these persons. Also special rules apply to banks and insurance companies

Bankruptcy reasons

Bankruptcy proceedings are opened when the existence of one of the grounds for bankruptcy against the bankrupt debtor is established.

Bankruptcy reasons are:

1. More permanent inability to pay
2. Threatening insolvency
3. Over-indebtedness
4. Failure to act or acting contrary to the adopted reorganization plan
5. Execution of the reorganization plan in a fraudulent or illegal manner

A more permanent inability to pay exists if the bankrupt debtor:

• cannot meet his financial obligations within 45 days from the due date of the obligation – is bound exclusively for non-fulfillment of financial obligations – the creditor proves that his claim has not been paid within 45 days from the due date. On the other hand, the court should determine whether it is an inability to pay or a deliberate failure to fulfill an obligation. This moment is determined at the moment of the court’s decision.
• Completely suspend all payments for a continuous period of 30 days (eg all accounts blocked for 30 days).

This reason should be distinguished from the reason of over indebtedness . In the case of over-indebtedness as a reason for initiating bankruptcy proceedings, the entire property of the bankrupt debtor is considered and this condition is met if the assets of the bankrupt debtor are less than his liabilities. Therefore, as a rule, when there is over indebtedness, there is also a more permanent inability to pay, while on the other hand, a more permanent inability to pay does not imply over indebtedness at the same time. Given that, as a rule, only the bankrupt debtor can have data on over-indebtedness, only he can invoke this reason.

Creditors in bankruptcy proceedings

In bankruptcy proceedings, there are several types of creditors, not all of whom have the same position. Due to the aforementioned difference in the status of creditors, it is extremely important that you have the legal support of a lawyer during the contracting of jobs and entering into contractual relations, in order to secure your claim in the best possible way, and to insure it. Creditors in bankruptcy proceedings can be:

1. Bankruptcy creditors
2. Creditors of the bankruptcy estate
3. Different creditors
4. Exclusive creditors
5. Pledge creditors
6. Creditors who are recipients of financial security

Bankruptcy creditors

A bankruptcy creditor is a person who has an unsecured claim against the bankruptcy debtor on the date of initiation of bankruptcy proceedings. In order for the bankruptcy creditor to exercise his right, it is necessary for the creditor to file a report of his claim with the court.

On the other hand, creditors of the bankruptcy estate can be defined as creditors whose claims arose after the opening of bankruptcy proceedings. What is their main characteristic, i.e. the difference in relation to bankruptcy creditors, is that, given that their claim arises after the initiation of bankruptcy, they have priority in settlement in relation to bankruptcy creditors.

Secured creditors

A person who has a real right to a thing or a right that belongs to the bankruptcy estate, and on the basis of which he can collect his claim from the value of that thing and/or rights before other creditors, provided that the debtor does not fulfill his obligation on maturity.

In bankruptcy law, we distinguish between two groups of secured creditors:

1. Different creditors – creditors of the bankrupt debtor whose claim is secured
2. Pledge creditors – creditors towards third parties for whom the bankruptcy debtor has provided security

Secured claims should be distinguished from the rights of separate creditors, who have the right to request that a certain object (thing or right) be separated from the bankruptcy estate because it does not belong to the bankrupt debtor, and therefore such an object cannot be used to satisfy creditors.

Bankruptcy pay orders

The importance of differentiating the types of creditors comes to the fore primarily in the order of collection of claims from the bankruptcy estate. After the costs of the bankruptcy procedure are settled, the bankruptcy creditors are classified into payment lines where we distinguish four bankruptcy lines:

• The first payment order consists of the claims of employees and former employees based on wages and unpaid contributions for pension and disability insurance for the last two years before the opening of bankruptcy proceedings.
• The second payment order consists of claims based on all public revenues due in the last three months before the opening of bankruptcy proceedings, except for pension and disability insurance contributions.
• The third payment line is all other unsecured claims of bankruptcy creditors.
• The fourth pay line includes:
• Claims of related parties on the basis of a loan given to the company by creditors who do not engage in the granting of loans and loans as their activity in the period of two years before the opening of bankruptcy proceedings
• In the case of contracted subrogation – when two or more creditors of the same debtor conclude an agreement through which one creditor agrees to be settled only after the complete settlement of the other creditor or other creditors.

Reorganization of the bankrupt debtor

Reorganization represents an essential contract through which the creditors and the bankrupt debtor agree to settle the debtor’s obligations according to the adopted reorganization plan, by redefining the debtor-creditor relationship, status changes of the debtor or in another way provided for in the reorganization plan. Reorganization is an alternative to bankruptcy and is implemented if it ensures a more favorable settlement of creditors compared to bankruptcy.

Two types of reorganization should be distinguished:

• Reorganization plan that is submitted in bankruptcy proceedings that have already been initiated for some other reason i
• Reorganization plan prepared in advance.

Reorganization plan in bankruptcy proceedings

The deadline for submitting the plan is 90 days from the opening of the bankruptcy proceedings. The law prescribes the minimum content of the plan, the lack of which makes it ineligible for adoption. Our law has 18 minimum elements, one of the most important of which is the reorganization measures that will be applied in order for the bankrupt debtor to fulfill his obligations and continue with his business. The law does not prescribe an exclusive list of all measures, but lists the following measures as an example:

1. Measures affecting the debt-creditor relationship – reducing the rights of creditors (debt write-off, extension of term, replacement of performance, waiver of pledge), giving greater or new rights to creditors (novation, pledge of property), measures to settle creditors’ claims (settlement from means of security).
2. Measures affecting the status of the bankrupt debtor – changes in status, changes in legal form, changes in general acts, conversion of claims into capital, cancellation of issued and issuance of new securities
3. Measures affecting the debtor’s liquidity – conclusion of credit agreements, rebuttal of legal actions of the bankrupt debtor
4. Measures affecting the debtor’s operations – dismissal of employees, hiring of other persons, measures to sell the debtor’s property, closing of non-profit facilities, transfer of part or all of the property to one or more existing and newly established entities, change of the debtor’s management system, appointment of new board members.

The adoption of the reorganization plan is decided by the creditors of the bankrupt debtor, except for – pledges, creditors and creditors of the bankruptcy estate. The others (bankrupt and divorced) have the right to vote. Creditors do not vote as a group but are divided into classes according to the similarity of their claims. The adoption of the reorganization plan results in the suspension of the bankruptcy.

Reorganization plan prepared in advance

A pre-prepared reorganization plan, or UPPR, is prepared by a part of the creditors outside the court procedure. Therefore, the creditors who are familiar with the plan and the creditors who will become familiar with the plan and vote on it after the submission of the proposal are different, so the law contains special provisions on informing creditors. Therefore, the UPPR, in addition to the mandatory legal elements that must be contained in the reorganization plan proposed in the already initiated bankruptcy proceedings, must also contain additional elements:

• the provision that the claims of creditors who did not participate in the plan will be settled in the same way and under the same conditions as the claims of other creditors of the same class;
• together with the UPPR, a non-binding signed statement of the majority creditors by class that they agree with the UPPR and are ready to vote for its adoption;
• a statement by the plan submitter that the information in the plan is true;
• an extraordinary report with an auditor’s opinion on the financial statements of the bankrupt debtor, which is drawn up with the state of the business books 90 days before the date of submission of the UPPR and which contain an overview of all claims and the percentage participation of all creditors in each class;
• statement of the auditor or bankruptcy administrator on its feasibility;
• a report on the expected important events after the plan is drawn up.

The only active authorized person to submit the UPPR is the bankruptcy debtor, who also bears the costs of the procedure. If the court approves the UPPR, a decision is made on the adoption of the proposal to open bankruptcy, confirming the adoption of the UPPR and suspending the bankruptcy. As a rule, the UPPR has a higher chance of being adopted compared to a proposal for reorganization that is submitted during the already initiated bankruptcy proceedings, given that the debtor submits it after consultation with all creditors whose consent is necessary for its adoption.

Conclusion

Insolvency and bankruptcy are serious challenges that require careful management and legal strategies to overcome. Knowledge of legal aspects and consultation with legal experts are key to successfully managing these situations. Implementing proper legal advice can help companies overcome financial difficulties and lay the foundation for sustainable business in the future.

This article offers basic guidelines and advice for managing business insolvency and bankruptcy situations, but it’s important to remember that every situation is unique. Consultation with legal experts tailored to the specific needs of the company is of utmost importance in order to achieve the best possible outcome.

This article is for informational purposes only and does not constitute legal advice. If you need additional information regarding the topic in question, please feel free to contact us by email at office@ncrlawyers.com or by phone at +381677049551.