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Mountains of unfulfilled obligations, unpaid salaries: is it time to declare bankruptcy?

This is the third time the suppliers have called - their invoice has been sitting unpaid for two months. And there is more than one such invoice. And where are the salary payments? You decide not to pick up the phone. Will that solve the problem? Hardly. But the money is gone and you don't know where to get it from, and the pile of unpaid bills on your desk keeps growing. You contact your lawyers, they assess the situation and then smile uncomfortably and say: "It's a very bad situation, you've waited too long. It looks like you will have to declare bankruptcy."

So when is it time to declare bankruptcy? Is it too early? What are the main criteria? Egidijus Langys, partner at AVOCAD, talks more about this.

What is assessed when deciding whether to declare bankruptcy?

It should be understood that a company with €100 in outstanding liabilities will certainly not be declared insolvent, even though today's legal framework would formally allow it. Thus, the criteria for assessing a company's insolvency are still relevant in court.

Assessing a company's insolvency looks at its balance sheet and liquidity ratios (balance sheet and liquidity tests), as well as its viability - in simple terms, what the company's future prospects are for meeting its obligations.

Insolvency is most often equated with a lack of working capital - delays in financing day-to-day operations, meeting creditors, paying wages, etc. It is a test of liquidity - the extent to which a company is able to operate and meet its obligations. 

The balance sheet test reveals the ratio of a company's liabilities to its assets and, importantly, the extent to which liabilities exceed assets.

The last criterion is the viability of the company, which shows how well the company is able to operate and generate profits. Case law elaborates on this criterion:

  • the causes of the company's insolvency problems;
  • the economic and commercial activities carried out by the legal person;
  • the prospects of the business, the expected income (profit) and whether it will enable the company to meet its future debts to creditors;
  • how many employees are working in the company (headcount turnover), etc.

The absence of commercial activities or the fact that the commercial activities envisaged will clearly prevent the legal persons from meeting their debts in the future raises doubts as to the viability of the company.

When is it time to declare bankruptcy?

There is always the risk that a manager will initiate insolvency proceedings prematurely. This can happen if only formal assessment criteria are assessed, if there is no experience or practice, if bad practice or examples are followed, if immediate reliance is placed on advice from oneself or from colleagues who have supposedly "been there".

Without legal advice, this situation will involve the company in legal proceedings. Filing for bankruptcy prematurely and not being declared bankrupt by the court could damage the company's business reputation, damage the company's image with its business partners, and put the company on the list of unreliable companies, even though the company is solvent and the manager has made a mistake about the company's insolvency.

Of course, it can happen that a company's insolvency process can be initiated too late. Managers often overestimate their capabilities and believe that certain circumstances will not affect the viability of the company, think that they have made a lot of effort, that the company is struggling but is still in business, and are late in applying to the court for insolvency proceedings, or do not apply at all. However, if the manager's efforts have been insignificant and the company is unable to continue to operate, the manager will face serious consequences for failing to comply with the obligation to initiate insolvency proceedings.