Tests for Insolvency

• Courts use three tests to determine whether a company is insolvent

• Equity Test (i.e., the cash flow insolvency test)

• A company is insolvent if it is unable to pay its debts as they become due

• Balance Sheet Test

• A company is insolvent if the sum of its debts exceeds the “fair saleable” value (which is not “fair market” value) of its assets

• The balance sheet test is not based on GAAP, but instead looks to the fair saleable value of assets and stated value of liabilities

• Adequate Capital Test

• A company is insolvent if it does not have adequate capital to operate the business

• Directors may need expert opinions on whether the company is solvent

• The advice of advisors may be evidence considered by a court if the insolvency determination of the directors is later challenged