Several major companies have already filed for bankruptcy during the novel coronavirus (COVID-19) crisis and many more large and small businesses are expected to follow suit. If you’re a creditor of a company that’s liquidating, it may be challenging to get back what you’re owed. That’s where a solvency opinion can help. An expert determines whether the company could meet its long-term interest and repayment obligations when it made — or didn’t make — payments to creditors.

Examining the subject

Solvency experts consider many issues when examining a business. But ultimately, the outcome of three tests enable an expert to determine solvency:

1. Balance sheet. At the time of the transaction at issue, did the subject’s asset value exceed its liability value? Assets are generally valued at fair market value, rather than at book value. The latter is typically based on historic cost, and fixed assets (such as vehicles and equipment) may be reduced by annual depreciation expense. But the balance sheet is just a starting point. Adjustments may be needed to balance sheet items so that they more accurately reflect the fair market value of assets.

2. Cash flow. This test examines whether the subject incurred debts that were beyond its ability to pay as they matured. It involves analysis of a series of projections of future financial performance. Experts consider a range of scenarios. These include management’s growth expectations, lower-than-expected growth, and no growth — as well as past performance, current economic conditions and future prospects.

3. Adequate capital. The final test determines whether a company has adequate capital and is likely to survive in the normal course of business, bearing in mind reasonable fluctuations in the future. In addition to looking at the value of net equity and cash flow, experts consider factors such as asset volatility, debt repayment schedules and available credit.

Companies generally are considered solvent by solvency experts if they pass all three of these tests.

Presumed insolvent

Courts typically presume that a company is insolvent unless a party to litigation proves otherwise. You can bolster your position with a comprehensive solvency analysis performed by a qualified expert. Contact us for more information about obtaining one.

© 2020 Covenant CPA

Your company has landed a lucrative new account, and the customer has already placed several small orders, paying in full, on time. Now the customer wants to place a larger order, but has requested that you first expand its credit account. Warning! There’s a chance that you could become a victim of bankruptcy fraud. Your new customer may be planning a “bust-out” — a common bankruptcy-related scam.

Bust-out scams

In a bust-out, fraudsters create a bogus company — often with a name similar to that of an established, reliable business — to order goods they have no intention of paying for. In fact, they plan to sell the products for fast cash, file for bankruptcy and leave you, the supplier, holding the empty bag.

In a variation of the scheme, bogus operators buy an existing company and use its good credit to order the goods. Either way, they sell the products they order below cost, for cash, and then file for bankruptcy, writing off the amounts of the supplier’s bill.

You can avoid becoming a bust-out victim by carefully vetting businesses that were formed only recently. Also be wary of established companies with new ownership — particularly if the new owners seem to want to keep their involvement under wraps. And pay particular attention to customers that have:

  • Warehouses stuffed with high-volume, low-cost items,
  • Disproportionate liabilities to assets,
  • No corporate bank account, and
  • Principals previously involved with failed companies.

Fraudulent conveyance schemes

Bust-outs are far from the only bankruptcy-related scams. In fact, the most common type of bankruptcy fraud is concealing assets — or fraudulent conveyance. This scheme involves hiding or moving assets in anticipation of a bankruptcy. The owner of a business on the brink of collapse may, for example, transfer property to a third party — most commonly, a spouse — for little or no compensation. The third party holds the property until bankruptcy proceedings have concluded, and then transfers it back to the business owner.

Alternatively, the business owner files for bankruptcy and then, with the court’s approval, sells property below value to a straw buyer. The owner’s relationship with the buyer isn’t disclosed, but the buyer holds the property until the owner is ready to reclaim it at an agreed-upon price.

In either case, the goal is the same: to keep property and monetary compensation out of the hands of creditors.

Prevention first

Fighting bankruptcy fraud typically requires professional legal and financial help. The best protection is prevention, but if you suspect one of your customers is trying to pull a fast one, contact us at 205-345-9898.

© 2018 Covenant CPA