Insolvency and bankruptcy

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A credit officer’s blackest fear.

This could mean many things including balancesheet insolvency and cashflow insolvency.

Broadly, it means you do not have sufficient assets to meet your liabilities, and you are no longer a viable business. Your creditors are entitled to apply to the court for the appointment of a receiver who will liquidate your assets, determine your liabilities, and distribute the proceeds of that liquidation to your creditors pro rata. After that, the game is up and you no longer exist.

There are all sorts of special regimes and intermediate statuses in different jurisdictions (such as America's famous chapter 11 protection - designed to help a struggling company reorganise itself and get out of insolvency without going to the wall - and banks and financial institutions generally will be subject to bank resolution and recovery regimes which make the winding up process a little bit more complicated.

Insolvency as a termination event

Termination upon insolvency

Credit officers will hotly deny this, but when it comes to closing out a master trading agreement there are two main triggers: failure to pay and bankruptcy/insolvency. They also tend to be the most lightly negotiated — it’s hard to argue that your counterparty shouldn’t be allowed to pull its trigger if you are insolvent.

Still, there are some nuances to what counts as insolvency. It may differ for different entity types: banks and insurers, in particular, having special local administrative regimes or recovery and resolution frameworks which ameliorate the hard lines between solvency and oblivion. So expect a little jiggery-pokery around the edges in defining what counts as an “insolvency event”. But it is not contentious stuff; just detail.

Where these suspension rights stop you quickly closing out and netting your exposures they might mean your netting analysis fails altogether. This gives you real-world, present time problems, since you must hold capital against the gross exposure under the contract.