- The Meaning of Suspect Transactions
Bankruptcy law works with the assumption that debtor asset is insufficient to meet the demands of creditors. In principle, a solvent debtor has every right to effect payments to any of his creditors since in this case there is no race to court room problem. Thus, to understand suspect transactions, it is necessary to define what insolvency means and when do we say the person is insolvent?
Simply, insolvency is inability to pay the debt when they become due and payable. There are two primary tests which have been employed in determining whether a person or a company is insolvent. These are cash flow test and balance sheet test.
The cash flow test provides that a company is insolvent when it is unable to pay its debts as they fall due. The important point is whether or not the company pays its debt in carrying on the business. If a company fails the test it means in effect, that it has insufficient resources available to pay creditors. On the other hand, balance sheet test states that if its total liabilities (including the cost of liquidation) out weight the value of its assets and therefore the company’s assets are insufficient to discharge its debt. UNCITRAL guideline to insolvency law define balance sheet test based on excess of liability over assets as an indication of financial distress. Thus, a payment or transfer of debtor asset with in suspect period will have detrimental effect to the other creditors and hence it is suspect transaction. It is reasonable to raise the question, what means by suspect transaction?
Suspect transaction is simply transactions which result in a creditor obtaining an advantage or irregular payment. Thus, it is a transaction which benefits one or more creditors at the expense of other creditors. This creates a race of the most diligent which in turn dependent up on access to information. Furthermore, such type of transactions encourages favoritism by the debtor to some selected creditors by anticipating future relationship.