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Nice read – (Re)defining Corporate Solvency for Sustainability

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Title: (Re)defining Corporate Solvency for Sustainability

Authors: Yue S. Ang and Tineke Lambooy

Abstract: Solvency portrays the ability of a business to meet its debts and other financial obligations. It is a measure of a corporation’s financial health and is assumed to provide an indication of its ability to manage its operations in the foreseeable future. The concept of solvency is used in various ways. In corporate laws, solvency thresholds apply to dividend and capital distributions with the aim to protect creditors from opportunistic or abusive distributions being paid from corporate capital. Insolvency laws define the concept of insolvency, which concept is used to determine whether a corporation should go into restructuring or be declared bankrupt. Lenders and potential investors employ various financial solvency ratios, which also vary per industry, in order to consider a corporation’s creditworthiness.

Most corporations depend for their success on financial capital as well as on natural capital and human capital. Hence, it seems rational that only when all three forms of capital are maintained in an adequate way by a corporation, can it be considered solvent and able to continue its operations. Moreover, as the economy transitions towards a circular economy, one can question to what extent those purely financial thresholds and ratios provide a realistic insight into whether a corporation is fit for the future.

We reviewed the corporate capital maintenance laws of five mainstream Western jurisdictions and observed that upholding a corporation’s natural and human capital is not part of the solvency standards. Facing the triple threats of climate change, depleting ecosystems, and the global health pandemic, we contend that this legal approach fails to back corporate boards in adopting and implementing a sustainable and circular business model for their corporations’ business activities.

This article is a think piece that examines how the solvency of a corporation as employed in corporate laws could be measured in an integrated way. We propose to adopt an ‘integrated corporate capital solvency standard’ and argue that only when all three forms of capital are in good shape, is the corporation to qualify as a solvent corporation that can distribute excess funds to its shareholders. Such an integrated standard would create a duty for corporate boards of directors to effectively sustain all three forms of capital. Ultimately, it will support boards in successfully implementing the corporation’s sustainability strategy. ”

Publication info: International and Comparative Corporate Law Journal, Volume 15, 2022, Issue 2, p. 56-92

Read the full article HERE