The basic balance sheet test of insolvency: liabilities exceed assets. Simple for creditors? On the basis of the BNY case, not any more, says Stuart Evans.
Reaching the Point of No Return ?
Under section 123 Insolvency Act 1986, there are two basic tests of a company’s solvency. The first, being the cash flow test, is whether a company is unable to pay its debts as they fall due. The alternative test, known as the balance sheet test, provides that a company is also deemed unable to pay its debts “if it is proved to the satisfaction of the Court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities”. Arguably, the last eight words have been taken for granted until now.
In the case of BNY –v- Eurosail, which examined whether a contractual provision concerning insolvency had been triggered, those extra words concerning contingent and prospective liabilities were scrutinised in some detail. The Court of Appeal decided that in respect of the balance sheet test, a company’s accounts were not to be regarded as the only true and fair view possible, and they were also by their nature historic. In applying the test, described as “imprecise, judgment based and fact specific”, a Court would look beyond the simple balance sheet position in the accounts. The Court was of the view that if a debtor company failed the first limb of the balance sheet test, it should not follow that a company should automatically be wound up, as this might be unfairly preferential to short term creditors as against longer term or contingent creditors. It was important to assess whether a finding of balance sheet insolvency was commercially fair to both short and long term creditors and reflected the reality of the company’s situation.
In short, the Courts would look more objectively as to whether the company had genuinely reached the point of no return or whether its survival was possible, should the company be allowed to continue and not be required to use its assets to meet short term liabilities, reducing the pool available to long term creditors. It must equally follow that a company that has assets exceeding liabilities on the balance sheet in its accounts is not necessarily out of the woods either.
Conclusion
What this means for creditors is that when weighing up whether to trigger a contractual insolvency provision or issue a Winding-up Petition against a company, in applying the balance sheet test it may not be enough simply to look at the latest accounts to determine whether or not the company’s assets exceed its liabilities. The Court will go on to take into account the company’s contingent and prospective liabilities, and decide whether or not the company has reached the point of no return. This will require a greater analysis by creditors, snap decisions may be fatal. The BNY case arguably introduces more uncertainty for creditors who are dealing with companies that they believe may be insolvent. As ever, professional advice in these circumstances is recommended.
For more information on this or any other insolvency law issue, or commercial disputes generally, please contact Stuart Evans by emailing Stuart or by calling him on 08450 990045, or speak to your usual contact in the Commercial Disputes Team.
This document is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action as a result of the contents of this document.
