Supreme court confirm the balance sheet test for insolvency is not whether the company has reached ‘a point of no return’.
17th February 2012
The recent case of BNY Corporate Trustee Services Ltd v Eurosail-UK* will be of interest to company directors, companies, financial institutions and insolvency practitioners as the Supreme Court provided guidance on how to apply the test for insolvency set out in s. 123(2) of the Insolvency Act 1986 (the “Act”).
The Supreme Court, when handing down it’s judgment on 9 May 2013, made it clear that the “balance sheet test” for insolvency set out in s. 123(2) of the Act is whether, on the balance of probabilities, a company has sufficient assets to meet all its liabilities, including prospective and contingent liabilities. The Supreme Court rejected the Court of Appeal’s “point of no return” test.
When determining whether a company is insolvent, i.e. unable to pay it’s debts as they fall due, for the purposes of s.123(2) of the Act the courts are required to apply the balance sheet test. S.123(2) provides that a company is unable to pay its debts as they fall due “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”.
In BNY Corporate Trustee Services Ltd -v- Eurosail-UK, the company, Eurosail, was a special purpose securitisation vehicle which was set up to purchase a portfolio of UK mortgages on UK residential property by issuing loan notes. The Supreme Court found that despite the fact that financial and management accounts of the issuer showed net liabilities of £75m and £130m that according to the balance sheet test the company was not balance sheet insolvent. The Court confirmed that the balance sheet test is not necessarily the same as the accounting test and that the correct test to be applied is whether, on the balance of probabilities, a company has sufficient assets to meet all its liabilities, including prospective and contingent liabilities. The test is not whether the company has reached the “point of no return”.
The court should consider the circumstances of each particular case and the nature of the company’s business when applying this test.
The Supreme Court also provided guidance on the interpretation of the cash-flow test and confirmed that the cash-flow test is not concerned simply with debts which are presently due, but also with debts falling due from time to time in the “reasonably near future”. How far it is appropriate to consider the future will vary depending on the facts of each case.