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Solvent or Insolvent?

It would seem from a recent Court of Appeal decision that the answer to whether a company is solvent or
insolvent is less scientific than some might be led to believe.

Generally, a company becomes statutorily insolvent either by “being unable to meet its liabilities as they fall
due” and/or in the “balance sheet” sense in that the value of the company’s assets is less than the amount of
its liabilities. s123(1) of the Insolvency Act 1986 deals with the former and s123 (2) the latter. Both are
based on the principle (statutory definition) of a company’s ‘inability to pay its debts.’

Taking the former, a company is deemed unable to pay its debts: ‘(a) if a creditor (by assignment or
otherwise) to whom the company is indebted in a sum exceeding £750 then due has served on the
company, by leaving it at the company's registered office, a written demand … requiring the company to
pay the sum so due and the company has for 3 weeks thereafter neglected to pay the sum or to secure or
compound for it to the reasonable satisfaction of the creditor’ (s123(1)(a)) or ‘if it is proved to the
satisfaction of the court that the company is unable to pay its debts as they fall due’ (s123(1)(e)). Taking the
latter (“balance sheet”), ‘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’ (s123(2)).

Taking a strict scientific approach it ought not to take too much trouble working out whether a company is
solvent or insolvent. However, it appears that insolvency in the ‘balance sheet’ sense is neither so
straightforward nor so simple. In BNY Corporate Trustee Services v Eurosail-UK- 2007-3BL plc and Others
it was argued that s123 (2), ‘requires one simply to take the assets and liabilities of a company at their
respective face amounts, which are to be those in the company's balance sheet unless good reason is
shown to the contrary, and, if the aggregate of the liabilities so taken exceeds the aggregate of the assets
so taken, then the company is deemed to be insolvent.’ The CA rejected this argument.

This strict theoretical approach was ‘mechanistic’ said the CA, which could permit a creditor to present a
petition to wind up a company for an ‘artificial reason’. Having regard to Professor Sir Roy Goode in
Principles of Corporate Insolvency Law (third edition), the CA held that the purpose of s123(2) was, “to
cover a case where, although it could not be said that a company “is [currently] unable to pay its debts as
they fall due” (either because it has no debts which are currently payable, or because it has, or can achieve,
the cash flow to pay such debts), it is, in practical terms, clear that it will not be able to meet its future or
contingent liabilities. A future or contingent creditor of a company can often claim to be prejudiced by the
company using its cash or other assets to pay current creditors or even for some other purpose, but, within
bounds, that is an inherent risk in the futurity or contingency of the liability. It is only when it can be said that
the company's use of its cash or other assets for current purposes amounts to what may be vernacularly
characterised as a fraud on the future or contingent creditors that it can be said that it "has reached the
point of no return.””

The CA cited para. 216 of the Cork Report (Report of the Review Committee Insolvency Law and Practice,
Cmnd 8558, 1982), which seems to sum up the ‘correct’ practical approach in that: “A balance has to be
struck between the right of an honest and prudent businessman, who is prepared to work hard, to trade out
of his difficulties if he can genuinely see a light at the end of the tunnel, and the corresponding obligation to
'put up the shutters', when, by continuing to trade, he would be doing so in disregard of those business
considerations which a reasonable businessman is expected to observe.”

Honest! Prudent! Genuinely! I cannot help thinking that all is not yet settled!

-- Ryan Clement is a practising barrister at Conference Chambers: www.conferencechambers.com. He
specialises primarily in general commercial, construction and employment law. He accepts instructions
from both solicitors and the general public through the Bar Public Access Scheme. He provides training to
companies on all aspects of employment and some commercial law. To instruct Ryan or obtain further
information on his full areas of work please contact Conference Chambers on 07958 421 595

Conference Chambers