The balance sheet insolvency test

The balance sheet test in s123(2) of the Insolvency Act 1986 (s123(2)) is one of the grounds on which a company can become the subject of a winding up or administration order. It can also be used as an event of default in a variety of commercial and financial contracts. S123(2) provides that a company is deemed unable to pay its debts if the value of its assets is proven to be less than that of its liabilities - taking into account contingent and prospective liabilities.

In the Court of Appeal, it had been held that the test was not a mechanical asset-based approach and could only be relied on by future or contingent creditors of a company which had reached the end of the road, or the point of no return.

The Supreme Court in BNY Corporate Trustee Services Ltd and others v Eurosail-UK 2007-3BL Plc and others, while upholding the Court of Appeal's judgment that Eurosail was not insolvent, rejected its 'point of no return' test.

The Supreme Court held that s123(2) requires the court to make a judgment whether it has been established that, looking at the company's assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities. If so, it will be deemed insolvent although it is currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish. The court held this is very far from an exact test and the burden of proof will be on the party asserting balance sheet insolvency.

Given the nature of Eurosail's prospective liabilities, it would not be possible to determine for a substantial period of time (30 years or so) whether Eurosail was, or was not, able to pay all its debts and whether there would be any deficiency.

Things to consider

There is still likely to be uncertainty as to how the balance sheet test is applied in practice as it will very much depend on the particular circumstances of the case.

All monies guarantee

The true interpretation of a guarantee will determine whether it is intended to guarantee a specific contract or a course of dealing and what effect variations will have on its validity.

In National Merchant Buying Society Ltd v Mallett, the defendant and his co-director entered into personal guarantees to jointly and severally guarantee payment of all sums which were or became owing to the claimant by their company. The credit limit was at that stage £200,000. The defendant resigned as a director and thereafter, the company's credit limit was increased ultimately to £700,000. The company became insolvent owing the claimant £330,000 which it sought to recover from the defendant and his former co-director under the guarantee.

The defendant argued that his liability under the guarantee was limited to the initial £200,000 credit limit agreed. Although he had consented to increasing the credit limit to £400,000, he had not agreed a further increase to £700,000 and therefore his liability under the guarantee was discharged.

The Court of Appeal held that the defendant's liability depended on the true interpretation of the guarantee. If it guaranteed the due performance of obligations arising under a specific contract, that would be the limit of the obligations. If it was later varied in a substantial or prejudicial way to the guarantor, without his consent, the guarantor would be released. Otherwise he would be exposed to a liability he had never agreed to.

The position is different, however, where the guarantee relates to obligations arising from a course of dealings. Here, so long as the principal's and creditor's dealings remain within the scope contemplated by the guarantee, variations in them will not affect the continuing nature of the guarantor's liabilities.

Just because the guarantor was aware of the initial contract extending the £200,000 credit limit, but not the final extension, that did not mean the guarantee was a 'specific contract' guarantee. The interpretation of the guarantee obligation was not dictated by the knowledge the guarantor had. The language used in this guarantee pointed away from a specific contract to an all monies guarantee that was not limited to the initial credit limit.

Things to consider

If the parties to a guarantee intend that the guarantor's obligations be limited, they should ensure that the guarantee specifically provides so.

Negligence must cause loss

In Bateson and another v Savills Private Finance Ltd, the claimants owned seven properties on interest only mortgages. When acquiring their eighth property they sought advice from the defendant mortgage brokers and subsequently remortgaged the seven properties they already owned to raise capital to buy the eighth property. The remortgage was an aggregate or portfolio mortgage with the security being held jointly over all seven properties rather than seven individual and independent mortgages.

The claimants fell into arrears and the properties were repossessed and sold. The claimants brought a professional negligence claim against the defendant. They alleged the defendant failed to notify them of the nature and risk of the aggregate mortgage and the level of redemption penalties they would have to pay on the remortgages.

The High Court held there was no evidence that the claimants had been advised by the defendant as to the true nature of the remortgage - being that it would be over all seven properties, all of which would be subject to possession proceedings if they fell into arrears. The defendant had not possessed relevant information about redemption penalties, which were substantial and could possibly have been avoided, and had not advised the claimants to make enquiries about them. He had also failed to record the claimants' answers to questions on the mortgage application questionnaire.

The court considered the claimants' conduct was consistent with not having been properly advised as to the risks involved. The defendant was therefore in breach of its duty of care.

However, the claimants' solicitors had advised them as to both the redemption penalties, which the claimants had been prepared to suffer, and on the nature of the aggregate remortgage and what it meant. Armed with that advice, they had still continued with the remortgage.

The court therefore found that on the balance of probabilities, the claimants would still have gone ahead with the remortgage even had they been properly advised by the defendant. The loss they suffered had not, therefore, been caused by the defendant's breaches. The court concluded the claimants would not have been able to meet their mortgage payments (whether aggregate or individual), irrespective of the nature of the mortgage, due to their underlying financial difficulties.

Things to consider

The claimants failed the "but for" test i.e. would the damage have been sustained but for the defendant's breach? It was not the defendant's negligence which led to their losses.

Post-judgment interest

In Chubb and Bruce (Joint Administrators of Link Lending Ltd) v Dean and Dean, Link had made a short-term bridging loan to the defendants secured by second charge on their leasehold property. Arrears accrued, repossession took place and judgment was obtained for the outstanding mortgage debt and costs which was secured on another of the defendants' properties. An order for sale was obtained on that property.

The High Court had to determine several points: what rate of interest applied under the charging order (contractual or statutory); whether the contractual rate of interest applied to the mortgage led to an unfair relationship under the Consumer Credit Act 1974; and whether the claimant could apply the proceeds of sale as they saw fit.

The court held that it had no power to vary the statutory rate of interest under the Judgments Act 1838 (the Act), which is eight per-cent, and no power to award post-judgment interest aside from that provided for under the Act.

The interest rate under the original agreement had been clear on the face of the documentation and was not illegible. Although the interest rate was high, it was a stiff commercial bargain only. It was not so high as to render the relationship unfair.

Under the Law of Property Act 1925, s105, a mortgagee is entitled to appropriate funds as to capital or interest as it sees fit once prior charges have been discharged.

Things to consider

This judgment restates the court's views on certain important issues for lenders. The contractual rate of interest provided for under the original loan agreement could not be carried through to the charging order, as that was an enforcement action and a distinct and separate claim.

Pleading and proving compound interest

To claim interest on a compound basis, a party has to plead and prove its actual interest losses.

This was the finding of the High Court in JSC BTA Bank v Ablyazov and others in which the bank obtained judgments against the defendants for sums paid away as a result of fraud perpetrated by the defendants.

The claimant sought compound interest at a rate of eight per cent per annum with annual rests pursuant to common law or simple interest pursuant to s35 Senior Courts Act 1981 (s35). The claimant had not pleaded compound interest at common law.

The court held that compound interest could be recovered as damages at common law, but such damages had to be pleaded and proved. The claimant had not pleaded how the money would have been used had it not been paid away. There was no allegation of losses suffered in addition to having paid away the principal sum. The claimant's actual losses, in terms of funding costs thrown away, were not stated. In the absence of a specific plea of actual interest losses, the remedy lay in the statutory provision for interest i.e. s35 simple interest.

The court held that the rate of interest to be applied was the rate at which banks with the general attributes of the claimant could have borrowed money over the relevant period. Here, evidence showed that rate to be 7.3 per cent and interest was awarded at that rate from the date the cause of action accrued.

Things to consider

Simple interest is seen as some, albeit imperfect, compensation for the winning party having been deprived of the use of its money. Had the claimant wanted a more perfect recourse, it needed to have pleaded and proved its claim for compound interest.

Summary judgment

In Opus Property Finance Ltd v Arca Homes Ltd and Aggett, Aggett entered into a deed of guarantee and indemnity to guarantee a loan of £300,000 to the first defendant for the purchase of a property. The guarantee was signed by Aggett's solicitor to confirm Aggett had received legal advice. No payments were made under the loan and the claimant sought summary judgment under the guarantee.

Aggett alleged that he had not signed the loan agreement which appeared to bear his signature and that the signature page had been taken from an earlier agreement he had entered into with the claimant.

The High Court found Aggett's allegations that the loan agreement had not been signed fanciful. The loan agreement bore a reference number throughout the body of its terms and the same number appeared on the signature page, so it could not have been taken from another document. Aggett had signed board minutes confirming that a loan had been agreed and that a copy of it had been produced.

There was nothing in the correspondence between the parties to suggest that the loan was not going to be signed and nothing to suggest the signature page had been concocted. The claimant would not have advanced the loan sum without the agreement having been signed.

The court considered neither defendant had any prospects of successfully defending the claim at trial and granted summary judgment.

Things to consider

Where a claim or defence appears, on the evidence available, to be spurious or fanciful and without prospects of success, an application for summary judgment should be made. An application to strike out can also be considered where the claim or defence discloses no reasonable grounds for bringing or defending the claim, or is an abuse of process or likely to obstruct the just disposal of the proceedings. In such circumstances, the court should be asked to exercise its case management powers.