Like many legal tests, the test for insolvency is easy to state, but hard to apply in practice.
The United Kingdom Supreme Court (UKSC)1 has recently issued an important clarification, which confirms that an element of forwards projection must be applied – extending in extreme cases to assessments of balance-sheet as well as cash-flow solvency.
This liberal approach is likely to be followed in New Zealand, despite differences in statutory wording.
- how far into the future does the test extend? What result if a company is able to pay its debts today, but is highly unlikely to do so in three months’ time?
- in what circumstances will a contingent or prospective (but uncertain) liability render a company unable to pay its debts?
The UKSC decision in the Eurosail Case
- the “cash-flow” insolvency limb: “if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due” (s 123(1)(e)), and
- the “balance-sheet” insolvency limb: “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” (s 123(2)).
- the cash-flow test is concerned not simply with the company’s presently-due debt, but also with debts falling due from time to time in the “reasonably near future”. What is the reasonably near future will depend on all the circumstances, but especially on the nature of the company’s business
- once the court has to move beyond the reasonably near future, any attempt to apply a cash-flow test will become “completely speculative”. Hence “the only sensible test” is to consider assets and liabilities, including contingent and prospective liabilities, and
- as this is still “very far from an exact test”, the court should proceed with the greatest caution in deciding that the company is balance-sheet insolvent.
- where, due to liquidity constraints, it cannot do so in the present or reasonably near future, and
- where, due to fundamental balance-sheet weakness, it cannot be reasonably expected to meet all of its contingent and prospective liabilities.