Unable to pay its debts - the balance sheet test
We all know the definition of insolvency for a company - or do we?
The cashflow test - unable to pay its debts as they fall due - is relatively uncontroversial, but the balance sheet test is more difficult.
Section 123(2) Insolvency Act 1986 has rarely been subject to judicial interpretation, moving the Chancellor (Sir Andrew Morritt) to say in BNY Corporate Trustee Services Ltd v Eurosail- UK 2007- 3BL Plc & Ors  EWHC 2005 (Ch):
"this appears to be the first time the proper interpretation of the requirement in s.123(2) to "[take] into account [the company's] contingent and prospective liabilities" has required such close consideration."
Read the judgement for the detailed perspective, but the three key points about the balance sheet test are:
- Only present (ie excluding contingent and prospective) assets should be taken into account in the balance sheet test and those assets may include items not on the company's balance sheet such as unresolved claims in litigation.
- Contingent and prospective liabilities should not necessarily be taken into account at face value.
- The balance sheet test is a legal assessment, not an accounting exercise, and generally accepted accounting principles do not apply.
Sir Andrew Morritt (C) may have made it more difficult to establish that a company has failed the balance sheet test, but it is clear that each case should be decided on its legal (rather than accounting) merits.
Date: 10th August, 2010
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