Unable to pay its debts - the balance sheet test revisited
The first instance conclusion that each case should be decided on its legal (rather than accounting) merits has been strongly reinforced by the Court of Appeal in BNY Corporate Trustee Services Ltd v Eurosail - UK 2007 - 3bl Plc & Ors  EWCA Civ 227.
The Master of the Rolls (Lord Neuberger) noted in his leading judgment that:
- "I do not consider that the question whether section 123(2) applies simply turns on the question whether the liabilities of a company (however they are assessed) exceed its assets (however they are assessed). In practical terms, it would be rather extraordinary if section 123(2) was satisfied every time a company's liabilities exceeded the value of its assets."
- "I find it hard to discern any conceivable policy reason why a company should be at risk of being wound up simply because the aggregate value (however calculated) of its liabilities exceeds that of its assets."
- "Subsection (2) was, in my view, included in section 123 to cover a case where. . . it is, in practical terms, clear that it will not be able to meet its future or contingent liabilities."
- "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"."
- ". . . section 123(2) does not amount to a wholly new, relatively mechanical "assets-based", basis for seeking to wind up a company. . . the section can only be relied on by a future or contingent creditor of a company which has reached "the end of the road", or in respect of which the shutters should be "put up", imprecise, judgement-based and fact-specific as such a test may be."
In a concurring judgment, Toulson LJ noted that the "balance sheet" test is a judgment about:
- ". . . 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."
It is now beyond doubt that the balance sheet test is not a mechanistic or accounting exercise, but a judgment about whether a company will be able to pay its contingent and prospective creditors.
Date: 9th March, 2011
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