'Balance sheet' insolvency after Eurosail

What is the key feature of the judgment?

In a unanimous judgment handed down last Thursday (9th May 2013), the Supreme Court confirmed the ‘balance sheet’ test insolvency of the IA 1986, s 123 is not a mechanical exercise of comparing the value of a company’s assets against the value of its liabilities, but a more sophisticated test requiring a judgment as to whether the present assets of a company will reasonably enable the company’s present and future liabilities to be met. In so doing, their Lordships rejected the ‘point of no return’ test formulated by Lord Neuberger MR in the Court the Appeal.

Why is the balance sheet test important?

A clear definition of inability to pay debts is often said to be ‘fundamental’ to any system of insolvency law. An insolvent company may be compulsorily wound-up by the court on the ground that it is ‘unable to pay its debts’. Insolvency is a necessary condition for setting aside a preference or a transaction at an undervalue. A company’s inability to pay its debts is a commonly found ‘event of default’ in commercial contracts. As the Eurosail case shows, the determination of this question may be pivotal to the outcome for creditors.

The circumstances in which a company is to be ‘deemed unable to pay its debts’ under the IA 1986, s 123 include:

1. if ‘the company is unable to pay its debts as they fall due’,
2. if ‘the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities’

The former is commonly referred to as ‘cash-flow’ insolvency and the latter