Court of Appeal clarifies Eurosail

At what point will the court find a company is deemed unable to pay its debts? Frances Coulson of Moon Beever comments on a ruling in which the court considered the established law on the issue in the context of cashflow.

Original news

Carman (liquidator of Casa Estates (UK) Ltd) v Bucci [2014] EWCA Civ 383, [2014] All ER (D) 33 (Apr)

The liquidator had applied to recover money paid to the respondent company secretary as constituting transactions at an undervalue. The circuit judge found that the respondent had rebutted the statutory presumption that the company had not been insolvent at the time that the payments had been made. The High Court found that the presumption had not been rebutted and made its own findings on the solvency of the company at the relevant time. The Court of Appeal, Civil Division, considered the established law on when a company was deemed to be unable to pay its debts, within the meaning of and the Insolvency Act 1986, s 123 (IA 1986), and dismissed the respondent’s appeal.

How did the issue arise?

The issue arose because the liquidators of Casa Estates (UK) Ltd (of whom Mr Bucci was the sole director) were pursuing Mrs Bucci—the Company Secretary—for various transactions at undervalue. As she was a connected party there was a presumption of insolvency which she sought to rebut. She successfully did so at first instance but Warren J overturned Judge Purle’s decision to that effect on appeal, and the Court of Appeal agreed with Warren J.

The issue revolved around the definition of insolvency and the test therefor. The company was unusual in its arrangements. Both Warren J and the Court of Appeal were careful to say it was not a Ponzi scheme, but the Court of Appeal used a Ponzi scheme company as an analogy to show that a company which was cashflow solvent (because it could pay its debts as they fell due), could still be balance sheet insolvent. For instance, because in the case of a Ponzi scheme at the extreme—the cash paid by new investors was paying old investors rather than being actually invested—so if the new investors didn’t appear or sought their money back the Ponzi company couldn’t pay, so was balance sheet insolvent.

In this case, the company’s business was introducing investors to property in Dubai. It had an agent, Casa Dubai. The company said it had an agreement to pay Casa Dubai a monthly retainer of £10,000 while Casa Dubai would pay the company an average 6% commission on sales. The company also passed on funds it received from its clients for Dubai property investment to Casa Dubai, which was to make payments to developers on behalf of the company’s clients. There was an oral set-off agreement, such that if investor A paid, say, £50,000 to the company and Casa Dubai owed the company (for argument’s sake) £40,000 commission, Casa Dubai would withhold the commission from the company and pay it over to the developer—and the company would make up the £10,000 shortfall to Casa Dubai. There were never any funds flowing from Dubai to UK—always UK to Dubai and the £10,000 retainer was rather ignored by the director in his explanations of the oral set-off agreements.

Part of the issue arose because Judge Purle decided the case at first instance on the basis of the company not being ‘beyond the point of no return’ prior to the Supreme Court decision in BNY Corporate Trustee Services Ltd v Eurosail-UK-2007-3BL plc [2011] EWCA Civ 227, [2011] 3 All ER 470, which finally overturned that test. The Eurosail judgment was finally handed down by the Supreme Court on 9 May 2013 while Judge Purle’s judgment here had been in December 2012.

What did the Court of Appeal decide are the relevant factors for deciding cashflow insolvency?

The court made no change to this—it clarified it and referred to Lord Walker’s judgment in Eurosail, namely that:

  1. IA 1986, s 123(1) and (2) were not intended to change pre 1986 law on solvency
  2. the cash flow test looks to the future as well as the present—the future being the reasonably near future, and the test being flexible and fact sensitive
  3. cash flow and balance sheet tests stand side by side but when looking at the balance sheet test it wasn’t ‘mechanical’

In Bucci, the Court of Appeal reiterated that the cash flow test was not the end of the investigation. Going back to the Ponzi scheme analysis, it is also to ask, how is it able to pay? It was said to be ‘counter intuitive’ to say a company was solvent if it was paying its debts as they fell due simply by getting deeper into long term debt.

What factors are relevant to balance sheet insolvency?

Mrs Bucci had submitted that if a company is cashflow solvent there is no need to consider whether it is also balance sheet insolvent. Judge Purle had found that the company was indeed cashflow solvent so the court should not go on to consider balance sheet solvency. The Court of Appeal rejected that view. Lewison LJ said it was clear from the Eurosail case and its approval of Re Cheyne Finance plc (No 2) [2007] EWHC 2402 (Ch), [2008] 2 All ER 987 that a balance sheet test is not excluded just because the company is paying its debts as they fall due.

It was also clear from Eurosail that the two tests stand side by side. They stand (as Warren J said) as part of a single exercise, in other words to determine whether a company is unable to pay its debts. In Cheyne Finance, Briggs J said a realistic examination may reveal that a company is on any commercial view insolvent even though it may continue to pay its debts for the time being. Relevant factors include the real nature of some of the debtors, for example, and proper valuations of assets and the likelihood of contingencies coming to pass.

What is the effect of a presumption of insolvency regarding connected persons?

The respondent will have to rebut the presumption that the company was insolvent at the time of the undervalue transaction by producing contrary evidence. In this case, the respondent complained that the judge had been unable to make findings of fact on several issues but the Court of Appeal said that did not assist her as, if no finding could be made the court reverted to the presumption, and whereas Judge Purle had not gone far enough in his inquiry, Warren J was entitled to find Mrs Bucci had not rebutted the presumption of insolvency.

Are there any trends emerging post-Eurosail?

It is really a restatement of the law, but was rather specific on its facts—and cases with more usual trading continue to give clarification with more useful examples of what to look at.

What practical points can insolvency lawyers with potential clawback claims take away from this judgment?

Know the company. You will need to know the real commercial reality of the company, each asset and liability, and debtor and creditor. After all Eurosail wasn’t a simple widget company—the determination of its solvency or otherwise rested on complex and future contingencies far distant, and a judgement of those. In less complex cases, the realistic nature of the company’s debtors, the value of its contracts, and so on, all need to be understood in real commercial factual ways.

Further reading

If you are a LexisPSL Subscriber, click the link below for further information on security:

'Balance Sheet' insolvency after Eurosail (Subscriber access only)

Can a liquidator/administrator challenge/unwind transactions entered into by the company before it was wound-up/enters administration (Subscriber access only)

Not a subscriber? Find out more about how LexisPSL can help you.

Interviewed by Nicola Laver.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Relevant Articles
Area of Interest