Supreme Court rules it a question of judgment and steers a U–turn from ‘Point of No Return’ analysis
The Supreme Court has this week considered the application of the balance sheet test for insolvency in BNY Corporate Trustee Services Limited v Eurosail and others [2013] UKSC 28.  The decision is one of major and widespread significance. This is the first time that UK’s highest court has had to interpret the balance sheet test at S123(2) of the Insolvency Act 1986.  In doing so, the Supreme Court has also provided helpful confirmation of the correct approach to the interpretation of the cash-flow test for insolvency at S123(1)(e).
The Supreme Court agreed with the conclusions of the High Court and the Court of Appeal that Eurosail, a special purpose securitisation vehicle which had issued loan notes by way of financing, was not balance sheet insolvent, but it did so based in part on slightly different reasoning from the lower courts.

In summary the Supreme Court held as follows:

• The cash-flow test is not concerned simply with debts which are presently due, but also with debts falling due from time to time in the ‘reasonably near future.’ The extent to which it is appropriate in applying this test to look to the future will vary, depending on factors such as the nature of the company’s business and whether it is continuing to carry out new trading transactions.
• Once the court has to move beyond the ‘reasonably near future’ any attempt to apply the cash-flow test will become completely speculative.  At that point a comparison of present assets with present future liabilities (with adjustments for contingencies) becomes the only sensible test for insolvency.
• The application of the balance sheet test requires the court to evaluate whether a company has sufficient assets so that it can reasonably be expected to meet all of its liabilities, including its prospective and contingent liabilities. This assessment has to be made in the light of the available evidence and circumstances of the particular case, bearing in mind that the more distant the liabilities, the greater the scope was for intruding uncertainties making it less likely that the balance sheet test for insolvency will be satisfied.
• The ‘point of no return’ test, adopted by Lord Neuberger in the Court of Appeal as a paraphrase of the balance sheet test for insolvency was unhelpful and should not be used as an alternative formulation of that test.

About the cash-flow and the balance sheet tests:
The cash-flow and balance sheet tests provide independent but related bases upon which a creditor can ask the court to order a company be wound up on the grounds that it is ’unable to pay its debts’.  By way of reminder, the cash-flow test provides that a company is deemed unable to pay its debts ‘if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.’ The balance sheet test set out at S123(2) provides that a company is also deemed unable to pay its debts ‘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.’   Both tests are frequently incorporated as triggering events in contractual termination clauses and also operate as key markers in other contexts, including, for example, the operation of wrongful trading provisions.
Impact of the decision:
Although the balance sheet and cash-flow tests continue as independent bases upon which to establish that a company is unable to pay its debts, the decision in Eurosail confirms that the tests have to some extent merged. The Supreme Court agreed that the cash-flow test has an element of futurity and that the balance sheet test can be relevant when applying the cash-flow test.  The application of both tests is fact specific and the balance sheet test will not be triggered simply on the basis that at any snap shot in time a company’s liabilities exceed its assets. As their lordships noted at the outset of their judgment, ‘There is no statutory provision which links section 123(2) of the 1986 Act to the detailed provisions of the Companies Act 2006 as to the form and contents of a company’s financial statements.’  (para 1)  One consequence is that parties may wish to move away from the use of these tests as triggers on termination clauses because of uncertainties as to whether the tests are met.
View our summary of the Court of Appeal decision in Eurosail, upheld in outcome on appeal, here.