When a company becomes insolvent there can be serious consequences:
- An increased risk of personal claims and Directors disqualification
- Winding up petitions
- Disposal of assets will be void once a winding up petition has been made
- Banks and Lenders will enforce their security
- Termination of contracts with customers and suppliers
- Transactions entered into within the previous 2 years can be reviewed and reversed
There are two tests for corporate insolvency:
- the cash-flow test: is the company currently, or will it in the future, be unable to pay its debts as and when they fall due for payment?
- the balance sheet test: is the value of the company’s assets less than the amount of its liabilities, taking into account as-yet uncertain and future liabilities?
If the evidence proves that the answer to either of these questions is yes on balance of probabilities, then the company is deemed insolvent under English law.http://www.out-law.com/en/topics/financial-services/restructuring/corporate-insolvency-the-basics/
On the 9th May 2013 the Supreme Court ruled in the case of:
Lord Walker acknowledged the uncertainty that is inherent in the (Balance Sheet) test, commenting that: “it is still very far from an exact test, and the burden of proof must be on the party which asserts balance-sheet insolvency.” It will, therefore, not simply be a matter of looking at a company’s statutory balance sheet at a given moment in time as there may be relevant assets and liabilities not contained in that document. However, nor will it involve a rather more complex assessment of whether the debtor has reached the point of no return.
Further comments on the case:
It is of course true that a snapshot of a company’s balance sheet is not conclusive as to its commercial and economic viability, and to make every company in this position vulnerable to a winding-up or administration order would be unfair and uncommercial.
The Supreme Court’s decision should therefore be welcomed for clarifying that the two tests are mutually exclusive and both represent different ways of analysing whether a company is insolvent. The judgment does leave some issues unresolved, for example the correct methodology for discounting future liabilities and the timing of the accrual of future and contingent liabilities.