Balance sheet insolvency
|The Jolly Contrarian’s Glossary |
The snippy guide to financial services lingo.™
also known as “technical insolvency” or “accounting insolvency”, “Balance sheet insolvency”, like cashflow insolvency, is a variety of being “unable to pay one’s debts”, an expression which in turn features in many definitions of “insolvency” or “bankruptcy”.
Compared with the carefully crafted prose of other limbs, this seems a dangerously vague expression. But it has a pretty technical meaning — conferred by statute, no less — Section 123(2) of the Insolvency Act 1986, which says a company will be 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”. This is what we mean by balance sheet insolvency.
English courts have recently had an opportunity consider what this means, and have resourcefully concluded: “what it says”.
In BNY Corporate Trustees v Eurosail the Supreme Court noted that while this test this is often called “balance sheet insolvency” it can’t be satisfied purely by reference to the company's statutory balance sheet, because that may omit important information like contingent liabilities. Nor does it mean that the company has “reached the point of no return because of an incurable deficiency of assets”, which was what the Court of Appeal in this case had hypothesised.
The court decided that for “the value of the company’s assets to be less than the amount of its liabilities, taking into account its contingent and prospective liabilities” the court must be satisfied, on the balance of probabilities, that the company has insufficient assets to be able to meet all its liabilities including prospective and contingent liabilities (I know what you’re thinking by the way — the highest court in the land isn’t adding a whole lot of value at this point is it?) discounted for contingencies and deferment.
Whether that is satisfied depends on the particular circumstances, and the burden of proof will be on the party asserting insolvency.