Date 31 March 2011
The Court of Appeal recently reviewed one of the methods of assessing a company’s solvency in the case of BNY Corporate Trustee Services Limited v Eurosail–UK 2007–3BL Plc and (7) others [2011] EWCA Civ 227. It also reinforced the adage that arose from the Cork Report on Insolvency that “Insolvency Law is not an exact science”.
A company is deemed unable to pay its debts if the value of its assets is less than the amount of its liabilities (whether contingent, future or otherwise). This "balance-sheet" test of insolvency is drawn from section 123(2) of the Insolvency Act 1986 and is a common test, the failure of which has led to many a formal insolvency. The test is commonly used by advisers and companies alike to determine whether to “pull the plug” and appoint an Administrator, Liquidator or Supervisor.
BNY Corporate Trustee Services Limited (“BNY”) had issued Notes, in Euros, Sterling and Dollars, to help fund acquisitions (in this case of mortgages). To lessen its risk it had hedged its currency and interest rate exposures with different Lehman companies (which in turn were guaranteed by other Lehman companies). It initially covered the liability but the collapse of the Lehman Group and the loss of its “risk coverage” created uncertainty over BNY's ability to cover its potential liabilities.
As the mortgages BNY purchased were redeemed the proceeds went to pay off owners of the Notes in order of priority. There were seven different types or class of notes (A1, A2, A3, B1, C1, D1 and E1) and all of those owners of one type of Note had to be paid off before the next type down could be paid (e.g. all of A1 got paid before any of A2 got paid). All fine if there is enough to go round and unsurprisingly different classes of Note holder fell out when it no longer looked as certain that there would be enough to go round.
The Court of Appeal held that what was necessary when considering BNY's solvency was not a simplistic or mechanical comparison of the value of the assets and liabilities in its last audited balance sheet. Instead, a range of factors had to be included in the analysis. Contingent and prospective liabilities in particular had to be valued and an assessment of when those liabilities would arise and the period over which they would fall due. All this combined to create a great deal of uncertainty, especially when assessing the currency exposure.
The Court's view was that it was for the complaining Note holder (who was asserting insolvency) to demonstrate that BNY had reached the point of no return. As the uncertainties were so great, in this case the Note holder had failed to establish this.
This is a detailed review of the balance-sheet test by the Court of Appeal. Don’t expect it to be revisited soon. Interestingly, the Court appears to suggest that it would be “positively dangerous” for there to be more detailed guidance on the judicial approach of the Court than it provided in this case.
If you would like more information or advice relating to a specific matter, please do not hesitate to contact Robert Ryall on 01727 798000 or any member of the Commercial Dispute Resolution team.
© SA LAW 2011
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