Eurosail balance sheet insolvency

Insolvency is a necessary condition for setting aside a preference or a transaction at an undervalue. A company’s inability to pay its debts is a commonly found ‘event of default’ in commercial contracts. As the Eurosail case shows, the determination of this question may be pivotal to the outcome for creditors.

The decision is one of major and widespread significance. Eurosail ’s latest audited balance sheet showed a net deficit of over £74m. While Eurosail continued to pay interest and principal under the loan notes when due, a group of its noteholders commenced litigation, arguing that Eurosail was insolvent under the s123(2) balance sheet insolvency test. Although a highly fact-specific case, Eurosail illustrates the type of factors that the Court will take into account when determining balance-sheet insolvency.

The Supreme Court’s finding that, in effect, a debtor may become insolvent before “the point of no return” is particularly important for borrowers and their lenders. The case concerned an issue by Eurosail, a special purpose vehicle, of five classes of loan notes, as part of a securitisation transaction relating to a portfolio of mortgage loans. The events of default under the loan notes included a direct reference to s123(2) IA, which was potentially relevant as Eurosail’s latest audited balance sheet showed a net deficit of over £74m.

See full list on linklaters. The Supreme Court upheld the Court of Appeal’s decision that Eurosail was not “balance sheet insolvent” under the s123(2) test, holding that: 1. Lord Neuberger’s description in the Court of Appeal of s123(2) being a “point of no return” test “should not pass into common usage as a paraphrase of the effect of section 123(2)”. To illustrate the need to consider the specific circumstances of each case, the Supreme Court indicated that it would be easier to demonstrate that a SPV such as Eurosail was insolvent under the s123(2) test than an actively trading company which was making on-going commercial decisions about its business, suppliers, pricing policy and even raising new capital. The current net asset position of such a com. Insolvency related Events of Default: This decision confirms that the s123(2) test is very fact specific.

If, therefore, a party wishes to have a contractual termination right if their counterparty’s statutory balance sheet shows net liabilities, they shoul rather than simply referring to s123(2) IA, either have an event of default referable to their counterparty’s audited balance sheet or include a financial covenant, requiring the counterparty to have net assets which, if breache would constitute an event of default. Implications for insolvency based actions: A liquidator or administrator may only challenge the validity of a transaction under s2IA (transaction at an undervalue), s2IA (preference) or s2IA (avoidance of certain floating charges) if it took place at a time when the company was unable to pay its debts. Had the “point of no return” formulation of the s123(2) insolvency test been adopte it is probable that only transactions which took place when insolvenc. The s123(2) test, on the other han is concerned with liabilities accruing beyond that time. As Lord Walker pointed out, using a cash-flow test in this context would be “completely speculative”, the “only sensible test” for such a period being “a comparison of present assets with present and future liabilities (discounted for contingencies and deferment)”.

It is clear, however, that the Supreme Court did not view the two tests as being entirely separate. For the s123(2) test to be met, there must be an expectation that a debtor will not be able to meet its future and contingent liabilities when they fall due. As such, what is commonly described as a balance sheet insolvency test is, in effect, more of a medium to long term liquidi.

Balance sheet or technical insolvency occurs where the value of a company’s assets is less than the amount of its liabilities, taking into account both contingent and prospective liabilities. The term liabilities is broader than debts as it encompasses liquidated and unliquidated liabilities arising from contracts, tort, restitution etc. Christopher Boardman, barrister at Stone Buildings, believes the decision in Eurosail will be welcomed by directors but less by creditors and liquidators.

The UK Supreme Court has now unanimously confirmed the test for balance - sheet insolvency under section 1of the Act in its decision in BNY Corporate Trustee Services Limited v Eurosail and others UKSC 28. Eurosail to pay its debts within the meaning of section 123(2). Applying these propositions to the facts, the Chancellor concluded that Eurosail was not balance sheet insolvent.

Since Eurosail , and most recently in Evans v. The Court suggested that in order to determine whether a company is insolvent requires a factual enquiry based on “all the available evidence and the circumstances of a particular case”. They argued to the courts that Eurosail was ‘ balance - sheet ’ insolvent, an event of default. The Supreme Court unanimously upheld the earlier decisions of the High Court and the Court of Appeal, agreeing with the Anoteholders that Eurosail was not balance - sheet insolvent for the purposes of section 123(2) of the Insolvency Act. Balance sheet insolvency occurs when a company’s total liabilities are greater than its assets – a situation that can be determined by taking a ‘balance sheet test. Along with a cash flow test, it provides a clear picture of the company’s financial status, and helps directors to avoid accusations of insolvent trading.

The High Court agreed with Eurosail, as did the Court of Appeal, but on a different analysis of the law. The Court of Appeal concluded that the balance sheet test for insolvency was whether the debtor had “reached the point of no return” so that to continue trading would amount to a fraud on future and contingent creditors. The Eurosail decision introduced a new and potentially complicating factor, namely the question of whether having recognised that the company is.

Firstly, it considered whether or not. On the Supreme Court in the United Kingdom (BNY Corporate Trustee Services Ltd v Eurosail UKSC 28) found that the ‘balance sheet’ test for insolvency must take account of the wider commercial context, and that courts must look beyond the assets and liabilities used to prepare a company’s statutory accounts when deciding whether a company is insolvent.