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The Conditions of Insolvency

The solvency of a Company is not accurately assessed purely by reference to the Balance Sheet of a Company. An assessment on this basis does not fairly reflect the commercial realities of trading.

Rather, solvency is assessed by reference to a “Cash Flow Test”, which is set out at Section 95A of the Corporations Act, 2001:

  • A Company is solvent if and only if, the Company is able to pay all its debts, as and when they become due and payable;
  • A Company which is not solvent is insolvent.

The Australian legislation was recently referred to (and accepted) by the UK Supreme Court in BNY Corporate Trustee Services Ltd & Ors v Eurosail-IK2007-3BL olc and others.

The UK Insolvency Act measures solvency by reference to both cash flow and the Balance Sheet. This can be prohibitive to a Company when assessing its liquidity in a trading environment.

Considerations to be made when assessing a Company for solvency in accordance with Section 95A are more subjective than considerations made when assessing by reference to a Balance Sheet. A Liquidator will seek to identify indicators of insolvency based on behaviours evidenced by the Company and its officers.

Such indicators were discussed in ASIC v Plymin Elliott & Harrison. These included:

  • Special arrangements with selected creditors
  • Payments to creditors of round sums
  • Demand letters, judgments
  • Inability to produce timely and accurate financial information
  • Suppliers placing the Company on COD terms
  • Creditors unpaid outside trading terms
  • Outstanding statutory liabilities
  • Dishonoured cheques and issuing of post-dated cheques

The implications of Section 95A are that a Liquidator will consider various behaviours and symptoms of insolvency and not rely purely on the Balance Sheet of a Company. Directors need to be mindful of the existence of such behaviours emerging within their organisations and seek appropriate advice early.