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Legal Focus
JULY 2013
Insolvency and the Balance Sheet Test
In light of the recent decision by the UK Supreme Court in the case BNY Corporate Trustee Services Limited and others v Eurosail-UK 2007-3BL PLC – concerning the use of “balance sheet” tests for insolvency, Lawyer Monthly speaks to John Houghton, the global co-chair of the Insolvency Practice and head of the European Restructuring, Insolvency and Workouts Practice at Latham and Watkins. Please introduce yourself, your role and your firm.
The Latham & Watkins European Restructuring Group specialises in advising creditors, secondary debt traders, sponsors, insolvency practitioners, insolvent companies and their directors on all areas of international restructurings, insolvency and corporate rescues. It is one of the few firms which can deliver a fully integrated global restructuring and insolvency practice, including a full service European Restructuring practice and a leading practice in the US.
What are the key legal issues businesses face relating to insolvency and corporate recovery in the UK?
As a director of a business in financial distress, you face a difficult juggling act. On the one hand you want to ensure the business stays afloat, keeps trading and holds on to an untarnished reputation. Perception is key, and as soon as ‘cracks in the wall’ become evident, for example when a company hires a financial adviser to ‘consider its options’, confidence will wane and the markets will react. On the other hand, directors have to be extremely careful that they do not breach their common law and statutory duties, including the crucial one: to act in good faith and to promote the success of the company.
Once the company has entered the “zone of insolvency”, to avoid liability for wrongful trading (as per s. 214 IA 1986) – and risk being required by the court to contribute personally to the company’s assets and to be disqualified as a director – it
becomes the directors’ duty to take every step to minimise loss to creditors, and so this represents a fundamental shift away from the shareholders, who are likely to be the constituency that the directors most usually have at the forefront of their minds. This duty is echoed by s. 172(3) Companies Act 2006, which states that the duty to promote the success of the company “has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.” What a director knows, or must be taken to know, is assessed by a mixture of objective as well as subjective tests so a finance director, for example, could find himself under much heavier scrutiny than say a purely operationally – focused director. It is often a tricky balance; when will action be regarded as timely? A director could just as easily be criticised for filing too early for example, and be accused of jeopardising the company’s survival and the value of its assets.
Can you give me a brief overview of the balance sheet insolvency test?
The balance sheet test cuts across many aspects of insolvency law and restructuring practice, not just in the area of wrongful trading. For example: (a) it is a gating item as regards the appointment of an administrator; (b) it is often a specific event of default in loan and bond documentation; (c) it is used to ascertain whether there are grounds to disqualify a director and (d) it will determine the “relevant time” as regards any attempt by a liquidator or administrator to set aside a pre- insolvency transaction.