When Is A Company Insolvent?

A new judgment of the Court of Appeal has made more complex and subjective the determination of whether a company is insolvent by reason of the so-called balance sheet test in section 123(2) Insolvency Act 1986.

Although the case concerned a structured finance, asset-backed, transaction, the Court's detailed consideration of the balance sheet test is of considerable general interest.

Definition of insolvency

If a company is insolvent (ie, unable to pay its debts), it not only runs the risk that it may be wound up by the court under section 122 Insolvency Act 1986 (the IA), it may also trigger an event of default in key contracts such as financing agreements.

Typically, such events of default refer to the definitions of inability to pay debts in section 123 IA, in particular the test of a company's inability to pay debts as they fall due in section 123(1)(e) and the so-called balance sheet test in section 123(2) which provides that: