
Mathew Newman
Partner | Legal
Guernsey

Mathew Newman
Partner
Guernsey
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What is the Guernsey solvency test?
The solvency test, found in section 527 of the Companies (Guernsey) Law 2008 as amended ("the Law"), is used to determine whether a Guernsey company is solvent. For non-regulated companies, it is a two-part test. For regulated companies there is a third part to the test[1] which concerns compliance with the solvency requirements imposed by their specific regulatory regimes. The test is cumulative, meaning that a company is insolvent if it fails any applicable part of the test.
Cash flow solvency
The first part of the solvency test, which is commonly called the cash flow test, requires a company to demonstrate that it is able to pay its debts as they become due[2]. The cash flow test has an element of futurity which is imposed by the phrase "as they become due". In other words, a company must show that on the present facts it can in the future meet its debts as they mature and become legally payable. This aspect of "looking to the future" arguably better reflects the commercial situation when a company may be able to pay its debts due right now but will inevitably fail due to future debts.This point was admirably made by Mr Justice Briggs in Re Cheyne Finance plc (No 2)[3] in the context of the similarly worded English “as they fall due” test:
“It is clear… that … cash flow or commercial insolvency is not to be ascertained by a slavish focus only on debts due as at the relevant date. Such a blinkered review will, in some cases, fail to see that a momentary inability to pay is only the result of a temporary lack of liquidity soon to be remedied, and in other cases fail to see that due to an endemic shortage of working capital a company is, on any commercial view, insolvent, even though it may continue to pay its debts for the next few days, weeks or even months before an inevitable failure.”[4]
Unlike in other jurisdictions, there is no fixed timeframe as to how far in the future the company must look with regard to when the debts become due. However, some persuasive guidance can be found from the Supreme Court case of BNY Ltd v Eurosail[5] ("BNY") where Lord Walker, when commenting on very similar wording in English legislation, considered that the reasonable near future will depend on all the circumstances of the case, but especially on the nature of a particular company's business[6]. In practice, directors can take a conservative approach and consider not only all debts which the company has a legal obligation to meet but also contingent liabilities (at their highest value) irrespective of when they become due.
Balance sheet solvency
The second part of the test, often called the balance sheet test, requires a company to show that the value of its assets is greater than the value of its liabilities[7]. The directors must have regard to[8] the most recent accounts for the company, all circumstances that the directors know or ought to know affect or may affect the value of the company's assets and liabilities and they may also rely on reasonable valuations of assets or estimates of liabilities. They should also take in account all contingent and prospective liabilities. In BNY Lord Walker agreed with the view that the balance sheet test involves the court making a judgment as to whether it has been established, when looking at the company's assets and making proper allowance for its prospective and contingent liabilities, that it cannot reasonably be expected to be able to meet those liabilities. If it cannot, then it will be deemed insolvent even if it is currently able to pay its debts as they fall due. It follows from this that the more distant the liabilities, the harder it will be to establish whether or not it can reasonably be expected to meet them.
In practice, directors can take the cautious route of disregarding contingent assets but including all contingent and prospective liabilities.
Why is the test important?
The test is important in various situations including:
Conclusion
To avoid potential liabilities, directors should carefully consider whether their company meets the solvency test not only when it has entered into significant financial difficulties but also before they make any decisions which are likely to have a significant impact on its finances. At these critical moments directors may be greatly assisted and often reassured by taking independent legal and accountancy advice to ensure that the steps they take do not have undesirable consequences for them personally in the future.
[1] Section 527 (1) (c) of the Law
[2] Section 527 (1) (a) of the Law
[3] [2008] BCC 182
[4] Paragraph 51
[5] [2013] 1 WLR 1408
[6] Paragraph 37
[7] Section 527 (1) (b) of the Law
[8] Section 527 (2) of the Law
[9] Sections 304 of the Law
[10] Section 303 of the Law
[11] Section 434 of the Law
[12] Judgment 38/2017
[13] Paragraph 603 of Carlyle
[14] Paragraph 607 of Carlyle
[15] Paragraph 441
[16] Paragraph 455
[17] [2019] EWCA Civ 112
[18] Section 406 (e) of the Law
[19] Section 407 of the Law
[20] Section 374 (1) of the Law
[21] Judgment 34/2012
[22] Section 374 (3) of the Law.
[23] Section 424 of the Law
[24] Within the meaning of section 407 of the Law
[25] Such as bringing a customary Pauline action, see Royal Court decision in Flightlease Holdings (Guernsey) Ltd v International Lease Finance Corporation, October 26th, 2005
[26] Section 371 (3) (a) of the Law
Ogier is a professional services firm with the knowledge and expertise to handle the most demanding and complex transactions and provide expert, efficient and cost-effective services to all our clients. We regularly win awards for the quality of our client service, our work and our people.
This client briefing has been prepared for clients and professional associates of Ogier. The information and expressions of opinion which it contains are not intended to be a comprehensive study or to provide legal advice and should not be treated as a substitute for specific advice concerning individual situations.
Regulatory information can be found under Legal Notice
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