CFM33194 - Loan relationships: the matters and computational rules: amounts not brought into account: debt releases: corporate rescue exemption: material risk

This guidance is applicable to certain events that take place on or after 1 January 2015.

CTA09/S323(A1)

Material risk of the company being unable to pay its debts

As explained in CFM33193, the phrase ‘unable to pay its debts’ is based on section 123 of the Insolvency Act 1986. The Insolvency Act definition is based on the evidence a creditor would need to present to a court to begin winding up proceedings. It is not necessary for such proceedings to have begun in order for the exemption in CTA09/S322(5B) to apply. Nor does it mean that a debtor can merely claim the exemption just because any creditor could at any time commence court proceedings.

Case law on insolvency (for example, Colt Telecom [2002] EWHC 2815, and BNY Corporate Trustee Services Ltd [2013] UKSC 28) emphasises that a court will require more than a ‘modest threshold of probability’ before agreeing to insolvency proceedings.

The test of a company being ‘unable to pay its debts’ within the meaning of CTA09/S323(A1) (like sections 123(1)(e) and (2) of the Insolvency Act 1986) contains what are often called a ‘cash flow’ test and a ‘balance sheet’ test.

CTA09/S323(A1)(a): unable to pay its debts as they fall due

Lord Walker in BNY confirmed that ‘the ‘cash flow’ test [in section 123(1)(e) of the Insolvency Act 1986] is concerned not simply with the petitioner’s own presently-due debt, nor only with other presently-due debt owed by the company, but also with debts falling due from time to time in the reasonably near future. What is the reasonably near future, for this purpose, will depend on all the circumstances, but especially on the nature of the company’s business.’

CTA09/S323(A1)(b): the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities

In BNY, Toulson LJ said: ‘In practical terms it would be rather extraordinary if section 123(2) was satisfied every time a company’s liabilities exceeded the value of its assets. Many companies which are solvent and successful, and many companies early on in their lives, would be deemed unable to pay their debts if this was the meaning of section 123(2). Essentially, section 123(2) requires the court to make a judgment whether it has been established that, looking at the company’s assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to meet those liabilities. If so, it will be deemed insolvent although it is currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish.’

Under the so-called ‘balance sheet’ test, therefore, the court must be satisfied that there will ‘eventually be a deficiency’ (Lord Walker in BNY).

For the exemption to apply, then, there must be a ‘real prospect of insolvency’ as an insolvency court would understand it, within the next 12 months. It will not be enough for a company to claim the benefit of the exemption on the basis of temporary cash flow difficulties for which it is seeking bridging finance or which it meets by selling assets. Nor is it sufficient that there is a mere possibility that the company may (like any business) run into problems in some years’ time.

See CFM33195 for more on the 12 month period.