past the point of no return?
10 June 2011
In BNY Corporate Trustee Services Ltd v Eurosail UK 2007-3BL
Plc & Ors [2011] the Court of Appeal considered the
application of Section 123(2) of Insolvency Act 1986 (the ‘balance
sheet test’) and upheld the earlier decision of the High Court.
The facts of the case are complicated. Broadly, Eurosail UK
2007-3BL Plc, a securitisation special purpose vehicle set up by
Lehman Brothers issued a series of notes backed up by a pool of UK
near prime domestic mortgages. The terms of the notes did not
permit any excess interest to be paid down against the principal
sum unless there had been an event of default. Certain of the
noteholders considered that an event of default would therefore
benefit them and they requested that an event of default be called
under condition 9(a)(iii) of the notes, which mirrored the wording
of the ‘balance sheet test’ for insolvency.
Eurosail and some of the other noteholders argued that there was
no event of default. Eurosail claimed it was able to pay its debts
as and when they fell due. It said that its assets should include
its claim in the Lehman bankruptcy and certain foreign currency
liabilities that were payable in the future should also be taken
into account.
The Court of Appeal found that Eurosail was not balance sheet
insolvent and there had been no event of default. Lord Neuberger MR
said that, whilst the audited accounts should be used as a starting
point, it would be impractical and undesirable for the balance
sheet test to be satisfied every time a company’s liabilities
exceeded its assets on the basis of its audited accounts. In
carrying out the ‘balance sheet test’, assets and liabilities need
to be valued sensibly taking into account when debts are due, the
value of the debts and with a view to commercial reality and
fairness.
The Court held that in order to be ‘balance sheet’ insolvent,
the company must have reached ‘the point of no return’. This was
not defined but Lord Neuberger MR explained that this was when
directors should have ceased trading as to continue trading harms
the interests of the company’s creditors.
Prior to this case, there have been no reported cases on the
meaning of the ‘balance sheet test’. Whist this case gives some
guidance, it makes it extremely difficult for creditors to petition
for the winding up of a company on the basis of the ‘balance sheet
test’ alone, unless it is clear that the company is balance sheet
insolvent and has indeed passed the ‘point of no return’.
This case also has wider implications in relation to claims
under the Insolvency Act 1986 such as wrongful trading,
transactions at an undervalue and preferences. A more detailed
analysis of the company’s financial position, beyond consideration
of the accounts alone, will now be required.
The content of this bulletin is provided for the purposes of
general interest and information. It contains only brief summaries
of aspects of the subject matter and does not provide comprehensive
statements of the law. It does not constitute legal advice and does
not provide a substitute for it.