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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 companys 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 companys 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 companys financial position, beyond consideration of the accounts alone, will now be required.

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