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The Supreme Court clarifies the test for insolvency - Eurosail

31 July 2013

In the recent case of BNY Corporate Trustee Services Limited v Eurosail 2007 3BL plc (Eurosail) the Supreme Court made two important findings, one in respect of post enforcement call options (PECO) which relate to securitization transactions and the second in relation to the test for insolvency. The focus in this legal update is on the test for insolvency.

The Supreme Court decision, which overruled that of the Court of Appeal is a move away from the principle that when assessing a companys solvency consideration should be given as to whether a company has gone beyond a point of no return. Instead the Supreme Court considered that it was necessary to carry out a commercial assessment of a companys situation taking into account its prospective future liabilities and assets.

What this means in practice is that a petitioning creditor will have an arguably higher hurdle to overcome when asserting a companys insolvency. Furthermore, deciding whether a company is insolvent or not will be a very much fact specific exercise.

Section 123 of the Insolvency Act 1986

Sections (1) and (2) of section 123 of the Insolvency Act 1986 (the Act) currently define a companys inability to pay its debts if:

(a) There is non-compliance with a statutory demand for a debt exceeding £750 presently due;

(b) to (d) there is an unsatisfied execution on judgment debt;

(e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.

(2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the companys assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

There are two measures on which it is traditionally considered whether a company is insolvent, on the cash flow basis, as set out in s123 (1)(a) of the Act or on the balance sheet basis which is reflected in s123(2) of the Act.

Facts of the case - Eurosail

The facts of the case are complicated. Broadly, Eurosail, a securitization special purpose vehicle, was set up by Lehman Brothers to acquire a portfolio of subprime or non conforming loan on residential properties within the UK. The value of the loans was approximately £650m and the purchase was funded by Eurosail issuing five classes of loan notes, these being financial instruments used to evidence a debt between parties. The loan notes were issued in various currencies including sterling, euros and US dollars.

The statutory provisions as set out in section 123 of the Act were incorporated into the loan notes issued by Eurosail which provided that should a default event occur, an enforcement notice would be issued and enforcement would take place against the company. However, the notes provided that in the absence of an event of default occurring the loan notes would generally not become repayable until 2045.

Eurosail had a number of swap counterparties, including Lehman entities, whose insolvency meant that Eurosail was exposed to currency market fluctuations. When Eurosail applied the relevant rates of exchange to its accounts, it recorded liabilities far higher than its assets. It was upon these accounts that certain loan note holders contended that the default event had occurred and that Eurosail was unable to pay its debts as they fell due.

The court considered that there were three "imponderable factors" which determined Eurosails ability to meet its liabilities. These were:

1. Currency movements;

2. Interest rates; and

3. the UK economy and housing market.

These matters the Supreme Court considered were out of the companys control and arguably, a matter for speculation.

The Supreme Court held that Eurosail was not insolvent due to the fact that:

  • Eurosail was able to pay its debts as they fell due without further investment
  • it was not possible to place a value on the different currency exchange and interest rates and on this basis it could not satisfy itself that there would be a shortfall in Eurosails assets
  • the loan notes were very complicated and provided mechanisms to defer liabilities until a much later date.


This is an important decision and will affect the advice given by many insolvency experts. It is clear that a broader picture must be taken into account when assessing solvency, and not just a simple accounting exercise as to the state of a balance sheet.

Practical implications

The decision may affect contracts that include insolvency related events of default, as s123 of the Act requires consideration of the factual circumstances of the company in question. Practitioners should therefore be careful to consider the terms of any agreement that is terminated under an insolvency related event of default.

It is possible that more transaction at an undervalue pursuant to s238 of the Act and preference claims under s239 of the Act could be challenged as the date of when the company became unable to pay its debts is now potentially wider than before.

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The content on this page 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.

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