"The New Challenge With Defining Insolvency in the UK"

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

The statutory gateway to an insolvency process under U.K. law hinges on the definition of insolvency in the Insolvency Act 1986 (IA 1986). However, a 2013 decision by the Supreme Court of the United Kingdom has created ambiguity over the definition and has cast significant doubt on whether creditors can continue using a long-standing test to determine whether a company is insolvent.

Traditional UK Insolvency Definitions

In the U.K., a company may be wound up if one of two statutory provisions are proved to the satisfaction of a court:

  • The company is unable to pay its debts as they fall due (the cash-flow test); or
  • The value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities (the balance-sheet test).

In BNY Corporate Trustee Services Ltd v. Eurosail [2013] 1 WLR 1408, the Supreme Court analyzed the balance-sheet test for the first time. Its decision suggests that, except for the clearest cases, this test will be very difficult for a creditor to use to establish an insolvency event of default.

Background

Eurosail is a special purpose vehicle that was formed by Lehman Brothers in 2007. It acquired sterling-denominated mortgage-backed loans using the proceeds of long-term notes denominated in sterling, U.S. dollars and euros. The rights of the various noteholder classes, including their relative priority, were set out in the finance documents. Such provisions sometimes are known as the payment or priority “waterfall”: As cash becomes available, it flows down to meet payment obligations, starting with the most senior noteholders and ending with the most junior class.

Lehman’s collapse in 2008 caused adverse movements in foreign exchange rates after currency hedging arrangements were terminated between Eurosail and Lehman. This resulted in a slowdown in the rate at which Eurosail was repaying the non-sterling notes. One class of noteholders wanted to trigger a contractual change to the payment waterfall to improve the speed at which they would have been repaid (albeit at the expense of other noteholders). The finance documents provided that either cash-flow or balance-sheet insolvency was an event of default. The dissatisfied noteholder group alleged that Eurosail was insolvent on a balance-sheet basis only as it was patently able to pay its obligations as they fell due. The latest financial statements of Eurosail showed net liabilities of about £75 million and assets exceeding £600 million, and the applicant noteholders relied on this as clear evidence that the balance-sheet test had been triggered.

The Court’s Decision

Last year, the Supreme Court unanimously held that the noteholders had failed to establish that Eurosail was insolvent on a balance-sheet basis. A petitioner has to establish to the satisfaction of the court that, on the balance of probabilities, a company has insufficient assets to be able to meet all its liabilities, including prospective and contingent liabilities. Eurosail was a structured finance vehicle with income and payment obligations stretching out for 30 years. In such a case, a court should be very cautious in finding balance-sheet insolvency when the company was meeting current liabilities as they fell due. The noteholders faced an even greater hurdle in making their case, as there are inherent uncertainties to determining the levels of future interest and foreign exchange rates over an extremely long period of time.

The Court also held that the assessment of whether a company is balance-sheet insolvent may differ from a company’s balance sheet prepared in accordance with U.K. companies legislation. In particular, the assessment of future and contingent liabilities may be different from the standard company accounting approach. Significantly and unfortunately, the Court offered no guidance on how this assessment should be conducted.

Implications

A hostile creditor rarely has access to anything other than a company’s publicly available financial information. On the back of this judgment and absent extreme facts, it will be extremely challenging for a creditor to establish balance-sheet insolvency, and it remains for future cases to cast meaningful light on what valuation approach or approaches are appropriate. In the meantime, a prudent lender may wish to negotiate a balance-sheet event of default measurable by reference to the accounting standards ordinarily applicable to the borrower rather than the test set out in the Insolvency Act 1986.

* This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.