THE INSOLVENCY SERVICE AND UNIVERSITY COLLEGE LONDON

 

THE 6th INSOLVENCY RESEARCH CONFERENCE

Thursday, 19th April 2012 

THE CONCEPT OF BALANCE SHEET INSOLVENCY –

A COMPARATIVE ANALYSIS

byROBIN PARSONS

andMICHAEL SCHILLIG

Section 123(2) Insolvency Act 1986

"(2) [Proof that assets less than liabilities] 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 company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities."

BNY Corporate Trustee Services Limited

vEurosail-UK 2007-3BL PLC and Others [2011] EWCA Civ. 227

 The "point of no return" test

PRINCIPAL PURPOSES OF CONCEPT OF BALANCE SHEET INSOLVENCY

•Ground for winding up order•Ground for administration order•Avoidance of antecedent transactions•Qualification as members' voluntary winding up•Redemption or purchase by a private company of its own shares•Wrongful trading and director disqualification

ISSUES WHEN LOOKING AT THE BALANCE SHEET

•Valuation on a going concern basis•Assets acquired in the future•Contingent liabilities•Prospective (future) liabilities•Foreign currency conversion rate•Unliquidated liabilities•Hindsight•Costs and expenses of winding up

GermanyCash flow insolvency, InsO, §17 • Inability to pay due debts• General ground for opening proceedings • Filing duty/interdiction of payment for corporate

managementProspective cash flow insolvency, InsO, §18 • Ground for opening proceedings • Voluntary filings only

Balance sheet insolvency, InsO, §19(2)• Ground for opening proceedings for corporate

debtors only• Filing duty/interdiction of payment for corporate

management• Case law in the context of directors’ liability for

breach of filing duty/interdiction of payment

InsO, §19(2) version applicable 1/1/1999 – 17/10/2008 and again as of 1/1/2014 • “Balance sheet insolvency is a situation where the

debtor’s assets are no longer sufficient to cover its existing liabilities. However, the debtor’s assets are to be valued on a going concern basis if the continuation of the business is, under the given circumstances, predominantly likely.”

InsO, §19(2) version applicable 18/10/2008 – 31/12/2013 • “Balance sheet insolvency is a situation where the

debtor’s assets are no longer sufficient to cover its existing liabilities, unless the continuation of the business is, under the given circumstances, predominantly likely.”

Components of balance sheet insolvency

• Owner’s intention and willingness to continue• Objective feasibility test

o From an ex ante perspective, a reasonable business manager would decide to continue.

• Coherent, reliable and realistic business concepto Profitability plano Cash forecasts on a weekly or monthly basiso Forecasting period: end of the following financial

year • Comprehensive evaluation of the business prospects• Burden of proof on the defendant (directors)• Liquidity prognosis or profitability prognosis?

Positive going concern prognosis

Assets• If realizable and likely to increase value for creditors• Goodwill only in case of a concrete offer to buy• Investment securities/foreign currency: market

value/exchange rate on the relevant date• Debt receivables: ‘certain’, ‘dubious’, ‘uncollectable’• Receivables not yet due: discounted to present value

Liabilities• All obligations to be paid out of the debtor’s assets• In principle, nominal value• Not yet due: discounted to present value• Contingent liabilities: ‘probability discount approach’• Shareholder loans unless subordinated to deferred

creditors

Insolvency balance sheet

Equitable (cash flow) insolvency• Involuntary filing if controverted by the debtor, 11

USC §303(h)• Fraudulent transfers, 11 USC §548; UFTA §4• Dividends and distributions, MBCA §6.40• Breach of fiduciary duties in the interest of creditors

Unreasonably small capital• Fraudulent transfers, 11 USC §548; UFTA §4• Veil piercing (Minton v Cavaney 56 Cal.2d 576)

Legal (balance sheet) Insolvency, 11 USC §101(32), UFTA §2(a)• Fraudulent transfers and preferences• Fiduciary duties• (Dividends and distributions, MBCA §6.40)

United States

11 USC §101(32), UFTA §2(a)• “financial condition such that the sum of such

entity’s debts is greater than all of such entity’s property, at a fair valuation, …”

Production Resources 863 A.2d 772 (DelCh 2004)• “a deficiency of assets below liabilities” and • “no reasonable prospect that the business can be

successfully continued in the face thereof”Two-step process• (i) ‘going concern’ or ‘liquidation’ valuation?• (ii) Comparison of assets and liabilities on the basis of

(i)Presumption for ‘going concern’ valuation• Liquidation values only where the company is ‘on its

deathbed’

Elements of balance sheet insolvency

Financial statements in accordance with US GAAP merely provide a starting point and are not controlling

Assets• All assets that have value for creditors• Goodwill where it can be sold• Contingent assets discounted to present value on

the basis of probability• Valuation on the basis of market conditions at the

date of transfer, except ‘retrojection’ and actual asset sales (liquidation)

• Income approach, market approach or asset approach

• In general, present value of future cash flows

Inclusion and valuation

Liabilities• All existing debts representing actual liability at face value• Contingent liabilities

o GAAP: recorded only if ‘probable’ and can be reasonably estimated

o 11 USC: ‘claim’ = ‘right to payment’ irrespective of ‘liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed’

o In re Xonics Photochemical, Inc 841 F.2d 198: ‘probability discount analysis’: value = face value * likelihood of occurrence

• Future claimso Present conduct may cause injury in the futureo e.g. product liability, asbestoso Whether debtor’s assessment was reasonable at the

relevant time

Inclusion and valuation

POTENTIAL SOLUTION? •When carrying out a transaction that could put the company in jeopardy, management should conduct a balance sheet insolvency analysis by compiling an insolvency balance sheet.•If the insolvency balance sheet shows that liabilities exceed assets, management should conduct a ‘going concern analysis.’•If transaction is subsequently challenged and no insolvency balance sheet was compiled there is a presumption that the company was insolvent at the relevant time.

QUESTIONS/COMMENTS?