Реферат: Inability to pay debts (UK and Maltese law)

Contents

Introduction

Cash flow testand balance sheet test

The reasons ofnot having a single test

The definitionand treatment of the debts and liabilities under the both tests

Bibliography

 

Introduction

The company’s inabilityto pay debts is the most common ground for the winding up of companies and,by definition, all-encompassing in the case of insolvent companies.

Under Malteselaw section 214 (a) (ii) of Company Act 1995 states that the company may bedissolved and wound up by the court in case of the company is unable to pay itsdebts. The definition of this ground is to be found in sec. 214 (5) of CompanyAct. Based on it the inability to pay debts of the company can be proved by theway of two alternative tests: cash flow test and balance sheet test.These tests have different purposes. In simple words, cash flow test is ingeneral about the debts which have already become due; balance sheet test isabout the liabilities, e.g. contingent and prospective debts.

Before theconsideration of these tests I would like to mention that even though MalteseInsolvency law is mainly based on UK Insolvency law, there are some differencesbetween Maltese law and UK law in this question. The first difference isthat under UK law the ground inability to pay debts can be applied in fourscenarios, while in Maltese law there are only two of them. UK law describesthe inability to pay debts in Insolvency Act 1986[1]. Also there is adifference between UK and Maltese cash flow test, it will be considered lateron in this paper.


Cashflow test and balance sheet test

 

Cash flowtest ismore for the lawyers because you do not have to work with accounting documentsof the company. All you need is the state of a fact that there is a debt unpaidfor the period of 24 weeks after the issue of executive warrant on the basis ofexecutive title.

The scheme ofcash flow test can be represented as followed. There are two companies A and B.A owns B some money and does not pay it when it is due. B starts the case in acourt against A and wins it, e.g. court issues a judgment in favour of B. A judgmentis an executive title[2].In perfect situation A must pay its debts to B on the basis of this judgment.But usually companies do not do it. Then a judgment creditor is appointed. Thejudgment creditor has a power to issue an executive warrant[3]. Usually it can be inthree copies to the different banks where A has its accounts. The banks, intheir turn, freeze the accounts of A and send the debt money on the accounts ofB. If this scenario does not work, then B has to wait 24 weeks from the momentof issue the executive warrant and after can start the winding up proceedingsagainst A.

Under UK lawthe cash flow test is different[4].The company is deemed to be unable to pay its debts if a creditor to whom thecompany owes more then £750 immediately payable has delivered to it atits registered office a notice and the company has for three weeks thereafterneglected to pay the debt. Moreover, these twenty-one days should be clear. Ifthe creditor presents the petition for winding up before the expiration of thetime, he will not be able to rely on the company’s failure to comply with hisdemand for payment in the notice as proof of its inability to pay debts[5]. Above all, it must beshown that the company has neglected to pay the debt demanded. If the company,in good faith, disputes its liabilities, it can not be said to have neglectedto pay the sum demanded[6].

Observing theauthors, we find Sealy stating that cash flow test is the most common reasonfor making the winding up petition. Another author, Pennington, makes thedefinition of cash flow test very simple. Everything reduces to the presence ofcurrent cash. If a company does not have a cash to pay to a creditor, it isdeemed to be insolvent. 

Balancesheet testis more for the accountants. The balance sheet test for insolvency was firstintroduced in UK law in Insolvency Act 1985[7].Balance sheet test will is to be satisfied if the company is unable to pay itsdebts on prospective and contingent liabilities. Maltese legislation endorsedbalance sheet test. It is described under Maltese law in section 214 (5) (b) ofCompany Act 1995, and under UK law in section 123 (2) of Insolvency Act 1986.

Balance sheettest is a “red light” for the potential creditors. This solvency is veryimportant for the creditors who are in a position to invest their money in acompany. Usually, balance sheet test is more preferable than cash flow testbecause the creditors are more protected with it by giving them an opportunityto take into consideration future liabilities of the company and not only itspresent financial position. In other words, this test is much fair both to thecompany and the creditors. So, this test is all about the future possibleliabilities, and the circumstances are varied depending on the particular case.

Thereasons of not having a single test

These twotests are alternative. The test is to be chosen by a person who brings theapplication to the court. The reasons of having not a single test arefollowing:

1.     Thecompany may fail cash flow test but satisfies balance sheet test (e.g. bebalance sheet insolvent), and it still may be liquidated. And reversesituation: Prof. Prentice shows that the company may be balance sheet solventbut cash flow insolvent. As an example we can consider the CornhillInsurance case[8].The insurance company owned some amount of money to a certain person. For somereason it decided not to pay it. According to contingent and prospectiveliabilities it was solvent, but according to the fact of not paying the debt itwas insolvent. In conclusion court stated the inability to pay debts.

2.      It ismuch easier to state the fact of satisfaction of cash flow test than balancesheet test because the latter one needs the access to information (which noteverybody will be glad to give on request) and special expert knowledge to readand understand that information. Besides, it is not so easy for a person toconstruct a true and fair value of the company. On the other hand, there can besome problems of accuracy connected with cash flow test.

3.      Theminus of having cash flow test on its own can be illustrated with the followingsituation. There can be a sole creditor having a small claim against thecompany. That creditor because of some reason decided to request the winding upof the company. Therefore the remedy is excessive and not proportional to theclaim. The main interest and purpose of the Insolvency law is the protection ofthe creditors. The creditors can not be sufficiently protected with cash flowtest on its own. Prof. Goode states that balance sheet test adds moreprotection to the companies, while cash flow test makes individuals moreprotected. 

Thetreatment of the debts and liabilities under the both tests

Thedefinitions of debts and liabilities are to be found in UK Insolvency Act 1986.According to it,

’debt’ isto be construed in accordance with following: the bankrupt is deemed to becomea subject to that liability [a bankruptcy debt] by reason of an obligationincurred at the time when the cause of action accrued”[9].

’liability’means a liability to pay money or money’s worth, including any liability tounder an enactment, any liability for breach of trust, any liability incontract, tort or bailment and any liability arising out of an obligation tomake restitution”[10].

In theInsolvency Rules 1986 we can find following:

“’debt’ meansany of the following –

(a)       anydebt or liability to which the company is subject at the date on which it goesinto liquidation;

(b)       anydebts or liability to which the company may become subject after that date byreason of any obligation incurred before that date”[11].

The veryimportant provision is the rule 13.12 (3). It states that –

“ for thepurposes of references in any provision of the Act [Insolvency Act 1986] or theRules, it is immaterial whether the debt or liability is present or future,whether it is certain or contingent, or whether its amount is fixed orliquidated, or is capable of being ascertained by fixed rules or as a matter ofopinion”.

The term“liability” is wider than term “debt”. Under the alternative tests debts andliabilities are treated differently. 

Under cashflow test, the company is unable to pay its debts if it can not pay them asthey fall due out of cash or very liquid assets, and it can not pay all itsdebts over a lengthy period of time by a steady realization of all its assets.But on the other hand, cash flow test does not deal at all with the debts andother liabilities of the company which have not been accrued due, or which areliabilities for not liquidated damages.  

In ReCapital Annuities Ltd[12],it was held that inability to pay debts occurs where company’s present,contingent and prospective liabilities exceed the present value of its assets.So, under balance sheet test, the company is unable to pay its debts if the valueof its assets is less that the amount of its liabilities. Before 1871 the courtcould not take account of prospective and contingent liabilities in making thisassessment. Since those liabilities are very important for the insurancecompanies, in that year it was provided that account should be taken of suchliabilities of determining the solvency of those companies[13]. Later on, in 1907these liabilities were made applicable to assessing the solvency of all othercompanies[14]Maltese law fails to define what contingent and prospective liabilities are.That is why we have to refer to UK case law. One of the most important cases ininsolvency is Byblos Bank SAL v Al-Khudhairy [1987]. Here the courtoutlines certain guidelines which will be considered when assuming whether ornot balance sheet has been satisfied. Firstly, the court will take intoconsideration the fact that the company has ceased to carry out its business.If it definitely happens, than court can apply balance sheet test as possibletechnique. Secondly, the court has to draw the distinction between accruedliabilities and those which may accrue in future connected to transactions alreadyentered to. It should be done because accrued liabilities are definite debts.The liabilities which may accrue are dispute debts: if it takes very longperiod of time to repay these liabilities that they can be taken intoconsideration when applying balance sheet test. Also court held that no assetsshould be taken into consideration in balance sheet test if they may accrue infuture. As to contingent and prospective liabilities, in the Byblos Bankcase express provision were maid to include those liabilities in determiningthe company’s solvency.

In the othercase, Taylor’s Industrial Flooring Ltd v Malta & H Plant Hire(Manchester) Ltd[15]court held that the proof by a creditor that his debts has not being paid isthe prima facie evidence that the company is insolvent if the company gives noreason for not paying it.

In Malta thejudgment concerning balance sheet test is Axel Johnson InternationalAB vs. Aluminum Extrusions Ltd (28/05/2003). In this case the court:

1)       heldconsiderable discretion and determined the dissolution and winding up of thecompany;

2)       summedup its role within this context as debts inquiring to the general situation ofthe company: either determines that the winding order should be issued, or thatthe company will be able to operate in the future and will be in position topay its debts;

3)       tookinto consideration contingent and prospective liabilities when applying balancesheet test;

4)        declaredthe defendant company to be insolvent as its liabilities are far exceed itsassets, and ordered the dissolution and winding up of the company on the basisof Article 214 (2) (a) (ii) – inability to pay debts.

In conclusion,I would like to make it clear one more time. Cash flow tests deals only with debtsthat have already become due. Balance sheet test deals with future liabilitiesand future payments as well as available now assets. Balance sheet test takeinto consideration prospective and contingent liabilities.

Bibliography

1.   Company Act 1995, cap. 386Laws of Malta.

2.   Gower, L.C.B. “Gower’sPrinciples of Modern Company Law”. – 6th ed. /by Paul L.Davies, Sweet and Maxwell, 1997.

3.   Leonard Sedgwick Sealy,David Milman “Annotated Guide to the 1986 Insolvency Legislation”, CCH EditionsLimited, 1991 – 3rd ed.

4.   Michael Forde “The Lawof Company Insolvency”, The Round Hall Press, Dublin, 1993.

5.   Prof. Goode “Principlesof Corporate Insolvency Law

6.   Pennington, Robert R. “Pennington’sCorporate Insolvency Law”, Butterworth, 1991.

7.   UK law on line – www.opsi.gov.uk

8.   UK legislation – www.infolaw.co.uk/lawfinder

References

1.   Re Catholic Publishing andBookselling Co Ltd (1864).

2.   Re Fitness Centre (SouthEast) Ltd [1986].

3.   Cornhill Insurance plc vImprovement Services Ltd [1986].

4.   Re Capital Annuities Ltd [1979].

5.   Byblos Bank SAL vAl-Khudhairy [1987].

6.   Taylor’s Industrial FlooringLtd v Malta & H Plant Hire (Manchester) Ltd [1990].

7.   Axel Johnson InternationalAB vs. Aluminum Extrusions Ltd (28/05/2003).

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