The Court of Appeal’s recent decision in BNY v Eurosail 3BL is groundbreaking not only for the securitisation industry, but also for any business facing a possible challenge to its solvency. It provides invaluable clarification and guidance on the balance sheet test for insolvency. This should reduce the likelihood of disputes arising with business partners who might stand to benefit in an insolvency situation.
What has happened?
Eurosail 3BL was an issuer of residential mortgage backed securities. Its audited accounts showed a deficit between current assets and current liabilities of around £75 million. This led a group of investors to claim that Eurosail 3BL was insolvent. Had the investors been correct, they would have tried to call an event of default, with favourable consequences for them.
The Court of Appeal considered the balance sheet test for insolvency within s.123 (2) of the Insolvency Act, and held that Eurosail 3BL should not be considered balance sheet insolvent. The Court of Appeal also used the opportunity to give some valuable broader guidance on the balance sheet test.
What are the key points?
The Court of Appeal found that a company is not balance sheet insolvent simply because the value of its assets is less than its liabilities. Instead, the question needs to be considered, “with a firm eye both on commercial reality and on commercial fairness”.
As a result it is impossible to provide a practical set of rules to determine when and if the balance sheet test has been breached. Instead, the Court of Appeal concluded that each case would need to be considered on its facts and that the company would need to have reached what it termed as ‘the point of no return’.
Eurosail 3BL had not reached the point of no return. Although its liabilities exceeded its assets, these liabilities did not mature for many years and were in different currencies, each of which were subject to potential fluctuation over time. This meant that the Court could not say with any degree of certainty that, at the point at which the liabilities were to be repaid, Eurosail 3BL would not have the assets to cover them.
How will this affect me?
The guidance provided by the Court of Appeal in this case represents the first time that the courts have considered how the balance sheet test should be applied. Whilst Eurosail 3BL is a special purpose vehicle set up for the purposes of a securitisation (and is therefore different from many normal trading companies), the principles are the same for all trading companies.
Many companies, including many in the FTSE100, will have liabilities in excess of their assets. It would be perverse if these companies were considered to be balance sheet insolvent and, potentially, at the mercy of the discretion of the court on the presentation of a winding up petition.
This judgment provides comfort for those companies with a net liability position that, as long as they have not reached that point of no return (i.e. they can see a clear path to the repayment when due) then they will not fail the balance sheet test.
What are the next steps?
The decision in BNY v Eurosail 3BL is the subject of an application for permission to appeal to the Supreme Court. Whether or not this permission is granted remains to be seen. For the time being, the Court of Appeal decision provides the clearest judicial insight into the application of the balance sheet test.
The Court of Appeal’s analysis of the balance sheet test is a triumph for common sense. It cannot be right that a company should be deemed insolvent in every situation where its liabilities happen to exceed its assets.
In some situations it may be unclear whether a company has , or has not, reached the “point of no return”. Potential claimants will need to consider their position very carefully before making such assertions; the courts will take a pragmatic and commercial view of the company’s situation. If the company is likely to be able to meet its liabilities as they arise, then the guidance in Eurosail 3BL indicates that the company is unlikely to be insolvent.
BLP acted for Eurosail 3BL in this matter.
For further information on any of these issues, please contact Oliver Glynn-Jones.