Understanding Commercial Insolvency and Its Justifications as a Test for Winding Up

Abstract

The insolvency ground of winding up an insolvent company is present in many jurisdictions. In the UK it is found in the Insolvency Act 1986, s.123. It has worked well in practice but has not been as well understood as it should be, and this was brought home forcefully in two recent cases, Re Cheyne Finance plc (No 2) [2007] EWHC 2402 (Ch)and BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28.

Cheyne departed from the well-established unified doctrine of commercial insolvency tests, and this was approved in Eurosail. Further, the UK Supreme Court in Eurosail gave two different meanings to the word “deemed” in s 123 when it suggested that the insolvency in s 123(1)(a) [neglect to meet statutory demand] and s 123(1)(b) [unsatisfied execution] is deemed insolvency while that in s 123(1)(e) is actual insolvency. This reflected an unarticulated premise that although a company that has committed a single default would be commercially insolvent under s 123(1)(a) and s 123(1)(b) and so might be wound up, single default was an inadequate basis for that purpose and, as a matter of theory or policy, multiple defaults was a sounder basis.

This article argues that, first, the use of the word “deemed” is a historical legacy dating from bankruptcy legislation and that it has only one meaning. It does not create a statutory fiction but states conclusively that a company is insolvent if any of the tests listed therein is proved. Secondly, an insufficient understanding of the rationales of the commercial insolvency tests and the powerful image of multiple defaults that an insolvent company brings to mind were main reasons for the decision in Eurosail. The premise is unfounded, as multiple defaults was an inappropriate criterion for commercial insolvency tests.

Keywords: Bankruptcy; Cash flows; Commercial insolvency; Future liabilities; Multiple defaults; Statutory interpretation; Single defaults; Winding up

JEL Classification: G33; G34; K22