When is broke broke? A UK Supreme Court perspective on insolvency

Like many legal tests, the test for insolvency is easy to state, but hard to apply in practice.

The United Kingdom Supreme Court (UKSC)1 has recently issued an important clarification, which confirms that an element of forwards projection must be applied - extending in extreme cases to assessments of balance-sheet as well as cash-flow solvency.

This liberal approach is likely to be followed in New Zealand, despite differences in statutory wording.

The concept of inability to pay debts is woven throughout the Companies Act 1993. Ability to pay debts is a prerequisite for the making of a distribution, such as a dividend (see the section 4 solvency test), and a transaction entered into at a time when the company is unable to pay its debts is voidable by a liquidator (section 292). A company may also be placed in liquidation if is unable to pay its debts (section 241(4)(a)). This will be the case if fails to comply with a statutory demand or if there is proof by "other means" that it cannot pay its debts. Section 288(4) provides that "[i]n determining whether a company is unable to pay its debts, its contingent or prospective liabilities may be taken into account".

But what does this important test mean in practice? In particular:

how far into the future does the test extend? What result if a company is able to pay its debts today, but is highly unlikely to do so in three months' time? in what circumstances will a contingent or prospective (but...