The cash flow or commercial insolvency test contains a flexible and fact sensitive futurity requirement in the phrase “as they fall due”, according to Briggs J in Cheyne Finance Plc (in receivership) [2007] EWHC 2402 (Ch).

Cheyne was a structured investment vehicle (“SIV”). It was one of the first SIVs to go into receivership as a result of the credit crunch. The receivers sought the court's directions as they had to identify whether an “Insolvency Event”, which was defined by reference to the cash flow test in s123 Insolvency Act 1986, had occurred.

s123(1)(e) provides that a company is deemed unable to pay its debts:

“if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due”

The wider implications of the Cheyne decision, which is the first time the court has considered this section, are that technical insolvency may be triggered earlier in some cases than might have been expected.

The judge gave the following example:

“The company has £1,000 ready cash and a very valuable but very illiquid asset worth £250,000 which cannot be sold for 2 years. It has present debts of £500, but a future debt of £100,000 due in 6 months. On any commercial view the company clearly cannot pay its debts as they fall due, but it is, or would be balance sheet solvent”.

In other words, if the company can continue to pay its present debts, but it cannot pay a known future debt, it is insolvent. 

Consider a company with positive net assets but limited cash, say £100,000, which it is burning at a rate of £50,000 per month. In one month’s time it has to pay a wages bill of £60,000. Provided that on the balance of probability it will continue to burn cash at £50,000 per month, it is insolvent now, not just in a month’s time when it no longer has the cash to pay its present debts.

This decision seems especially relevant during the current credit crunch when companies may have positive net assets but insufficient liquidity. It emphasises the need to take specialist advice early.

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In a post on an academic US blog about credit and bankruptcy, Credit Slips: Corporate Bankruptcy Costs and Recoveries in the UK, John Armour points out the results of his research into whether creditor control is better concentrated in the hands of a single creditor (receivership) or creditors generally (administration).

He concludes that there is no net difference as a result of two opposing factors:

there are higher gross realisations in administrations - due, Armour suggests, to higher accountability to junior creditors incentivising administrators to maximise realisations;

but dispersed creditor governance allows administrators to charge retail fee rates rather than the lower wholesale rates negotiated by secured creditors.

Intuitively, the explanation of higher administration realisations works at the margins. An administrator has a statutory priority of objectives and "getting the bank out" is last (as opposed to being the sole objective in receiverships).

But the retail/wholesale fees rationale is less persuasive. Bank panel firms are not always able simply to abandon wholesale rates once the bank is repaid. The fact is that administrations, with their heavier burden of broad obligations to creditors, including significant additional statutory reporting and compliance requirements, and a primary duty to have the company and its business continue as a going concern if possible, are simply more complex and costly procedures than receiverships.

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