UK Insolvency: When an Asset is Not an Asset
The UK Court of Appeal has recently considered the status of contingent assets within the balance sheet test for insolvency in the context of a company’s inability to pay its debts. Under Section 123 Insolvency Act 1986, a company is deemed unable to pay its debts if its assets are less than its liabilities including contingent liabilities but nothing is said about the status of contingent assets.
In the case of Evans v. Jones, the liquidator of Rococo Developments Limited (“Rococo”) was seeking to recover directors’ loans repayments of circa £450,000. The directors defended the action by stating that at the time the payments were made the value of Rococo’s assets was greater than the amount of its liabilities taking into account its contingent assets and as it was solvent, the preference action should fail.
The contingent asset in question was an unlawful dividend of £75,000 made by Rococo to its directors (who were also its shareholders and so the beneficiaries of the dividend) at or around the time the preferential payments were made. The question the Court of Appeal had to determine was whether the unlawful dividend could or should be treated as an asset of Rococo on the assumption that it was recoverable. If it was in fact an asset, then Rococo would not have been deemed unable to pay its debts at the time the preferential payments were made and those payments would not be recoverable as they would not have been made at a “relevant time” as required by Section 240 Insolvency Act 1986.
The Court of Appeal concluded that the claim against the directors with regard to the unlawful dividend payment was itself contingent on Rococo’s subsequent insolvency. This is because it was contingent on firstly, being discovered and secondly, being pursued – neither of which was likely to happen so long as the directors remained in control of Rococo. The court described the claim against the directors for unlawful dividend payments as an “unknown unknown” at the time the preferential payments were made and therefore so remote a contingency as past capable of properly being taken it into account when assessing Rococo’s commensurate balance sheet.
The court followed the approach taken in BNY v Eurosail  that the “… assets to be valued are present assets of the company. There is no question of taking into account any contingent or prospective assets…” The court also relied on the fact that Section 123(2) explicitly refers to contingent and prospective liabilities but not to contingent or prospective assets.
This case builds on the English jurisdiction’s critical analysis of balance sheet solvency with the benefit of 20/20 vision and further highlights the view that a “liberal” approach to the use of hindsight is permissible when reviewing payments made by a company suffering financial distress. However, it is not permissible, nor indeed sensible, to “re-write history.”