Section 123 Of The Insolvency Act 1986

Section 123 of the Insolvency Act 1986 sets out the legal definition of insolvency. It also includes two tests to evaluate whether a company is insolvent. Please note the new threshold figure in Section (1) is now £10,000. These are:

• The Balance Sheet Test states that a company is insolvent if its liabilities are greater than its assets.
• The Cashflow Test says that a company is insolvent if it is unable to pay its debts as and when they fall due. This circumstance could occur even though the company may have significant capital assets.

Which test to apply has been the subject of much debate over the years. A judgement in BNY Corporate Trustee Services Limited v Eurosail 2007 3BL plc is an authority on this.

What is commonly called the Eurosail Case said that if a company had stopped trading or was not likely to have any further income, then the most appropriate test to determine insolvency is the Balance Sheet Test. If its liabilities exceed its assets, then the company will be balance sheet insolvent.

If, however, the company was continuing to trade and likely to earn more income, then the Cashflow Test would be the most appropriate measure of insolvency.

There can be some warning signs that insolvency may be looming. Constantly juggling which creditors to pay first is one tell-tale sign. Another is if the company is making late payments or trying to extend credit terms. Arrears with HMRC or landlords is also never a positive indication.