Inability to pay debts (UK and Maltese law)
Inability to pay debts (UK and Maltese law)
Cash flow test and
balance sheet test
The reasons of not having
a single test
The definition and
treatment of the debts and liabilities under the both tests
The company’s inability
to pay debts is the most common ground for the winding up of companies and,
by definition, all-encompassing in the case of insolvent companies.
Under Maltese law section
214 (a) (ii) of Company Act 1995 states that the company may be dissolved and
wound up by the court in case of the company is unable to pay its debts. The
definition of this ground is to be found in sec. 214 (5) of Company Act. Based
on it the inability to pay debts of the company can be proved by the way of two
alternative tests: cash flow test and balance sheet test. These tests have
different purposes. In simple words, cash flow test is in general about the
debts which have already become due; balance sheet test is about the
liabilities, e.g. contingent and prospective debts.
Before the consideration
of these tests I would like to mention that even though Maltese Insolvency law
is mainly based on UK Insolvency law, there are some differences between
Maltese law and UK law in this question. The first difference is that under
UK law the ground inability to pay debts can be applied in four scenarios,
while in Maltese law there are only two of them. UK law describes the inability
to pay debts in Insolvency Act 1986.
Also there is a difference between UK and Maltese cash flow test, it will be
considered later on in this paper.
test and balance sheet test
Cash flow test is more for the lawyers because you
do not have to work with accounting documents of the company. All you need is
the state of a fact that there is a debt unpaid for the period of 24 weeks
after the issue of executive warrant on the basis of executive title.
The scheme of cash flow
test can be represented as followed. There are two companies A and B. A owns B
some money and does not pay it when it is due. B starts the case in a court
against A and wins it, e.g. court issues a judgment in favour of B. A judgment
is an executive title.
In perfect situation A must pay its debts to B on the basis of this judgment.
But usually companies do not do it. Then a judgment creditor is appointed. The
judgment creditor has a power to issue an executive warrant.
Usually it can be in three copies to the different banks where A has its
accounts. The banks, in their turn, freeze the accounts of A and send the debt
money on the accounts of B. If this scenario does not work, then B has to wait
24 weeks from the moment of issue the executive warrant and after can start the
winding up proceedings against A.
Under UK law the cash
flow test is different.
The company is deemed to be unable to pay its debts if a creditor to whom the
company owes more then £750 immediately payable has delivered to it at
its registered office a notice and the company has for three weeks thereafter
neglected to pay the debt. Moreover, these twenty-one days should be clear. If
the creditor presents the petition for winding up before the expiration of the
time, he will not be able to rely on the company’s failure to comply with his
demand for payment in the notice as proof of its inability to pay debts.
Above all, it must be shown that the company has neglected to pay the debt
demanded. If the company, in good faith, disputes its liabilities, it can not
be said to have neglected to pay the sum demanded.
Observing the authors, we
find Sealy stating that cash flow test is the most common reason for making the
winding up petition. Another author, Pennington, makes the definition of cash
flow test very simple. Everything reduces to the presence of current cash. If a
company does not have a cash to pay to a creditor, it is deemed to be
Balance sheet test is more for the accountants. The
balance sheet test for insolvency was first introduced in UK law in Insolvency
Balance sheet test will is to be satisfied if the company is unable to pay its
debts on prospective and contingent liabilities. Maltese legislation endorsed
balance sheet test. It is described under Maltese law in section 214 (5) (b) of
Company Act 1995, and under UK law in section 123 (2) of Insolvency Act 1986.
Balance sheet test is a
“red light” for the potential creditors. This solvency is very important for
the creditors who are in a position to invest their money in a company.
Usually, balance sheet test is more preferable than cash flow test because the
creditors are more protected with it by giving them an opportunity to take into
consideration future liabilities of the company and not only its present
financial position. In other words, this test is much fair both to the company
and the creditors. So, this test is all about the future possible liabilities,
and the circumstances are varied depending on the particular case.
reasons of not having a single test
These two tests are
alternative. The test is to be chosen by a person who brings the application to
the court. The reasons of having not a single test are following:
The company may
fail cash flow test but satisfies balance sheet test (e.g. be balance sheet
insolvent), and it still may be liquidated. And reverse situation: Prof.
Prentice shows that the company may be balance sheet solvent but cash flow
insolvent. As an example we can consider the Cornhill Insurance case.
The insurance company owned some amount of money to a certain person. For some
reason it decided not to pay it. According to contingent and prospective
liabilities it was solvent, but according to the fact of not paying the debt it
was insolvent. In conclusion court stated the inability to pay debts.
It is much
easier to state the fact of satisfaction of cash flow test than balance sheet
test because the latter one needs the access to information (which not everybody
will be glad to give on request) and special expert knowledge to read and
understand that information. Besides, it is not so easy for a person to
construct a true and fair value of the company. On the other hand, there can be
some problems of accuracy connected with cash flow test.
The minus of
having cash flow test on its own can be illustrated with the following
situation. There can be a sole creditor having a small claim against the
company. That creditor because of some reason decided to request the winding up
of the company. Therefore the remedy is excessive and not proportional to the
claim. The main interest and purpose of the Insolvency law is the protection of
the creditors. The creditors can not be sufficiently protected with cash flow
test on its own. Prof. Goode states that balance sheet test adds more
protection to the companies, while cash flow test makes individuals more
treatment of the debts and liabilities under the both tests
The definitions of debts
and liabilities are to be found in UK Insolvency Act 1986. According to it,
“’debt’ is to be
construed in accordance with following: the bankrupt is deemed to become a
subject to that liability [a bankruptcy debt] by reason of an obligation
incurred at the time when the cause of action accrued”.
a liability to pay money or money’s worth, including any liability to under an
enactment, any liability for breach of trust, any liability in contract, tort
or bailment and any liability arising out of an obligation to make restitution”.
In the Insolvency Rules
1986 we can find following:
“’debt’ means any of the
any debt or
liability to which the company is subject at the date on which it goes into
any debts or
liability to which the company may become subject after that date by reason of
any obligation incurred before that date”.
The very important
provision is the rule 13.12 (3). It states that –
“ for the purposes of
references in any provision of the Act [Insolvency Act 1986] or the Rules, it
is immaterial whether the debt or liability is present or future, whether it is
certain or contingent, or whether its amount is fixed or liquidated, or is
capable of being ascertained by fixed rules or as a matter of opinion”.
The term “liability” is
wider than term “debt”. Under the alternative tests debts and liabilities are
Under cash flow test, the
company is unable to pay its debts if it can not pay them as they fall due out
of cash or very liquid assets, and it can not pay all its debts over a lengthy
period of time by a steady realization of all its assets. But on the other
hand, cash flow test does not deal at all with the debts and other liabilities
of the company which have not been accrued due, or which are liabilities for
not liquidated damages.
In Re Capital
it was held that inability to pay debts occurs where company’s present,
contingent and prospective liabilities exceed the present value of its assets.
So, under balance sheet test, the company is unable to pay its debts if the
value of its assets is less that the amount of its liabilities. Before 1871 the
court could not take account of prospective and contingent liabilities in
making this assessment. Since those liabilities are very important for the
insurance companies, in that year it was provided that account should be taken
of such liabilities of determining the solvency of those companies.
Later on, in 1907 these liabilities were made applicable to assessing the
solvency of all other companies
Maltese law fails to define what contingent and prospective liabilities are.
That is why we have to refer to UK case law. One of the most important cases in
insolvency is Byblos Bank SAL v Al-Khudhairy . Here the court
outlines certain guidelines which will be considered when assuming whether or
not balance sheet has been satisfied. Firstly, the court will take into
consideration the fact that the company has ceased to carry out its business.
If it definitely happens, than court can apply balance sheet test as possible
technique. Secondly, the court has to draw the distinction between accrued
liabilities and those which may accrue in future connected to transactions
already entered to. It should be done because accrued liabilities are definite
debts. The liabilities which may accrue are dispute debts: if it takes very
long period of time to repay these liabilities that they can be taken into
consideration when applying balance sheet test. Also court held that no assets
should be taken into consideration in balance sheet test if they may accrue in
future. As to contingent and prospective liabilities, in the Byblos Bank
case express provision were maid to include those liabilities in determining
the company’s solvency.
In the other case, Taylor’s
Industrial Flooring Ltd v Malta & H Plant Hire (Manchester) Ltd
court held that the proof by a creditor that his debts has not being paid is
the prima facie evidence that the company is insolvent if the company gives no
reason for not paying it.
In Malta the judgment
concerning balance sheet test is Axel Johnson International AB vs.
Aluminum Extrusions Ltd (28/05/2003). In this case the court:
discretion and determined the dissolution and winding up of the company;
summed up its role
within this context as debts inquiring to the general situation of the company:
either determines that the winding order should be issued, or that the company
will be able to operate in the future and will be in position to pay its debts;
took into consideration
contingent and prospective liabilities when applying balance sheet test;
defendant company to be insolvent as its liabilities are far exceed its assets,
and ordered the dissolution and winding up of the company on the basis of
Article 214 (2) (a) (ii) – inability to pay debts.
In conclusion, I would
like to make it clear one more time. Cash flow tests deals only with debts that
have already become due. Balance sheet test deals with future liabilities and
future payments as well as available now assets. Balance sheet test take into
consideration prospective and contingent liabilities.
1. Company Act 1995, cap. 386 Laws of
2. Gower, L.C.B. “Gower’s Principles
of Modern Company Law”. – 6th ed. /by Paul L. Davies, Sweet and
3. Leonard Sedgwick Sealy, David Milman
“Annotated Guide to the 1986 Insolvency Legislation”, CCH Editions Limited,
1991 – 3rd ed.
4. Michael Forde “The Law of Company
Insolvency”, The Round Hall Press, Dublin, 1993.
5. Prof. Goode “Principles of
Corporate Insolvency Law”
6. Pennington, Robert R. “Pennington’s
Corporate Insolvency Law”, Butterworth, 1991.
7. UK law on line – www.opsi.gov.uk
8. UK legislation – www.infolaw.co.uk/lawfinder
1. Re Catholic Publishing and
Bookselling Co Ltd
2. Re Fitness Centre (South East) Ltd .
3. Cornhill Insurance plc v Improvement
Services Ltd .
4. Re Capital Annuities Ltd .
5. Byblos Bank SAL v Al-Khudhairy .
6. Taylor’s Industrial Flooring Ltd v Malta
& H Plant Hire (Manchester) Ltd .
7. Axel Johnson International AB vs.
Aluminum Extrusions Ltd (28/05/2003).
 Section 123 (1) (e) is about cash flow test; section 123 (2)
describes balance sheet test.
 Executive title also can be public deed and judicial bills of
 An executive warrant may be a judicial sale, a warrant of
seizure, a judicial warrant, a warrant in factum or a warrant of ejection.
 Section 123 (1) (a) of Insolvency Act 1986.
 Re Catholic Publishing and Bookselling Co Ltd (1864) 2
De GJ & Sm 116.
 Re Fitness Centre (South East) Ltd  BCLC 518.
 Schedule 6, para 27 (1) (u).
 Cornhill Insurance plc v Improvement Services Ltd 
1 WLR 114.
 Sections 385 (1), 382 (2) of Insolvency Act 1986.
 Section 382 (4) of Insolvency Act 1986.
 Rule 13.12 (1) of the Insolvency Rules 1986.
  1 WLR 170.
 Section 21 of the Life Assurance Companies Act 1871.
 Section 28 of the Companies Act 1907.
  BCLC 216,  BCC 44.