The Companies Act Solvency and Liquidity Test
A company would satisfy the solvency and liquidity test if, considering all reasonably foreseeable financial circumstances of the company at that time:
- the fair value of the assets of the company equal or exceed the fair value of its liabilities; and
- it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of –
- 12 months after the date on which the test is performed; or
- in the case of a distribution/dividend, 12 months following that distribution/dividend declaration.
The test is required to be performed by the board of directors of a company and the board must consider appropriate and satisfactory accounting records and financial statements of the company to reach their conclusion regarding the company’s solvency and liquidity. Section 4(2)(b) of the Companies Act also introduces a ‘substance based’ approach, where the directors must consider a fair valuation of the company’s assets and liabilities (including any reasonably foreseeable contingent assets and liabilities and irrespective of whether or not these may arise as a result of the proposed transaction). The directors may also consider any other valuation of the company’s assets and liabilities that is reasonable in the circumstances.
The purpose of the test is to ensure that other stakeholders of the company are not prejudiced by certain transactions which have the ability to erode the value of the company to the benefit of only a select group of stakeholders. When a company declares dividends or provides financial assistance, the Act specifically requires a written board resolution and compliance with the solvency and liquidity test should be documented in the resolution. This resolution should be completed and signed at the date of dividend declaration or provision of financial assistance.