The Solvency & Liquidity Test – an absolute must for Directors!

Section 4 of the Companies Act, 2008 lays out the requirements of the Solvency and Liquidity Test that must be applied by directors of companies when entering into certain transactions or commencing with certain actions.

This test adopts an approach of stopping companies from trading recklessly in an insolvent situation by requiring that the Company be not only liquid, i.e. able to pay its debts as they become due in the ordinary course of business, but also that it is solvent at the time of the transaction.

The definition of solvency stipulates that the assets of a company, fairly valued at the time of the transaction, must be equal to or exceed the liabilities of a company, fairly valued at the time of the transaction.

The Solvency and Liquidity Test must be applied by the directors of the Company when contemplating the following transactions:

  1. Financial assistance for the acquisition or subscription of securities;
  2. Financial assistance provided to directors and prescribed officers and/or to certain related and inter-related parties, this is particularly relevant to loan account transactions between entities and directors;
  3. Dividends and distributions;
  4. The issue of capitalisation shares;
  5. Share buy backs;
  6. Amalgamations or mergers;

Failure by the board to adhere to this test will result in the directors at fault being held personally liable for any resulting damage caused to the Company. Even though the Companies Act, 2008 has reduced the number of offences that will result in criminal sanctions, this has not relieved directors of any personal liability risk. It is therefore critical that directors apply their minds when contemplating the above transactions, as well as other transactions that could impact on the Company’s solvency and liquidity.

Should you have any queries, please do not hesitate to contact either Dave or Alexis.

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