BNY Corporate Trustee Services Limited and others v Eurosail plc [2013] – UK Supreme Court considers the meaning of the ‘Balance-Sheet Insolvency Test’

31 May 2013



The legislation at the centre of these proceedings was the Insolvency Act 1986, specifically subsections (1)(e) and (2) of section 123 which read:

  “(1) A company is deemed unable to pay its debts –


(e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.

(2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities”

The circumstances giving rise to a finding under (1)(e) are referred to as the “cash flow” test and (2) the “balance sheet” test. This appeal was concerned with the construction and effect of s. 123(1)(e) and 123(2) as incorporated into documents for the issue of loan notes.

Interest-bearing loan notes to the value of £660m were issued to certain companies by a special purpose entity formed by the Lehman Brothers group, Eurosail-UK 2007-3BL. Eurosail used the issue of the notes to fund the purchase of a portfolio of non-conforming mortgage loans, to the value of £650m, secured on residential property in the UK. The notes were issued in 5 principal classes in order of priority for repayment. The classes ran from ‘A’ to ‘E’ and comprise various sub-classes, the relevant subclasses being ‘A2’ and ‘A3’. In practical terms, the A2 notes were no longer to have priority to the A3 notes.

Condition 9(a) of the issue provisions specifies that in an ‘Event of Default’ an Enforcement Notice may be served by BNY Corporate Trustee Services Ltd, the Trustees. Thereafter, if the issuer (Eurosail) becomes “unable to pay its debts” as per s. 123, this would constitute an ‘Event of Default’. In the absence of such an event, the final redemption date of the lowest priority notes was in 2045. It was in these circumstances that the construction of s. 123(2) assumed such importance. In the Court of Appeal, therefore, the court considered that s. 123(2) should be interpreted broadly in line with standards of commercial probity. In the Appellant’s view, however, interpretation of s. 123 warrants a much stricter construction.

The cross-appeal, which was determined only to be relevant in the event that the appeal was successful, concerned the so-called Post-Enforcement Call Option (“PECO”) which is a part of the securitisation transaction. The image presented by the Appellant’s counsel of the ‘prudent trader working hard to turn his business around’ was considered by Lord Walker to be a far cry from the setup which fell to be analysed by the Supreme Court in these proceedings. Furthermore, Eurosail’s present financial position was not one which could result in either praise or criticism of its managers given their lack of control over three pertinent factors – the currency exchange rate, LIBOR movements or interest rate movements and the performance of the UK economy as a whole and the property market in particular. This was the wider context in which this action was to be placed.

The Judgment

The Trustees commenced proceedings to seek a determination of whether the difficulties suffered by Eurosail constituted an ‘Event of Default’ on the basis that it was unable to pay its debts within the meaning of s. 123. In delivering the lead judgment, Lord Walker stated that the enactment of s. 123 should be viewed as having made little significant change in the law. The changes in form emphasise that the “cash-flow” test is concerned with debts presently falling due and in the reasonably near future. The meaning of “reasonably near future” is fact-sensitive and will depend especially on the nature of the company’s business.

In moving beyond the “reasonably near future”, applying the “cash-flow” test would become a much more speculative procedure. The only sensible option then is to compare present assets with present and future liabilities (the latter having taken into consideration contingencies and deferred payments). This is the rationale behind the inclusion of the “balance sheet” test. Much like the test included in s. 123(1)(e), the “balance sheet” test in s. 123(2) is case-specific. Indeed, having recourse to the facts, Eurosail was not engaged in normal trading activities and it would therefore have been a better approach to look to present assets in order to assess long-term liabilities. Against this backdrop also, relevant business factors such as currency movements, interest rates and the UK economic climate should be considered. Given that the liabilities could be deferred until 2045 and given they were “cash-flow” solvent, the court therefore concluded that they could not be satisfied that there will eventually be an inability on the part of Eurosail to pay its debts.

Although not required to assess the merits of the cross-appeal, Lord Hope made some brief conclusions in relation to the PECO. He found that the PECO points in a similar direction to the transaction documentation as whole and does not affect the quantification of Eurosail’s liabilities.


The Supreme Court were evidently loathe to adopt the high standard adopted by the Court of Appeal that adopting the “balance sheet” test warranted a determination that the company had reached “the point of no return”. The court will therefore be required to assess whether the company can be reasonably expected to meet all its liabilities, looking at the company’s assets and making proper allowance for the nature of prospective and contingent liabilities. This decision is relevant not only for those in the securitization market, but also has wider ramifications for company directors and insolvency practitioners given that the balance sheet test is one of the avenues which can lead to a winding up or administrative order.

However, this is not to say that the distinction between the “balance sheet” and the “cash flow” tests has been clarified and the fact-specific nature of the court’s findings attest to the need for consideration on a case-by-case basis. That the “balance sheet” test remains “imprecise, judgment-based and fact-specific” as noted by the Court of Appeal, means that there can be no ruling out of legislative action is this area in the “reasonably near future”.