(Court of Appeal, Sullivan, McFarlane and
Lewison LJJ, 03 April 2014)
A company which could only pay its debts as they
fell due by going deeper and deeper into long term debt was insolvent
In an action under s 238 of the Insolvency
Act, Mrs. Bucci, company secretary and wife of the director, sought to rebut
the presumption of insolvency in s 240(2) that at the time of the payments
to her, Casa Estates Limited (‘CEL’) was unable to pay its debts as they fell
CEL introduced property investors to Dubai, through Casa Dubai Ltd (‘CDL’) in Dubai. It appeared that CEL paid CDL a
monthly retainer of £10,000 and CDL agreed to pay CEL 6% commission on sales.
CEL passed investors’ moneys to CDL who was in turn to pass them to the
developer. CDL set off the sums it was due to pay CEL against the investors’
money it was to receive from CEL and would pay the withheld money to the
developers in Dubai,
with CEL transmitting any shortfall in payments due to developers. This meant
that money only flowed from CEL to CDL and not vice versa, and no profits were
remitted from CDL back to CEL.
CEL did not maintain a client account, but mixed
depositor’s monies with its own. Its accounting systems did not enable
depositor’s monies to be accurately identified. When CEL received customer
deposits it had an obligation to account to the customer for those deposits,
which was a liability to those customers until such time as the deposits were
correctly applied towards the purchase of property in Dubai by payment to the developers.
At the time payments were made to Mrs. Bucci,
CEL was marginally insolvent on a balance sheet test. CEL had recorded as an
asset a loan to another connected company, Gianluca (UK) Lt (GUL), but there
was no real prospect of CEL ever recovering this loan since GUL was loss making
from the start.
At first instance, HHJ Purle QC held that CEL
had been cash flow solvent because there was no suggestion that any creditor
had served a statutory demand or obtained a judgment against CEL, there was no
creditor pressure and CEL was in fact paying its debts as they fell due. It had
no cash flow problems at the time that it made payments to Mrs Bucci, these
only arose after the collapse of the Dubai
property market in late 2008 and it was not until that point that CEL reached
the “Point of no return” (the phrase which had been applied by the Court of
Appeal in Eurosail).
The decision was appealed and by the time Warren
J gave his decision on appeal the Supreme Court had considered the appeal in Eurosail and held that “the point of no
return” test was not the appropriate test (see  UKSC 28). He considered
that the continued payment of debts was only possible because new deposits from
investors were used to pay old debts, and there was no material upon which it
could be said that, if no significant value was attributed to the GUL loan, CEL
would be able to meet its liabilities.
On appeal by Mrs Bucci to the Court of Appeal,
Lewison LJ (with whom McFarlane LJ an Sullivan LJ agreed) considered the proper
test to be applied following Eurosail
and Cheyne Finance (paras 27 and 28
). The cash-flow test and balance sheet test stand side by side and the balance
sheet test is not excluded simply because the company is in fact able to pay
its debts as they fall due. The two tests are part of a single exercise to
determine whether a company is unable to pay its debts.
When applying the cash-flow test it is not
enough for the court merely to ask whether the company is for the time being
able to pay its debts as they fall due. In an appropriate case it must inquire
how it was managing to do so. If a company is only able to pay its debts by
borrowing new money (taking deposits from new investors) to pay off old debts,
then unless it is able to trade out of insolvency, it is insolvent whether on a
cash-flow or balance sheet test. Further, as a trading company CEL was
insolvent on a balance sheet basis, as the loan to GUL was of no value. While
that in itself may not be a conclusive answer to the question whether CEL was
insolvent, it is difficult to see how it could not lead to that conclusion in
the case of a trading company unless there was credible evidence that the
balance sheet would improve in the near future.
There was no underlying material to substantiate
the claim that CDL’s assets exceeded the amount owed by CEL to depositors. The
inference was that CEL had used investors’ deposits for its own ends and so was
using new deposits to pay old deposits.
Lewison LJ also emphasised
that, where the statutory presumption of insolvency applies, if the judge is
not in a position upon the evidence to make a finding of solvency, or not in a
position to make findings about one or more of the building blocks in the case
that the company was solvent, the presumption prevails.