For what seems to be a relatively easy concept, the meaning of 'insolvency' has proven to be a surprisingly contentious issue for the courts over the years. This is important because when insolvency occurs, the courts can seek to overturn transactions which are deemed to be to the detriment of creditors.
In a guideline decision, the Court of Appeal has ruled that a property investment company that relied upon the inflow of new money, whilst building up long-term debts, was insolvent both on a balance sheet and cash flow basis.
The company specialised in introducing clients to property in Dubai. It operated no client account and investors' money was mixed in with its own cash. That practice had prompted an accountant to express the view that the company had treated many millions of pounds of clients' money as its own.
Following the collapse of the Dubai property market in 2008, the company went into insolvent liquidation with sums owed to investors estimated at up to £1.05 million. In the course of the preceding two years, the company had paid sums totalling more than £100,000 to its company secretary. It was ultimately not disputed that those payments were made in connection with transactions at an undervalue.
The company's liquidators sought recovery of those sums and an issue therefore arose as to whether the company was insolvent within the meaning of Section 123 of the Insolvency Act 1986 when the payments were made. A judge had initially ruled against the liquidators on the basis that the company had not at that stage passed 'the point of no return'; however, that decision was later reversed by the High Court.
In dismissing the company secretary's appeal against the latter decision, the Court of Appeal emphasised that there was no suggestion that the company was a Ponzi scheme. However, the reality was that it had relied upon the continued inflow of investors' money to maintain its cash flow whilst going deeper and deeper into long-term debt.
In any commercial sense, the company was insolvent in that, despite its apparently healthy cash flow, it would have been unable to cover all its liabilities had it ceased trading. In those circumstances, it could not be said that the company was able to pay its debts when they fell due or that the value of its assets was greater than the amount of its liabilities. The company secretary had therefore failed to rebut the presumption that the monies paid to her were recoverable by the liquidators.
For advice on the proper segregation of client funds or any matter related to solvency or corporate governance generally, please contact Leanne Schneider-Rose on 0121 698 2200, email l.schneider-rose@sydneymitchell.co.uk or fill in our online enquiry form.
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