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New Solvency Test

This article was written by Paul Wilson.

Introduction

Some of the changes made to the Jersey Companies Law ("Law") on 1 February 2006 were of much significance. This briefing will consider one of those changes - the introduction of a new solvency test.

The Law requires the directors of a Jersey incorporated company to confirm the company’s solvency before undertaking certain corporate actions, such as:

  1. a distribution of assets to the company’s members, whether this relates to a payment of dividends, the redeeming of shares, a buy back of shares by the company, or the provision of financial assistance by the company to those purchasing shares in the company; or

  2. the migration of the company to another jurisdiction (and the Law also requires the directors of a non-Jersey company to give a confirmation of solvency if it is looking to migrate the company to Jersey); or

  3. the merger of the company with one or more other companies; or

  4. the summary winding up of the company.

This confirmation is commonly referred to as the solvency test and it is the precise wording of the confirmation that changed on 1 February 2006 insofar as it relates to a distribution of assets to the company’s members.

Reasons for the change

The change attempted to achieve two things:

  1. to do away with the solvency test that required directors to assess the solvency of the company on both a balance sheet and cash flow basis in favour of a test based purely on cash flow; and

  2. to standardise the solvency tests for the various different types of distribution.
The change

Following the change the Law requires the directors to confirm, before proceeding with the proposed action:

"[that] having made full enquiry

[emphasis added] into the affairs and prospects of the company [they] have formed the opinion:

(a) that, immediately following [the proposed transaction], the company will be able to discharge its liabilities as they fall due; and

(b) that, having regard to the prospects of the company and to the intentions of the directors with respect to the management of the company’s business and to the amount and character of the financial resources that will in their view be available to the company, the company will be able to continue to carry on business and will be able to discharge its liabilities as they fall due [for a period of one year following the proposed action (or, if earlier, up until when the company is summarily wound up)]"
Problem

Whilst the reasons for the change were laudable, there is a notable problem as the new solvency test requires, among other things, for the directors to make "full enquiry into the affairs and prospects of the company".

This requirement for "full enquiry" is more onerous than the previous solvency test to the extent that it has ‘raised the bar’ as regards the degree of investigation that the directors need to carry out before giving the confirmation. In the minds of many, including the writer of this briefing, this "full enquiry" element means that directors would be well advised in many (if not most) cases to have company accounts prepared, and then considered, before giving the confirmation. In other words, how can a director be said to have made "full enquiry" if he has not reviewed up to date accounts?

Further changes

In April 2006 a consultation paper was issued by the States of Jersey proposing further changes to the Law. (A separate briefing on these proposed changes has been produced.)

Happily, this paper accepts that the "full enquiry" requirement is too demanding and so is proposing that the words "having made full enquiry into the affairs and prospects of the company" are simply removed from the solvency test. The directors will be guilty of an offence if they then give a confirmation "without having reasonable grounds" for having done so.

This paper is also proposing that the prohibition on a company providing financial assistance to its members with regard to the purchase of its shares is removed. If this occurs, companies will no longer need to legitimise the giving of financial assistance by following the convoluted ‘whitewash’ procedure which has, at its core, a solvency test.

Update

This briefing will be updated as and when we have substantive news relating to the passage of the proposed changes to the Law.

Crill Canavan Solicitors & Advocates, All Rights Reserved.