Establishing Corporate Insolvency: The Balance Sheet Insolvency Test

Cash flow and balance sheet insolvency tests are the two predominant means of determining insolvency. A company is cash flow or commercially insolvent if it is unable to pay its debts as they fall due. Balance sheet or technical insolvency occurs where the value of a company’s assets is less than the amount of its liabilities, taking into account both contingent and prospective liabilities. The term liabilities is broader than debts as it encompasses liquidated and unliquidated liabilities arising from contracts, tort, restitution etc. Commercial insolvency is clearly the more prominent of the tests. In its analysis of resolving insolvency in assessing ease of doing business in Nigeria in 2019, the World Bank Group stated the basis for insolvency proceedings in Nigeria as being inability to pay debts as they mature. This typifies a widely held misconception that technical insolvency is not recognized under Nigerian law. Establishing commercial insolvency is comparatively easier. Commercial insolvency may be established by the neglect of a debtor to pay a single due debt. In the context of restructuring, a creditor’s immediate concern is often the debtor’s ability to make payments as they mature as opposed to whether its assets are sufficient to meet its present and future liabilities. Unsurprisingly, virtually all reported cases of winding-up of companies for inability to pay debts are premised on commercial insolvency under section 409(a) of the Companies and Allied Matters Act 1990 (CAMA). Despite its seeming obscurity, balance sheet insolvency test is commonly employed in commercial transactions as an event of default. This provides counterparties with early warning signs in ongoing or long-term contracts where there are no avenues of making demands capable of triggering commercial insolvency.