“Solvency and Liquidity” test in terms of the Companies Act No. 71 of 2008

Section 22 (1) (b) of the Companies Act No. 71 of 2008 (“Act“) prohibits a company from trading in insolvent circumstances. The transactions that will require that the solvency and liquidity test be satisfied include:

  • the provision of financial assistance to third parties for the acquisition of the company’s own
    shares (section 44);
  • loans or other financial assistance (Section 38 in the current Act) to related parties, including subsidiary companies, holding companies and directors (section 45);
  • dividends or other “distributions” (as defined in section 1) to shareholders (section 46);
  • the issuing of capitalisation shares on terms whereby the recipient can choose whether to take the shares or to take cash (section 47);
  • share buy-backs – in other words, where the company buys back its own shares (section 48); and
  • an amalgamation or merger with another company (section 113).

The test to be applied:

(1) For any purpose of this Act, a company satisfies the solvency and liquidity test at a particular time if, considering all reasonably foreseeable financial circumstances of the company at that time –

(a) the assets of the company or, in the case of a holding company, the consolidated assets of the company, as fairly valued, equal or exceed the liabilities of the company or, in the case of a holding company, the consolidated liabilities of the company, as fairly valued; and
(b) it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of –

(i) 12 months after the date on which the test is considered; or
(ii) in the case of a distribution contemplated in paragraph (a) of the definition of distribution’ in section 1, 12 months following that distribution.”

The board or any other person applying the solvency and liquidity test to a company must consider a fair valuation of the company’s assets and liabilities, including any reasonably foreseeable contingent assets and liabilities, irrespective of whether or not arising as a result of the proposed distribution, or otherwise and may consider any other valuation of the company’s assets and liabilities that is reasonable in the circumstances and unless the Memorandum of Incorporation of the company provides otherwise, a person applying the test in respect of a distribution is not to be regarded as a liability any amount that would be required, if the company were to be liquidated at the time of the distribution, to satisfy the preferential rights upon liquidation of shareholders whose preferential rights upon liquidation are superior to the preferential rights upon liquidation of those receiving the distribution.

The consequence(s):

A director of a company is liable for any loss, damages or costs sustained by the company  as a direct or indirect consequence of the director having, inter alia:

  • acquiesced in the carrying on the company’s business despite knowing that it was being conducted in a manner prohibited by section 22 (1); and/or
  • been a party to an act or omission by the company despite knowing that the act or omission was calculated to defraud a creditor, employee or shareholder of the company, or had another fraudulent purpose.

The agreement entered into with a third party is voidable and can be declared void by a court of law. Financiers of Companies must consider to updating credit policies to obtain a solvency and liquidity declaration from all companies in all circumstances.

 Watch the news on this !!!

10 March 2011