Isle of Man: The Isle Of Man Insolvency Test - Is It Time For Reform?

Last Updated: 12 June 2013
Article by Michelle Hotchkiss

With the Companies Bill 2013, which plans to consolidate and update the Isle of Man Companies Acts 1931- 2004 (the 1931 Act) and a proposed new Insolvency Bill in the offing, the time is ripe for reform of the Isle of Man corporate insolvency test, found at section 163(1) of the 1931 Act (and applying irrespective of whether a company is incorporated under the 1931 Act or the Isle of Man Companies Act 2006 (the 2006 Act)).

A company is considered to be insolvent when it is unable to pay its debts. There are a number of tests for determining when a company is unable to pay its debts and it may be surprising to learn that the Isle of Man test differs from the current insolvency test in England.

In the Isle of Man, a company is deemed unable to pay its debts if it is proved to the satisfaction of the court that the company is unable to pay its debts and, in determining whether a company is unable to pay its debts, the court is required to take into account the contingent and prospective liabilities of the company.

In England, there are two primary tests, (i) the cash flow test, found at section 123(1)(e) of the Insolvency Act 1986 (the UK Insolvency Act), which provides that a company is deemed unable to pay its debts if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due and (ii) the balance sheet test, found at section 123(2) of the UK Insolvency Act, which provides that a company is deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

Generally speaking, the "cash flow test" focuses on cash and determines whether a company can pay its debts when they fall due. The "balance sheet test" is a little more complex as it looks at whether, on the balance of probabilities, the company's assets are sufficient to discharge all its liabilities, including its contingent and prospective liabilities (see Lord Walker in BNY Corporate Trustee Services Limited and others v Eurosail-UK 2007-3BL PLC [2013] UKSC 28 (Eurosail) para 48). In the Isle of Man, by asking the court to 'take into account the contingent and prospective liabilities of the company' the test goes further than the English cash flow test, but falls short of the full balance sheet test. It essentially cuts across the two current English tests and reflects the position in England prior to the enactment of the UK Insolvency Act and, its predecessor, the Insolvency Act 1985. There is undoubtedly uncertainty regarding the interpretation of the Isle of Man test, particularly as to the degree that future liabilities should be taken into account in determining solvency.

For an interpretation as to the meaning of the current Isle of Man insolvency test it is necessary to look to English case law prior to 1985, which is sparse given that it is based on now defunct law. This factor alone is relevant in considering the need for reforming the insolvency test in the Isle of Man, but it is also helpful to consider the reasons for the evolution of the test in England.

The position in England mirrored the current position in the Isle of Man until 1985 when, with the enactment of the Insolvency Act 1985, a separate cash flow and balance sheet test emerged (such tests are now embodied in the UK Insolvency Act). Whilst interpretation of the English insolvency tests is fact and circumstances specific, with case law continuing to provide guidance (see, for example, the Supreme Court's recent decision in Eurosail), it is argued that the balance sheet test is important to protect creditors whose debts are due in the future and that the dual test of inability to pay debts is necessary to successfully balance the interests of immediate and future creditors.

Whilst it is recognised that the position in England is not clear cut, many jurisdictions are now opting to adopt a definition of inability to pay debts, which encompasses both a cash flow and a balance sheet test, such as the BVI and Guernsey. However, it is not uncommon for jurisdictions to have a simple cash flow test, as the Cayman Islands have chosen to do.

Appleby (Isle of Man) LLC is currently assisting with the drafting of a new Insolvency Bill, which will serve to reform the Isle of Man insolvency test. It is understood that it is likely that we will follow the current position in England and adopt both a cash flow and a balance sheet test. Indeed, a dual test is not an altogether alien concept in the Isle of Man given that the 'solvency test' in the 2006 Act already adopts this approach. The dual test of inability to pay debts is aimed at providing better protection for creditors, which should offer comfort is these uncertain times. Further, by replicating the English tests, practitioners will benefit from the wealth of English and Commonwealth case law, which will assist the interpretation of the legislation and be persuasive on the Manx courts. In all, the proposed reform is welcome and we look forward to the enactment of this legislation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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