UK: UK Corporate Update – Recent Cases Of Interest - June 2013

This corporate update summarises certain decisions in the Court of Appeal and the Supreme Court relating to the balance sheet insolvency test, agreements to agree and the exercise of contractual discretion. The decisions clarify the law in a number of areas of day-to-day relevance.

UK BALANCE SHEET INSOLVENCY TEST: Implications for lenders and borrowers


The balance sheet insolvency test set out in s.123(2) Insolvency Act 1986 ("IA") is an important element of English insolvency law, with a significant impact on matters such as directors' duties, directors' disqualification, and administration and insolvency procedures. The balance sheet test set out in s.123(2) IA is as follows:

"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."

The recent decision of the Supreme Court in BNY Corporate Trustee Services Ltd and others v Eurosail-UK 2007-3BL Plc and others provides guidance on the way the test should be interpreted and rejects the view that the test involves considering whether a company has reached "the point of no return" as suggested by the Court of Appeal.

Eurosail was a special purpose vehicle established in 2007 as part of the Lehman Brothers group to acquire a portfolio of some Ł650 million mortgage-backed loans relating to UK properties. The acquisition was funded by the issue to investors of various classes of notes, with different priorities and in different currencies, with a final redemption date of 2045 for the lowest priority notes. Eurosail's position in relation to its exposure under the notes was hedged by various currency and interest rate swaps with another entity in the Lehman group, which were terminated following the collapse of Lehman Brothers in 2008. The fall in the value of sterling against the dollar after 2008 meant that a shortfall between Eurosail's assets and liabilities emerged. However, the company did not experience cash flow problems because the interest payments received from the underlying mortgages were greater than the interest payable under the notes.

A class of noteholders (the A3 class) asked the trustee representing the noteholders to serve an enforcement notice on the basis that Eurosail was unable to pay its debts as they fell due in accordance with s.123(2) IA. The effect of this would have been to change the priority of payments and enforcement by bringing all the A class noteholders into one group, ranking equally among themselves for repayment.

Otherwise, the A2 noteholders would have priority to the other A class noteholders in relation to payments of principal from mortgage redemptions in the underlying portfolio.

The transaction documents had also provided for a post-enforcement call option (PECO) the terms of which obliged the noteholders to transfer the notes to the option holder (an associate of the issuer) with the intention that the liabilities under the notes would be forgiven by the option holder. The effect of this was that the issuer would not be regarded as unable to pay its debts.


The Supreme Court upheld the decision of both the High Court and the Court of Appeal in finding that the balance sheet insolvency test is not simply an accounting exercise, and that Eurosail could not be regarded as balance sheet insolvent under s.123(2) IA.

The judgments of both the High Court and the Court of Appeal emphasised that the balance sheet test should not be applied simply by aggregating a company's assets and liabilities. They were particularly aware of the adverse consequences of applying such a literal approach to a whole range of companies including those, like Eurosail, with non-trading businesses, and others with cyclical businesses. The Supreme Court held that in deciding whether a company is "balance sheet insolvent" the Court must decide whether, on the balance of probabilities, and considering the company's assets, as well as its prospective and contingent liabilities, it cannot reasonably be expected to meet those liabilities. In the case of Eurosail there were too many uncertain factors to say whether or not in 2045, when its final obligations matured, the company would be able to meet them. As a result it could not be considered balance sheet insolvent.

The Court also considered the "cash flow" test for insolvency, even though it was not directly relevant to the case. This is set out in s.123(1)(e) IA, 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". It approved a decision of the High Court holding that the cash flow test is not simply a picture of current debts due, but should also take account of debts falling due from time to time in the reasonably near future. What counts as the "reasonably near future" will depend on the company's business.

Finally, it was also decided (although the comments were not central to the decision) that for the purposes of assessing assets and liabilities in order to apply the balance sheet insolvency test, the PECO was not relevant. This is helpful as PECOs are commonly used in securitisations.


This case provides useful guidance on a number of important issues in relation to the balance sheet and cash flow tests for insolvency. The outcome of applying the test is necessarily fact specific and the case makes it clear that neither test can be characterised precisely. In particular, it becomes more difficult to state that a company fails the "balance sheet test", as the dates on which the various liabilities to be taken account of become due further into the future.

AGREEMENTS TO AGREE: Guidance from the Court Of Appeal


Under English law "agreements to agree" are unenforceable, but it is also clear that parties may agree to be contractually bound, but defer dealing with significant matters arising under the contract until later.

The important issue is how to distinguish an unenforceable agreement from one which is enforceable, and this issue has recently been considered by the Court of Appeal in MRI Trading AG v Erdenet Mining Corp.

This case involved the sale of copper concentrates by Erdenet to a Swiss company, MRI Trading. A dispute arising about a contract originally entered into in 2005 was referred to arbitration, which resulted in the parties entering into a settlement agreement under which the original contract was terminated and new sale and purchase contracts entered into in 2010. Two of these contracts were performed, but Erdenet failed to supply certain goods as required under the 2010 contract. When the dispute regarding this failure was referred to arbitration, EMC argued that it was not under an enforceable obligation because of the "agreement to agree" provision in the third contract, which provided for the parties to agree on the shipping schedule and on some refinement and treatment charges. An arbitration panel accepted this argument, but MRI's appeal to the High Court was successful and the Court of Appeal has upheld that decision.


The Court of Appeal (applying existing case law) held that where a contract is incomplete or uncertain, it may nevertheless be capable of being enforced by looking at the wider context of the relationship between the parties. In these particular circumstances the court could imply a term to the effect that, in default of an express agreement on the relevant matters, the parties would adopt reasonable terms allowing the contract to be performed.

The key question was whether the parties intended that the contract would continue to be enforceable even if agreement on the outstanding points was not achieved. In this instance, the Court found that was the case, and that interpretation of the relevant provisions showed that the parties' intention had been that the matters to be agreed upon in the future were to be determined by the imposition of objective terms of fairness or reasonableness (in default of agreement on specific terms). The 2010 contact was an integral part of an overall deal under which both parties had derived benefits, a deal which they had worked through together for over a year without any suggestion that the final part "fell in to a different and unenforceable category of obligation".

The language used by the parties in both the settlement agreement and the 2010 contract reflected this. This led to the conclusion that it was "almost implausible" to attribute to the parties an intention not to conclude a binding agreement, particularly since the agreement was part of an overall transaction settling the earlier dispute.


Although this case follows existing law and does not establish new principles in this area, it is a useful reminder that the courts are reluctant to hold agreements unenforceable where it appears from the agreement itself that the parties intended to create a legally enforceable relationship at the time they entered into it. Two matters were particular pointers to enforceability in this case. The first was that there had already been part performance of the arrangements between the parties, and the second was that the parties had stipulated for the arbitration of disputes by a market tribunal. Accordingly, in these circumstances, the court was willing to imply such terms as were required to enable the contract to be enforceable.

Despite this case, parties requiring flexible (but legally enforceable) future arrangements should still set out as clearly as possible the machinery for settling such outstanding matters.

INTERPRETATION OF CONTRACTS: Exercise of contractual discretion and other contractual interpretation


In a recent case, Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd, the Court of Appeal considered some difficult issues of contractual interpretation.

The case concerned a catering contract entered into between the Trust and Compass in 2008. The contract allowed the Trust to award itself deductions from the payments due under the contract and to award itself points for failure in service which were relevant to its rights to terminate the contract. In July 2009, the Trust purported to terminate the contract on the basis of a provision which allowed termination in the event that the relevant number of points for service failure had been exceeded. Compass responded by asking the Trust to repay certain deductions it had made under the contract, and to correct some of the data that the Trust had used in making the deductions.

In September 2009, Compass also purported to bring the contract to an end on the basis that the Trust had committed a material breach of the contract in failing to correct the data used by it in making some of the payment deductions. The following month, the Trust withdrew the notice of termination which it had given in July, and issued a new one relying on the same provision. The parties agreed that the contract should end, but both argued that they had terminated it on valid grounds.

In the subsequent High Court action Compass claimed damages for breach of contract and the Trust also claimed for damages (on the basis that its own termination of the contract was the valid one).


In the High Court, the judge found that, since both parties had a valid right to bring the contract to an end, neither of them could succeed in a claim for damages.

The Trust appealed to the Court of Appeal, which considered a number of issues relating to interpretation of the contract. There were three particular issues which are worthy of note.

Exercise of discretion: The contract gave the Trust discretion to make payment deductions where Compass' performance did not meet the required standard. The Court of Appeal decided that there was not an implied term that the Trust would not exercise its discretion in an "arbitrary, capricious or irrational" way: the cases where such a term had been implied were ones where the discretion involved choosing from a range of options, rather than a simple decision whether or not to exercise a contractual right.

Duty to co-operate in good faith: Under the contract, the parties were obliged to co-operate with each other in good faith, and to take all reasonable action required for the efficient transmission of information and instructions, to allow the Trust to derive the full benefit of the contract. The Court of Appeal rejected Compass' argument that this duty was a general one applying to all the obligations of the parties where they interacted under the contract. It held instead that the obligation was limited to the relevant clause, and only applied for the two purposes stated in that clause.

The Court underlined that no general duty of good faith exists under English law, and that where such a duty is imposed by contract its scope is a matter of interpretation and is defined by its contractual context. In this case the Trust's behaviour in awarding itself (excessive) service failure points and payment deductions did not breach the obligation to co-operate in good faith because the "good faith" clause related solely to the provision of information etc. (and because the Trust was not acting dishonestly).

Material breach of contract: Although the Trust's behaviour in relation to its excessive payment deductions and service point failures did not breach the good faith clause, it did breach other provisions of the contract. However, the Trust had cured the breaches relating to the payment deductions by repaying the sums involved before Compass gave notice of termination. The Court held that the remaining breach, relating to excessive service point failures, was not a material one. As a matter of interpretation of the contract, the Court found that a breach did not have to be so serious as to amount to a repudiatory breach in order to be "material", although it did have to be a serious matter, not one that was trivial. It followed that since the Trust was not in material breach of the contract, Compass' termination alleging material breach was wrongful. By contrast, the Trust's termination of the contract when Compass had exceeded its termination points threshold was something it was entitled to do, and was a valid termination.


While the findings on material breach and good faith are of interest, the most important aspect of the case is arguably the guidance on when and whether a court will imply a term not to act arbitrarily, capriciously or irrationally, and it now seems that such a term will not normally be implied where a contract party has a simple discretion as to whether to exercise a right or not (as opposed to a situation where it has the right to exercise its discretion in a variety of ways).

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.