poundsOn 9 May 2013 the Supreme Court unanimously dismissed the appeal and cross-appeal in BNY Corporate Trustee Services Ltd & Ors v Neuberger Berman Europe Ltd & Ors; BNY Corporate Trustees Services Ltd & Ors v Eurosail-IK 2007-3BL PLC [2013] UKSC 28. The case concerned the meaning of the ‘balance-sheet test’ for insolvency under the Insolvency Act 1986, s 123(2) as incorporated into the documentation of an issue of loan notes.  It concluded that when considering whether a company is unable to pay its debts because the “value of the company’s assets is less than the amount of its liabilities taking into account its contingent and prospective liabilities”, there must be a detailed consideration of a company’s position, and the court cannot be satisfied simply because the aggregate value of its liabilities exceeds the value of its assets.


In 2007, Eurosail (the “Issuer”) issued loan notes (the “Notes”) to enable it to acquire a portfolio of sub-prime mortgage loans secured on residential property in the United Kingdom. These Notes were in five principal classes (A, B, C, D and E) comprising 14 different subclasses (A1, A2, A3 etc.), some denominated in sterling, some in US dollars and some in euros. All of the underlying mortgage loans were in sterling.  The most senior Notes, class A1, had already been repaid, but – in the absence of an “Event of Default” – the other notes were not repayable until 2045 at the latest.

On the occurrence of an Event of Default, condition 9(a) of the Notes provided that the trustee of the noteholders (the “Trustee”) could serve on the Issuer a written notice declaring the Notes to be due and repayable (an “Enforcement Notice”). The service of an Enforcement Notice would have significant consequences for the A2 and A3 noteholders. Under the original conditions of the Notes, A2 and A3 noteholders ranked pari passu for interest payments, but A2 noteholders had priority over A3 noteholders for the repayment of principal. However, if an Enforcement Notice was served, the A3 and A2 noteholders would rank pari passu for the repayment of principal as well.

The terms of the Notes provided that it was an Event of Default for the Issuer to be deemed unable to pay its debts under s123 1986 Act.  Section 123 provides that a company is deemed unable to pay its debts either if it is unable to pay those debts as they fall due (the ‘cash-flow test’, s 123(1) of the 1986 Act) or if the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities (the ‘balance-sheet test’, s 123(2) of the 1986 Act).

In order to reduce its exposure to currency fluctuations (because of the currency difference between the Notes and the mortgage loans), the Issuer entered into currency swap agreements with a Lehman Brothers’ group entity. With the collapse of Lehman Brothers in 2008, the currency swap agreements were terminated. This left the Issuer unprotected against currency and interest rate fluctuations and caused a significant deficit in the Issuer’s net asset position, although it did continue to pay its debts.

The A3 noteholders therefore claimed that there had been an Event of Default, on the basis of the balance-sheet test under s 123(2) of the 1986 Act.  The A3 noteholders requested that the Trustee serve an Enforcement Notice, which would cause them to rank pari passu with the A2 noteholders for the repayment of principal as well as for interest. The Trustee applied to the court for directions, adopting a neutral position.  The Issuer, A2 and A3 noteholders were all parties to the action.

The terms and conditions of the Notes also included a post-enforcement call option (“PECO”). This PECO entitled an associate company to purchase all the Notes for a nominal price, if security for the notes was enforced. This PECO was included in order to ensure the Issuer was considered ‘insolvency remote’ by the ratings agencies, resulting in a higher credit rating for the Notes. The A2 noteholders argued that, in the event that the Issuer was otherwise deemed unable to pay its debts under s 123(2) of the 1986 Act, the effect of the PECO would offset that position.

Decision of the High Court and Court of Appeal

The Issuer and A2 noteholders argued that s 123(2) should be interpreted broadly and in line with standards of commercial probity.  The A3 noteholders adopted a much stricter construction, emphasising that a company’s inability to pay its debts is no more than a precondition to the exercise of the court’s jurisdiction (which is discretionary) to make a winding up order or an administrative order.  They argued that this precondition should be transparent and certain, leaving scope for the exercise of discretion on the hearing of the petition.

Finding for the Issuer and A2 noteholders, the High Court and Court of Appeal held that the Issuer was not unable to pay its debts within the meaning of s 123(2) of the 1986 Act, and therefore there was no Event of Default.  The A3 noteholders appealed to the Supreme Court on the construction of s 123(2) of the 1986 Act. There was also a cross-appeal by the Issuer against the decision that the PECO would not have prevented the Issuer from being deemed unable to pay its debts under this section of the Act.

Decision of the Supreme Court

The Supreme Court unanimously upheld the Court of Appeal’s decision and dismissed both the appeal and the cross-appeal. However, whilst reaching the same conclusion on the construction of s 123(2) of the 1986 Act, the Supreme Court’s reasoning departed from that of the Court below.

The Court of Appeal had concluded that the thrust of the balance-sheet test under s 123(2) of the 1986 Act was to decide whether a company had “reached the end of the road”. The Supreme Court disagreed and held that the ‘point of no return test’ was not the correct test. Instead, the balance-sheet test was seen as a comparison of present assets with present and future liabilities, discounted for contingencies and deferment of payments. The balance-sheet test was not an exact science, so the burden of proof must be on the party which asserts balance-sheet insolvency. Although the Supreme Court rejected the Court of Appeal’s version of the balance-sheet test, the Supreme Court held that the Court of Appeal would have reached the same conclusion without reference to any ‘point of no return test’.

In these circumstances, the Issuer could not be considered to be balance-sheet insolvent under s 123(2) of the 1986 Act. As the Issuer was not engaged in normal, on-going trading, its present assets should be used as a guide to its ability to meet its long term liabilities. These should be considered against three “imponderable” factors outside the Issuer’s control: currency movements, interest rates and the UK economy and housing market. These would determine if the Issuer could meet its long-term liabilities, but were a matter of “speculation rather than calculation”. As the final redemption date was 2045, over 30 years in the future, and the Issuer was paying its debts as they fell due, the Court said it should be cautious in deciding that the Issuer was balance-sheet insolvent. As the Issuer’s ability to pay its debts would not be determined until closer to the final redemption date, at that time the Court could not be satisfied that there would eventually be a deficiency.

Although the effect of the PECO was no longer directly relevant, this question was still considered, obiter, as PECOs are widely used in securitisation transactions and so the question is important to the securitisation market generally. The Supreme Court agreed with both the High Court and the Court of Appeal that the PECO had no effect on the amount of the Issuer’s liabilities. In opposition to the Issuer’s argument that legal form should not triumph over commercial substance, Lord Hope considered that both the legal and the commercial effect of the PECO “point in the same direction”.


The Supreme Court’s judgment makes clear that the balance-sheet insolvency test under s 123(2) of the 1986 Act is not a ‘point of no return test’, but requires detailed consideration of a company’s assets and liabilities (including prospective and contingent liabilities). Accordingly, even where a company’s liabilities clearly exceed the company’s assets on the face of the balance-sheet, s 123(2) will not necessarily be satisfied.

However, there are unanswered questions. The specific situation of the Issuer, which the Supreme Court described as a ‘closed business’ differs greatly from the majority of businesses and the balance-sheet test itself is very dependent on the specific circumstances of the case, leaving uncertainty as to its application.

The Supreme Court’s comments on the effect of the PECO may also be significant. As the judgment demonstrates that an issuer may not rely on a PECO to genuinely limit its liability to noteholders, this may reduce an issuer’s ability to establish that it is insolvency remote, and therefore may affect its credit rating.