BNY Corporate Trustee Services Limited and others v Neuberger Berman Europe Ltd (on behalf of Sealink Funding Ltd) and others

Section 123(1)(e) of the Insolvency Act 1986 extends beyond presently due debts to those falling due in the reasonably near future. That period depends on all the circumstances, especially the nature of the company’s business.

Beyond that horizon, cash-flow analysis becomes speculative. Section 123(2) then requires present assets to be compared with present and future liabilities, properly allowing for contingencies and deferment. It does not impose a mechanical balance-sheet test or a separate “point of no return” requirement.

The party asserting balance-sheet insolvency must prove that the company has insufficient assets to meet all its liabilities. Courts should exercise particular caution where liabilities are remote and valuations depend on inherently unpredictable variables.

Eurosail issued loan notes to fund a securitised portfolio of residential mortgages. The conditions incorporated section 123(1) and (2) of the Insolvency Act 1986 into an Event of Default. Enforcement would accelerate the notes and alter the priorities between classes of Noteholders.

A3 Noteholders contended that Eurosail was balance-sheet insolvent because its liabilities exceeded its assets. Eurosail and the A2 Noteholders disputed that conclusion. Eurosail also contended, by cross-appeal, that a post-enforcement call option reduced the liabilities to be counted because it was commercially equivalent to limited recourse.

Sir Andrew Morritt C rejected both contentions at first instance: [2010] EWHC 2005 (Ch), [2011] 1 WLR 1200. The Court of Appeal dismissed the appeal and cross-appeal: [2011] EWCA Civ 227, [2011] 1 WLR 2524. The central questions were the proper relationship between the cash-flow and balance-sheet tests and whether Eurosail’s long-term financial position satisfied section 123(2).

1. Disposition. The Supreme Court unanimously dismissed both the appeal and the cross-appeal. Lord Walker delivered the leading judgment, with which Lord Mance, Lord Sumption and Lord Carnwath agreed. Lord Hope agreed with Lord Walker’s reasons and gave separate reasons concerning the post-enforcement call option.
2. Relationship between the statutory tests. Section 123(1)(e) of the Insolvency Act 1986 is not a true deeming provision based on proof of a single default. It examines the company’s ability to pay all its debts as they fall due. That inquiry includes debts falling due in the reasonably near future, whose length depends on the circumstances and particularly on the nature of the business. Once the inquiry moves beyond that horizon, cash-flow analysis becomes speculative. The sensible approach is then to compare present assets with present and future liabilities, discounted for contingency and deferment.
3. Section 123(2). Balance-sheet insolvency is not established merely by showing that the aggregate face value of liabilities exceeds the value of assets. The court must decide whether, after proper allowance for contingent and prospective liabilities, the company cannot reasonably be expected to meet them. The burden lies on the party asserting insolvency. Lord Walker rejected “the point of no return” as a separate statutory test. At most, that expression illuminates the policy of protecting later creditors from an incurable deficiency.
4. Application. Eurosail’s liabilities could largely be deferred until 2045. The transaction contained mechanisms for deferring principal and interest, while the ultimate result depended on unpredictable currency movements, interest rates, mortgage performance and the housing market. Those matters were incapable of confident prediction over more than 30 years. The court could not be satisfied, on the balance of probabilities, that an eventual deficiency would arise.
5. Post-enforcement call option. Although the issue no longer required determination after dismissal of the principal appeal, the court dismissed the cross-appeal because of its market significance. Lord Hope explained that the option did not reduce Eurosail’s liabilities when applying section 123(2) through the default condition. Before enforcement, the Noteholders retained full-recourse claims. Exercise of the option merely assigned those claims to the option holder; it did not release Eurosail. Commercial good sense could assist in choosing between available contractual meanings, but could not replace the parties’ unambiguous language with a limited-recourse arrangement they had not made.

1. United Kingdom Supreme Court — In [2013] UKSC 28, the court unanimously dismissed the A3 Noteholders’ appeal and Eurosail’s cross-appeal.
2. Court of Appeal — In [2011] EWCA Civ 227, [2011] 1 WLR 2524, the court upheld the conclusion that section 123(2) had not been satisfied and dismissed both the appeal and the cross-appeal.
3. High Court, Chancery Division — In [2010] EWHC 2005 (Ch), [2011] 1 WLR 1200, Sir Andrew Morritt C held that Eurosail had not been shown to be balance-sheet insolvent and that the post-enforcement call option did not reduce its liabilities.