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

The Supreme Court dismissed the appeal and cross-appeal. The court analysed the meaning and interaction of section 123(1)(e) and section 123(2) of the Insolvency Act 1986 as incorporated into the loan note Conditions and confirmed that the statutory tests for inability to pay are to be applied with caution and in light of the particular commercial and documentary context.

The court reiterated that section 123(1)(e) embodies the cash-flow test (inability to pay debts "as they fall due") which looks to the reasonably near future, whereas section 123(2) embodies a balance-sheet enquiry requiring the court to take account of contingent and prospective liabilities. The burden of proof of balance-sheet insolvency rests on the party asserting it.

Applying those principles, the court held that the complex securitisation documentation contained mechanisms (deferred payment regimes, liquidity facility, principal deficiency ledger and related provisions) that reasonably deferred Eurosail's liabilities until the long-dated final redemption and that the evidence did not establish, on the balance of probabilities, that Eurosail was balance-sheet insolvent. The court also held that the Post-Enforcement Call Option (PECO) did not, as a matter of legal construction, reduce Eurosail's liabilities for the purposes of Condition 9(a)(iii) until and unless the option holder released the issuer; commercial reality did not displace the documents' legal effect.

Background and parties: Eurosail-UK 2007-3BL plc ("Eurosail") issued secured loan notes in 2007 in a securitisation of non-conforming UK residential mortgages. BNY Corporate Trustee Services Ltd acted as trustee for the Noteholders. A group of A3 Noteholders (appellants) contended that Eurosail was unable to pay its debts under Condition 9(a)(iii), which incorporated section 123(1)(e) and section 123(2) of the Insolvency Act 1986, and sought declaration that an Event of Default had occurred so that the Trustee might serve an Enforcement Notice. There was a cross-appeal on the effect of a Post-Enforcement Call Option (PECO).

Procedural history: The Chancellor (Sir Andrew Morritt C) dismissed the claim at first instance [2010] EWHC 2005 (Ch); the Court of Appeal ([2011] EWCA Civ 227) dismissed the appeal; the matter came to the Supreme Court on appeal.

Nature of the claim / relief sought: The appellants sought a finding that Eurosail was unable to pay its debts for the purposes of Condition 9(a)(iii) so as to enable an Enforcement Notice and the shift to the post-enforcement payment waterfall; the cross-appeal concerned whether the PECO altered Eurosail's liabilities for that purpose.

Issues framed:

• How to construe section 123(1)(e) and section 123(2) of the Insolvency Act 1986, particularly their interaction and application when incorporated into contractual Events of Default;
• Whether, on the evidence and in the context of the transaction documents, Eurosail was balance-sheet insolvent under section 123(2); and
• Whether the PECO affected the legal quantification of Eurosail's liabilities for the purposes of Condition 9(a)(iii).

Court’s reasoning and conclusions: The court explained that section 123(1)(e) (cash-flow test) looks to a company's ability to meet debts "as they fall due" and may require inquiry into near-future obligations; section 123(2) (balance-sheet test) requires taking account of contingent and prospective liabilities but is not a mechanistic comparison of aggregate assets and liabilities. The court emphasised that the proper test depends on the facts and the nature of the company's business and that the burden of proof of balance-sheet insolvency lies on the party asserting it.

Applying those principles to Eurosail, the court found multiple contractual features that lawfully deferred or mitigated liabilities (payment waterfall pre- and post-enforcement, liquidity facility, principal deficiency ledger, and other mechanisms) and noted the long timescale to final redemption (to 2045) and the speculative character of long-term currency and interest movements. On the evidence the court could not be satisfied, on the balance of probabilities, that Eurosail's assets were less than its liabilities when properly taken into account.

On the PECO, the court held that the option did not alter the legal quantification of the issuer's liabilities for the purposes of the Event of Default: the documents treated Noteholders' rights as full recourse until enforcement (and arguably until exercise and completion) and unless and until the option holder released the issuer the legal liabilities remained unaffected; commercial reality did not displace that legal construction.

Wider context: The court noted the rarity and difficulty of petitions based on contingent/prospective liabilities and cautioned courts to proceed carefully where long-dated liabilities and complex contractual deferral mechanisms are present.

Appeal dismissed and cross-appeal dismissed. The Supreme Court held that section 123(1)(e) and section 123(2) must be applied with care: (1) section 123(1)(e) is the cash-flow test looking to debts "as they fall due"; (2) section 123(2) is a balance-sheet enquiry taking into account contingent and prospective liabilities; and (3) on the facts and documentary context of this securitisation the appellants had not proven balance-sheet insolvency. Further, the PECO did not, as a matter of construction, reduce the issuer’s liabilities for the purposes of the default provision until and unless the option holder released the issuer; commercial substance did not displace the documents’ legal effect.

First instance: Sir Andrew Morritt C, [2010] EWHC 2005 (Ch). Court of Appeal: [2011] EWCA Civ 227 (Lord Neuberger MR et al). Appeal to the Supreme Court: [2013] UKSC 28 (this judgment).