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The solvency statement procedure – a salutary warning to take care when forming the necessary opinion

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25/05/2018

Companies wishing to reduce their share capital as part of a group restructure or in order to pay out a dividend can do so under section 643 of the Companies Act 2006 (the Act). Before the share capital can be reduced, the Act requires each director to declare that he has formed the opinion that, if the capital reduction takes place, there is no ground on which the company would then be unable to pay its debts over the 12-month period following the declaration. This declaration is called the solvency statement.

If a director makes a solvency statement without having reasonable grounds for holding that opinion, that director may face criminal penalties under the Act. Section 643 of the Act does not however provide that the solvency statement is itself invalid if there are no reasonable grounds for the opinion so long as the director honestly and genuinely formed that opinion. A solvency statement will be valid as long as the director honestly and genuinely formed the required opinion, even if the director did not have reasonable grounds for doing so (BTI 2014 LLC v Sequana [2014]).

LRH Services Ltd (in liquidation) v Trew [2018] takes this a step further. A solvency statement will be invalid unless the directors have, at a minimum, actually turned their minds to the contingent and prospective liabilities of the company and only taken into account assets that are properly available to the company in considering whether it will be able to meet its debts. In other words, directors not only must form the required opinion genuinely and honestly, but also have asked themselves the right questions in doing so.

The significance of a solvency statement being invalid is that all actions done pursuant to it, such as payment of a dividend, will in turn be invalid and the directors will become personally liable, potentially up to the full amount of dividend.

Facts of the case

The case concerned claims brought by the liquidator of LRH Services Ltd against three of the company’s former directors. The directors had carried out a group reorganisation some years previously and as part of the reorganisation the company’s share capital had been reduced through the solvency statement procedure and a £21 million dividend paid out to the company’s sole shareholder (also a group company).

Despite the solvency statement having been made, the company’s assets were, however, grossly insufficient to meet its liabilities. All it would take would be for one tenant to fail to pay its rent and the company would be unable to meet its debts. One of the defendants, Mr Trew, had said that he had been confident that the company would be able to meet its liabilities because he controlled its ultimate shareholder and he would ensure that the company was kept in funds by the shareholder.

What did the court decide?

The court found that each of the directors had breached his duties to act in the best interests of the company (which was by then a duty to act in the interests of creditors) by carrying out the reorganisation in a way that left the prospect of insolvency inevitable.

The court further found that the solvency statement was invalidly made, and that each director was responsible to the company for the £21m dividend paid out in consequence.

The court held that Mr Trew had failed to form the opinion required by the Act, because:

  • he did not make any enquiry or give any consideration to the company’s actual liabilities, including the extent to which those liabilities were being met at the time of the reorganisation
  • he had assumed the company could have its liabilities met as needed by another group company, without any binding agreement (such as a guarantee) that would require this group company to step in and perform. Ad hoc inter-company assistance was not an asset which could be properly taken into account.

WM comment

The key point to note from this judgement for those advising on or carrying out a group restructure is to ensure that there is a detailed account in the board minutes of the assets and liabilities that have been considered so that a director cannot be accused of failing to consider the question properly. In addition, where a company has always relied on inter-company support then this should be evidenced in writing so that it can be treated as an asset.

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