CFM33193 - Loan relationships: the matters and computational rules: amounts not brought into account: debt releases: corporate rescue exemption: reasonable to assume a company is unable to pay its debts

This guidance is applicable to certain events that take place on or after 1 January 2015.

CTA09/S322(5B)

CTA09/S322(5B) applies where it is reasonable to assume that, but for a release of a debt, and any arrangements of which the release forms part, there would be a material risk that within 12 months from the release the company would be unable to pay its debts.

Unable to pay its debts

‘Unable to pay its debts’ is defined in CTA09/S323(A1) as meaning that the company is unable to pay its debts as they fall due, or that the company’s assets will be worth less than its liabilities, contingent and prospective. These terms are based on sections 123(1)(e) and (2) of the Insolvency Act 1986, and should be interpreted in accordance with case law on insolvency (see CFM33194).

Material risk

The exemption requires that, in the absence of the restructuring, there would be a ‘material risk’ that the company would be unable to pay its debts. This is a hypothetical test that looks at what the position would have been without the release or accompanying arrangements. This requires a significant risk of insolvency that is of real concern to the directors.

However, the test for the exemption to apply is not the same as the condition in section 214((2)(b) of the Insolvency Act of there being ‘no reasonable prospect’ that the company will be able to avoid insolvency. Importantly, it does not imply that the directors would be vulnerable to accusations of wrongful trading.

Reasonable to assume

The evidence for such a ‘reasonable assumption’ in the context of this provision may include, for example:

  • likely breaches of financial covenants, negotiations with third party creditors over release or restructuring of debt;
  • enforcement actions taken by creditors;
  • adverse trading conditions with no prospect of recovery, failure of a material customer or supplier, redundancies, business disasters, litigation that the company may be unable to meet;
  • management accounts, reports and forecasts showing material cash flow shortfalls;
  • an insolvent balance sheet;
  • qualified audit reports, accounts prepared on a break up basis.

Likely breaches of financial covenants, negotiations with lenders, or an insolvent balance sheet are each strong evidence of a reasonable assumption that the company would be in the position of being unable to pay its debts within the next 12 months, although no single factor will necessarily be determinative, and such evidence will usually comprise a number of factors taken together.