Solvency and Reckless Trading

The Companies Act, 2008, states that a company must not carry on its business recklessly, with gross negligence, with intent to defraud or trade under insolvent circumstances. (Sect 22) If a company trades in such circumstances, the Commission may require the company to cease carrying on business.

Although “trading under insolvent circumstances” is not defined in the Act, it is accepted to mean that a company does not meet the “solvency and liquidity test” criteria. There are many trading companies which are liquid, meaning they can pay  their debts as they become due, but not necessarily solvent as defined in the solvency and liquidity test.

In terms of the “solvency and liquidity test”, solvency relates to the assets of the company, fairly valued, being equal or exceeding the liabilities of the company. Liquidity relates to the company being able to pay its debt as they become due in the ordinary course of business for a period of 12 months.

The solvency and liquidity test applies to the following:

  • financial assistance for the subscription of securities (sect 44)
  • loans or other financial assistance to directors (sect 45)
  • distributions to shareholders authorized by the board (sect 46)
  • capitalization of shares (sect 47)
  • company or subsidiary acquiring company’s shares (buy backs or buy ins) (sect 48)
  • amalgamations or mergers (sect 113)
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