“Unable to pay its debts as they become due in the ordinary course of business” is the single most important phrase in the insolvency provisions of the Companies Act 1997. Section 335 tells you when it is presumed.
Section 335 — the four presumptions
(a) the company has failed to comply with a statutory demand; or
(b) execution issued against the company in respect of a judgment debt has been returned unsatisfied in whole or in part; or
(c) a person entitled to a charge over all or substantially all of the property of the company has appointed a receiver under the instrument creating the charge; or
(d) a compromise between the company and its creditors has been put to a vote under Part XV but has not been approved.
Each is rebuttable — “unless the contrary is proved”. A company that ignored a statutory demand because it was misdirected, or whose receiver was appointed on a technical default while it remained able to pay, may prove the contrary.
Note how (c) operates. The appointment of a receiver over substantially all the property is itself evidence of insolvency — which is why a chargeholder’s appointment often precipitates a liquidation application by someone else. And (d) means a failed rescue attempt counts against the company.
Section 336 — evidence and related matters
On an application for an order that a company be put into liquidation, evidence of failure to comply with a statutory demand is not admissible as evidence of inability to pay debts unless the application is made within one month after the last date for compliance with the demand.
A statutory demand has a short shelf life. Compliance is due within one month of service (s 337(2)(d)), and the application must be filed within one month after that date. A creditor who lets the demand go stale must serve a fresh one or prove insolvency by other means.
(2) Section 335 does not prevent proof by other means that a company is unable to pay its debts.
(3) Information or records acquired under section 219, or — where the Court so orders — under section 220, may be received as evidence of inability to pay debts.
(4) In determining the question, the company’s contingent or prospective liabilities may be taken into account.
Sections 219 and 220 are the investigation provisions. A shareholder or creditor who cannot prove insolvency directly may seek an inspection or investigation, and what it produces is admissible on a liquidation application.
Subsection (4) is a reminder that the cash flow test is forward-looking. Debts not yet due, guarantees that may be called, and unresolved claims all bear on whether the company will be able to pay its debts as they become due. That mirrors the second limb of the section 4 solvency test, which asks whether the company is able to pay its debts as they become due in the normal course of business.
Section 336(5) — contingent and prospective creditors need leave
An application to put a company into liquidation on the ground of inability to pay debts may be made by a contingent or prospective creditor only with the leave of the Court — and the Court may grant leave, with or without conditions, only if satisfied that a prima facie case has been made out that the company is unable to pay its debts as they become due.
Under section 291(2)(c) a contingent or prospective creditor may apply for a liquidator to be appointed. Section 336(5) adds a filter where the ground relied on is inability to pay debts: leave first, on a prima facie case.
The reason is obvious. A person whose claim has not crystallised has no unpaid debt to point to, and an unmeritorious application by such a person can do serious damage to a trading company. The other grounds in section 291(3) — persistent or serious failure to comply with the Act, non-compliance with section 11, and the just and equitable ground — are not subject to this filter.
Where the test does its work
| Provision | Role of the test |
|---|---|
| s 291(3)(a) | The principal ground for a Court appointment of a liquidator |
| s 242 | The gateway to proposing a compromise — the proponent must have reason to believe the company is or will be unable to pay its debts within the meaning of section 335 |
| ss 293(8), 294 | The board’s solvency resolution, and the liquidator’s duty to call a creditors’ meeting if it was unfounded |
| s 4 | The cash flow limb of the solvency test, which governs distributions, buy-backs and amalgamations |
| ss 348, 349 | Director and holding company liability for debts incurred when the solvency test is not satisfied |
| s 340 | A transaction is voidable only if made at a time when the company was unable to pay its due debts |
The statutory phrase is about payment when due, not about whether assets exceed liabilities. A company with substantial illiquid assets and no cash can be unable to pay its debts; a company with negative net assets but committed funding may not be.
Section 4 keeps the balance sheet question separate as its own limb of the solvency test — the value of assets must be greater than the value of liabilities including contingent liabilities. Section 335 is concerned only with the cash flow question.
Practical points
- For a creditor: a statutory demand is the cheapest route to a presumption — but diarise one month to comply, one month to apply.
- For a judgment creditor: a return of execution unsatisfied under paragraph (b) is equally effective and needs no demand.
- For a board: once any presumption is available, treat the company as insolvent for the purposes of sections 348 and 348A unless there is clear evidence to the contrary.
- For a contingent creditor: seek leave under section 336(5) first, with evidence establishing a prima facie case.
- For a company served with a demand: apply to set it aside within one month — no extension of time is available for making or serving that application.
Sources
- Companies Act 1997 — ss 4, 219, 220, 242, 291, 293, 294, 335–339, 340, 348, 349
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.