Section 4 of the Companies Act, 2008, (the Act) sets out a solvency and liquidity test for directors of companies to apply when embarking on certain actions or entering into certain transactions.

This test adopts a two pronged approach to avoiding a company trading recklessly in insolvent circumstances in that it requires not only that the company is liquid, namely that it is able to pays its debts as they become due in the normal course of trading but also that it is solvent.

Solvency relates to the assets of the company, fairly valued, being equal or exceeding the liabilities of the company.

The test requires that the business be both solvent and that it is liquid in that it is able to pay its debts as they become due in the ordinary course of business for a period of 12 months after the test is applied.

  • The solvency and liquidity test must be utilised for all of the following:
  • financial assistance for the subscription of securities (section 44)
  • loans or other financial assistance to directors (section 45)
  • distributions to shareholders authorized by the board (section 46)
  • capitalization of shares (section 47)
  • company or subsidiary acquiring company’s shares (buy backs or buy ins) (section 48)
  • amalgamations or mergers (section 113)

Although the Act contains fewer offences which carry a criminal sanction, the personal liability of directors has been increased in a codified form. Directors (which include by definition board members) may be held personally liable to the company for various acts and omissions as set out in the Act.

Specifically, section 218 (2) sets out that any person who contravenes any provision of the Act could be liable to any other person for any loss or damage suffered as a result of the contravention. In relation to the solvency and liquidity test, a director may be held liable to a company for any loss suffered by the company while trading under insolvent circumstances (section 77 (3)) and may also be held liable to any third party who have had dealings with the company and suffered loss as a result of the director’s actions.

It is therefore prudent that all directors apply their minds to the solvency and liquidity test when embarking on any of the actions set out above.