Solvency and liquidity test under the Companies Act 2008

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The concept of capital maintenance has recently been excluded in the new Companies Act.

Instead, section 4 of the Companies Act of South Africa, No 71 of 2008 (the Act) requires directors to perform a solvency and liquidity test when engaging in certain actions or entering into certain transactions.

The transactions that require a solvency and liquidity test are:

 

  • Financial assistance for the subscription of securities. For example where the company lends money to any person for the purpose of acquiring that company’s shares (section 44)
  • Loans or other financial assistance to related parties, including subsidiary companies, holding companies and directors (section 45)
  • Dividends declared to shareholders (section 46)
  • Other distributions (as defined) to shareholders, for example writing off a debt owing to the company by its shareholders (section 46)
  • Capitalisation of shares, whereby the recipient can choose whether to take the shares or take cash (section 47)
  • Company or subsidiary acquiring the company’s shares (also known as ‘buy-backs’ or ‘buy-ins’) (section 48)
  • Amalgamations and mergers (section 113)

The Act stipulates that the requirements of the solvency and liquidity test must be met immediately after the transaction in question (thus, that the company will still be liquid and solvent after the transaction) as well as for a period of twelve months thereafter.

In the case of declaring a dividend, the solvency and liquidity test must be applied twice – right after the dividend has been declared and when the dividend will be paid (and don’t forget the 12 months thereafter).

What does the solvency and liquidity test involve?

Solvency normally refers to the situation where a company’s assets must exceed its liabilities (also known as factually solvent).

For the statutory solvency test, the directors therefore have to compile a list of all the company’s assets and liabilities and determine their fair values. Any reasonably foreseeable contingent liabilities and assets must be taken into the consideration. Remember to include the company’s intellectual property or debts which have been incurred but are not yet payable, seeing that you need to consider the liquidity and solvency position for the next 12 months.

For the company to be considered solvent, the total value of the assets must be worth more than the total value of the liabilities, thus resulting in a net asset position.

Liquidity refers to a person’s possession of or access to cash (thus different from merely having assets) to be able to pay debts as and when they fall due. This is also referred to as commercial solvency (as opposed to factual insolvency above).

In determining if a company is liquid, or will be liquid in the foreseeable future, the only practical solution is to prepare a detailed cash flow forecast for at least the next 12 months.

It is important to note that the Act imposes a duty on the company’s directors to apply their minds to the matter, considering all reasonably foreseeable financial circumstances of the company at the time.

The board must also keep record (probably in the form of minutes of meetings) of where and how the considerations were made and what the resolution was.

At the same time, a director will be liable if he or she failed to vote against a board resolution approving a distribution contrary to the provisions of the Act (such as stating that the entity is solvent and liquid when in fact it is not). Abstaining from the board resolution is thus no longer a viable option.

Please do not hesitate to contact the relevant partner or our secretarial department should you require assistance or clarification with regards to the solvency and liquidity tests.

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your business consultant for specific and detailed advice.

 

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