Voidable transactions and a company’s ability to pay its due debts: are future debts relevant?

The Court of Appeal has delivered the latest word on whether and when a company can pay its due debts, in the context of a voidable transaction claim.

It has overturned a High Court judgment setting aside ~€25m of payments by CBL Insurance, as reinsurer, to Alpha Insurance A/S two weeks prior to CBL’s liquidation. In overturning the High Court judgment, the Court of Appeal declined to find that CBL was cashflow insolvent at the time of the payments. An actuarial estimated liability figure based on a wide range of insured claims which may not arise for years, if at all, did not amount to a “due debt”.

Insurance company liquidations are relatively rare but the decision should be of interest to liquidators outside that context too. And it should be of interest to directors considering the application of the solvency test in the context of shareholder distributions.

Context – the High Court judgment

In February 2018, following a lengthy period of uncertain solvency, interim liquidators were appointed to CBL Insurance. In the two weeks prior, CBL had made two substantial payments as reinsurer to Alpha Insurance A/S of €25m and £397k.

CBL’s liquidators sought to set aside the payments to Alpha under s 292 of the Companies Act. The only issue before the Court was whether CBL made the payments at a time when it was unable to pay its due debts. The presumption that CBL was unable to pay its due debts applied. It was common ground that:

the payments enabled Alpha to receive more than it would have in liquidation, and
that Alpha could not rely on the s 296(3) “good faith” defence.

As a reinsurer, CBL would effectively underwrite certain insurance companies’ claims in exchange for a proportion of the premiums those companies received. Some of the insurance companies (including Alpha, providing insurance to the French commercial construction market) would face a “long tail” of claims, potentially leaving CBL liable to make payments over a decade. In the meantime, CBL’s position was cashflow positive as a consequence of all of the premiums received.

The case boiled down to whether CBL’s “outstanding claims liability”, or OCL, was a “due debt”. The OCL is an estimate, provided by an insurance company’s approved actuary, of the insurer’s total likely claims exposure for the cover it has written. Its calculation is governed by IFRS standards, and it is a key part of calculating an insurer’s minimum solvency capital for regulatory purposes. It is not confined to claims made, and includes claims reported and not finalised, and even claims neither reported nor known.

Despite that, the High Court ultimately held that the OCL constituted a “due debt”. It concluded that such interpretation is consistent with the “common sense and practical business perspective” required by the Supreme Court in David Browne Contractors¹. A purposive approach, taking into account the specific context and nature of the business in question is necessary to determine whether a liability is a due debt. The High Court in particular reasoned that the OCL was a due debt for the purposes of s 292 because:

it is a mandatory requirement for all insurers, and must be professionally calculated and included in the insurer’s annual balance sheet.
it needed to be understood “as being the amount required to be included in the accounts for that year to ensure the insurance company can continue to operate”.
in an insurance company context, without looking into the future, a “totally artificial” picture would be painted of a company’s ability to pay its due debts, given the lag between receipt of premiums and payments of claims. Were the OCL not to be treated as a “due debt”, no insurance or reinsurance company would ever be subject to s 292.

Court of Appeal overturns High Court judgment

The appeal was succesful.

As a starting point, the Court of Appeal adopted the Supreme Court’s reasoning in David Browne Contractors (with some slight rewording) to conclude that “due debts” include not only contingent debts but also prospective debts that are “reasonably proximate in time”. That temporal qualifier must be applied to prospective debts, or they would amount to “due debts” even if they were not due to be repaid for many years.

The Court of Appeal went on:

To conclude that the OCL could not be a “due debt” because it included liabilities for incurred but not reported claims, which would not become legally due until, at least, they were reported to CBL. That could be many years away, and in some cases a decade. The Court of Appeal considered that treating such liabilities as “due debts” “collapses the distinction between cash flow solvency and balance sheet solvency”.
To acknowledge that cash flow solvency is of “limited relevance” to an insurance company’s business, and solvency of an insurer (including under the Insurance (Prudential Supervision) Act 2010) is more often assessed on a balance sheet basis. While that may result in insurance companies rarely making payments while unable to pay their due debts, that reflected Parliament’s choice not to expand s 292 to include balance sheet solvency generally, or in relation to insurance companies only. Put another way in the judgment: “the Court must apply s 292 as it is, not as it might like it to be”. That reflects a sharp turn away from the broad and purposive approach of the High Court.
To reject the argument that the inevitability of CBL’s liquidation meant that all its liabilities were to be treated as due. While the Companies Act provides for claims to be made in liquidation in respect of future debts and liabilities, it does not provide for the due date of future liabilities to be accelerated to the date of liquidation.
To conclude that CBL would have been able to pay claims as they fell due for a further three to five years. Debts beyond that point were not sufficiently proximate in time to conclude that CBL could not pay its due debts. Accordingly the payments to Alpha were not voidable.

At the time of writing it is unknown whether the Court of Appeal’s judgment will be appealed. Almost 10 years have passed since the Supreme Court ruled on the David Browne Contractors case and the issue is of sufficient public interest that it is conceivable the Supreme Court would grant leave.

Key takeaways

It is notable that the Court of Appeal’s judgment took a materially more “black letter” and less purposive approach than the High Court in concluding that the OCL was not a “due debt”. That type of approach would leave less room for liquidators to bring novel voidable transaction claims, and we will wait and see with interest whether that approach translates to first instance judgments.
In most liquidations and on most voidable transaction claims, whether a company could pay its “due debts” will turn on the immediate present circumstances. To the extent that the Court is willing to take into account future debts, looking months into the future (not years) is likely to be the outer limit in most cases.
Liquidators of insurance companies will in most circumstances find it difficult to bring voidable transaction claims because of the cashflow positive nature of an insurance business. Legislative change would be needed to allow voidable transaction claims to be brought for payments made at a time when the company was balance sheet insolvent, even if not cashflow insolvent.