CASH FLOW TEST AND S. 254(2)(C) COMPANIES ACT
In the recent Court of Appeal decision of Sun Electric Power Pte Ltd v RCMA Asia Pte Ltd (formerly known as Tong Teik Pte Lte) [2021] SGCA 60 (“Sun Electric”), the Court of Appeal clarified certain issues relating to s. 254(2)(c) of the Companies Act.
In this short update, we will focus on the key points raised by the Court of Appeal in the Sun Electric decision relating to s. 254(2)(c) of the Companies Act.
s. 254(2)(c) Companies Act. S. 254(2)(c) of the Companies Act provides that a company is deemed to be unable to pay its debt if:
“it is proved to the satisfaction of the Court that the company is unable to pay its debts; and in determining whether a company is unable to pay its debts the Court shall take into account the contingent and prospective liabilities of the company.”
It was submitted by the respondent in Sun Electric that the appellant would be found to be unable to pay its debts if it could be shown that the appellant was either insolvent on either the cash flow test or the balance sheet test; further, the cash flow test should be the dominant test such that the company should be deemed to be unable to pay its debts if the cash flow test is satisfied regardless of whether the balance sheet test was satisfied.
Cash flow test is the sole test. The Court of Appeal agreed and held that the “cash flow test should be the sole and determinative test under s 254(2)(c) of the Companies Act” ([56] Sun Electric; emphasis added).
The Court of Appeal found that the provision does not envisage two or more different tests ([57] Sun Electric), and that this interpretation is supported by United Kingdom case law ([59] Sun Electric).
Further, the “… balance sheet test compares a company’s total assets with its total liabilities. However, this ratio has no direct correlation with whether a company “is unable to pay its debts” [emphasis added].” ([62] Sun Electric; emphasis in original).
In contrast, the “… cash flow test assess whether the company’s current assets exceed its current liabilities such that it is able to meet all debts as and when they fall due. We agree with Mr Lim that “current assets” and “current liabilities” refer to assets which will be realisable and debts which will fall due within a 12-month timeframe, as this is the standard accounting definition for those terms.” ([65] Sun Electric).
The Court of Appeal further clarified that it is imprecise to say that “cash flow insolvency is established if a debtor demands payment of debt which is due, but the company is unable to pay the debt out of its liquid resources which are immediately available”. This is because the terms in bold are “imprecise, as the cash flow test does not require the debts to be already due or demanded, nor does it require the assets to be immediately available. Instead, the correct terminology… is whether the company’s assets “were realisable within a timeframe that would allow each of the debts to be paid as and when it became payable”… and whether the liquidity problem “can be cured in the reasonably near future”…” ([66] Sun Electric; emphasis in original)
This means that the court should also consider debts that may not have been demanded or which may not even be due, as the phrase “is unable” read in conjunction with the phrase “as they fall due” “indicates a continuous succession of debts rather than a calculation of debts existing on any particular day” and thus the court “may also have regard to claims falling due in the near future and to the likely availability of funds to meet such future claims and the company’s existing debts”. ([66] Sun Electric).
Non-exhaustive list of factors. The Court of Appeal also helpfully set out a non-exhaustive list of factors that should be considered under the cash flow test at [69] Sun Electric, which we duplicate below:
a) “the quantum of all debts which are due or will be due in the reasonably near future;”
b) “whether payment is being demanded or is likely to be demanded for those debts;”
c) “whether the company has failed to pay any of its debts, the quantum of such debt, and for how long the company has failed to pay it;”
d) “the length of time which has passed since the commencement of the winding up proceedings;”
e) “the value of the company’s current assets and assets which will be realisable in the reasonably near future;”
f) “the state of the company’s business, in order to determine its expected net cash flow from the business by deducting from projected future sales the cash expenses which would be necessary to generate those sales;”
g) “any other income or payment which the company may receive in the reasonably near future;” and
h) “arrangements between the company and prospective lenders, such as its bankers and shareholders, in order to determine whether any shortfall in liquid and realisable assets and cash flow could be made up by borrowings which would be repayable at a time later than the debts”.
Conclusion. While s. 254(2)(c) of the Companies Act only applies to an application for winding up filed prior to 30 July 2020 ([16] Sun Electric), given the similarity between the language of s. 254(2)(c) of the Companies Act and s. 125(2)(c) of the Insolvency, Restructuring and Dissolution Act 2018, Sun Electric will be useful in shedding light on how the Courts may approach s. 125(2)(c) of the Insolvency, Restructuring and Dissolution Act 2018.
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