Client Update: Singapore Court of Appeal holds that companies are now to be adjudged insolvent using only the cash flow test

In Sun Electric Power Pte Ltd v RCMA Pte Ltd (formerly known as Tong Teik Pte Ltd) [2021] SGCA 60 (“Sun Electric”), the Singapore Court of Appeal (per Justice Judith Prakash) addressed in its written ground of decision (“GD”) the questions of: (i) the applicable test for the purpose of determining insolvency under s 254(2)(c) of the Companies Act (Cap 50, 2006 Rev Ed) (“Companies Act”); and (ii) who would be the appropriate party to control the conduct of the appeal, as well as to bear the responsibility of any costs incurred during and after the appeal, following a company’s right to appeal a winding up order regardless of whether a stay order is granted.

The Singapore Court of Appeal found that the cash flow test is the sole applicable test under s 254(2)(c). This is a significant shift from the long-standing position before this case, under which the Court would also consider the balance sheet test for determining insolvency. Thus, the GD did away with any prior confusion as to whether both the cash flow and balance sheet tests need to be satisfied before a company would be deemed to be unable to pay its debts or whether the tests are disjunctive.

The GD also addressed a salient concern amongst creditors in the context of an appeal to a winding up order, which is the possibility of directors and/or shareholders whittling down the company’s funds to pursue unmeritorious appeals when these funds should be reserved for payment to the creditor.

Brief Facts

In Sun Electric, the Appellant was a company incorporated in Singapore that was in the business of transmitting, distributing and selling electricity. In late 2015, the Appellant entered into an agreement with the Respondent for the Respondent to assume certain market-making obligations owed by the Appellant, in exchange for 70% of all incentive payments that the appellant would receive for carrying out these market-making obligations. The Appellant initially paid the Respondent its 70% share, but after January 2018 stopped all payments. In 2019, following the inability of the Appellant to pay the Respondent funds owed pursuant to a statutory demand, the Respondent filed for the Appellant to be wound up.

Issues

The following issues had to be determined by the Court:

1. Which test applies for the purpose of determining insolvency under s 254(2)(c) of the Companies Act;
2. Who should control the conduct of an appeal against a winding up order and at whose cost; and
3. Whether a company may still be deemed to be unable to pay its debts under s 254(2)(a) of the Companies Act if it pays part of the statutory demand such that the remaining debt falls below the prescribed minimum quantum needed to serve the demand.

The Cash Flow test is the sole test in determining insolvency

The Court held that the cash flow test is the sole applicable test under s 254(2)(c) of the Companies Act to determine whether a company is unable to pay its debts. The cash flow test assesses whether the company’s current assets exceed its current liabilities such that it can meet all debts as and when they fall due. “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.

The Court further set out a non-exhaustive list of factors which should be considered under the cash flow test. These include:

1. the quantum of all debts which are due or will be due in the reasonably near future;
2. whether payment is being demanded or is likely to be demanded for those debts;
3. 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;
4. the length of time which has passed since the commencement of the winding up proceedings;
5. the value of the company’s current assets and assets which will be realisable in the reasonably near future;
6. 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;
7. any other income or payment which the company may receive in the reasonably near future; and
8. 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.

The Court found that the cash flow test is the sole applicable test under s 254(2)(c) of the Companies Act for three main reasons.

First, the plain words of the provision do not envisage two or more distinct tests being applied but only a single test, namely, whether “it is proved to the satisfaction of the Court that the company is unable to pay its debts”.

Second, the Court found that this proposition for single test is supported by United Kingdom (“UK”) case law on s 518(e) of the Companies Act 1985 (which is similarly worded to s 254(2)(c)) where the UK courts have interpreted as requiring only a single test of commercial insolvency.

Third, the single test intended by s 254(2)(c) of the Companies Act is not the balance sheet test. The balance sheet test compares a company’s total assets with its total liabilities. However, the Court found that the total assets and liabilities are only relevant in so far as they shed light on the quantum of debts which will soon be due and the quantum of assets which may be realised in the near future and is no way a good indicator of the company’s present ability to pay its debt.

The Court also pointed out that where the legislature intended to incorporate a balance sheet test, it has done so in no uncertain terms (see s 123(2) of the UK Insolvency Act 1986 and s 100(4)(b) of the Bankruptcy Act (Cap 20, 1996 Rev Ed) (now repealed by the Insolvency, Restructuring and Dissolution Act 2018 (Act 40 of 2018) (“IRDA”))). The fact that this was not done in s 254(2)(c) suggests that it was not intended.

Importantly, in doing the above, Sun Electric has set aside the long-standing case Re Great Eastern Hotel (Pte) Ltd [1988] 2 SLR(R) 276 (“Great Eastern”) on its application of s 254(2)(c) of the Companies Act.

First, Sun Electric departed from Great Eastern which took the view that both the balance sheet test and cash flow tests are applicable under s 254(2)(c).

Second, in Great Eastern, it was held 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. However, the Court in Sun Electric found that the terms emphasised in bold were 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”. The Court should also consider debts which may not have been demanded, and which may not even be due.

Directors to bear costs to appeal against winding up order

In Sun Electric, the Court allowed the director of the Appellant to continue the conduct of the appeal. To this end, the court held that a company has the right to appeal a winding up order regardless of whether a stay order is granted. The Court reasoned that it follows from the company’s right to appeal that its directors can control the conduct of the appeal. However, the Court highlighted that the directors and/or shareholders cannot deplete the company’s funds in pursuing an unmeritorious appeal when those funds should be used to pay off creditors. In this regard, the Court laid down two general rules:

1. The directors and/or shareholders controlling the conduct of the appeal should expect to pay any costs incurred in pursuing the appeal out of their own pockets, rather than using company funds. Nevertheless, if the appeal succeeds, the directors and/or shareholders can claim from the company the funds that they spent from their own pockets in pursuing the appeal.
2. The directors and/or shareholders controlling the conduct of the appeal should expect to be personally responsible for the payment of any party of party costs awarded in favour of the respondent if the appeal fails.

Since the Court dismissed the appeal, the Court ordered the director of the Appellant to pay $50,000 to the respondent, inclusive of disbursements, as costs of the appeal.

Company no longer deemed insolvent under s 254(2)(a) if it makes partial repayment during the prescribed three-week period such that outstanding debt falls below $10,000

It was not necessary for the Court to discuss the ground for winding up under s 254(2)(a) as the court found that the Appellant was to be wound up on the cash flow test. Nevertheless, the Court expressed its view in obiter that a company which makes partial payment of the debt demanded in a statutory demand within the prescribed three-week period such that the remaining amount payable falls under $10,000 should not be deemed to be unable to pay its debts pursuant to s 254(2)(a) of the Companies Act.

The Court also declined to decide whether, if partial payment of the debt demanded in a statutory demand is made after the prescribed three-week period but before the winding up hearing such that the remaining amount payable falls under $10,000, the company should be deemed to be unable to pay its debts pursuant to s 254(2)(a) of the Companies Act. The Court said it will decide this in a subsequent appropriate case.

Conclusion

Sun Electric is noteworthy as it definitively established the cash flow test as the sole applicable test for the purpose of determining insolvency under s 254(2)(c) of the Companies Act. This decision may also have significant implications in other areas of law which involve the determination of insolvency, such as the threshold test for putting a company into judicial management under s 91(1)(a) of the IRDA.

The Court also laid down safeguards against the directors and/or shareholders abusing the control of the appeal against a winding up order by having these directors and/or shareholders not only fund the appeal if the court later finds the appeal to be unmeritorious, but also liable for adverse party to party costs.

This client update is authored by Head of Restructuring & Insolvency, Meiyen Tan, and Partner Keith Han, Associate Angela Phoon and interns Cheryl Eio and Richard Xu. If you have enquiries pertaining to the new legal developments in corporate insolvency, or require assistance in any corporate restructuring or insolvency related matters, please do not hesitate to contact them.