Week 6: Governance and Accountability
The Solvency and Liquidity Test
Replaces the old capital maintenance system – a rule that said that a
company must have a minimum fund that serves as a guarantee so that
creditors can look to if the company ceases to exist. This tended to be
woefully inadequate and did not protect the creditors/shareholders (and
was the reason sub-rules like share par values exist).
The test requires that you consider all reasonably foreseeable financial
circumstances of the company at the time.
Financial information to be considered must be based on
- Accounting records that satisfy the requirements of section 28
- Financial statements that satisfy the requirements of section 29
Must consider a fair valuation of assets and liabilities including any
reasonably foreseeable contingent assets and liabilities
May consider any other valuation of the company’s assets and
liabilities that is reasonable in the circumstances
Two components
1. Solvency (advance recognition to ultimate priority that creditors enjoy
over shareholders upon dissolution; asks whether your assets exceed
your liabilities)
2. Liquidity (addresses fundamental expectation of creditors to be paid
on time; company must be able to pay its debts as they become due
for the next 12 months)
Must not be confused with the test for financial distress, which is used to
determine whether business rescue is needed:
- When the assets of the company as fairly valued equal or exceed
liabilities of the company
- When it appears that the company will not be able to pay its debts as
they become due in the ordinary course of business
For a period of 12 months after the date on which the test is
considered
Or in the case of a distribution, 12 months following the
distribution
Auditor and auditor liability
- To the auditor’s client – contractual agreement therefore can rely on
breach
- To third parties – no contractual agreement, only hope is a delictual
claim
Minimum number of directors
This is an alterable provision – MOI may specify a higher number
Private/personal liability – at least 1
The Solvency and Liquidity Test
Replaces the old capital maintenance system – a rule that said that a
company must have a minimum fund that serves as a guarantee so that
creditors can look to if the company ceases to exist. This tended to be
woefully inadequate and did not protect the creditors/shareholders (and
was the reason sub-rules like share par values exist).
The test requires that you consider all reasonably foreseeable financial
circumstances of the company at the time.
Financial information to be considered must be based on
- Accounting records that satisfy the requirements of section 28
- Financial statements that satisfy the requirements of section 29
Must consider a fair valuation of assets and liabilities including any
reasonably foreseeable contingent assets and liabilities
May consider any other valuation of the company’s assets and
liabilities that is reasonable in the circumstances
Two components
1. Solvency (advance recognition to ultimate priority that creditors enjoy
over shareholders upon dissolution; asks whether your assets exceed
your liabilities)
2. Liquidity (addresses fundamental expectation of creditors to be paid
on time; company must be able to pay its debts as they become due
for the next 12 months)
Must not be confused with the test for financial distress, which is used to
determine whether business rescue is needed:
- When the assets of the company as fairly valued equal or exceed
liabilities of the company
- When it appears that the company will not be able to pay its debts as
they become due in the ordinary course of business
For a period of 12 months after the date on which the test is
considered
Or in the case of a distribution, 12 months following the
distribution
Auditor and auditor liability
- To the auditor’s client – contractual agreement therefore can rely on
breach
- To third parties – no contractual agreement, only hope is a delictual
claim
Minimum number of directors
This is an alterable provision – MOI may specify a higher number
Private/personal liability – at least 1
