When should you apply the Solvency and Liquidity Test?

Solvency and Liquidity is dealt with in Section 4 of the Companies Act, No. 71 of 2008 (“the Act”) and has been legislated to ensure that a creditor is not prejudiced by the Company stripping itself of material assets or incurring excessive liabilities. The liquidity element specifically ensures a creditor will be paid timeously.

There are two elements of the Solvency and Liquidity test. The Solvency test, tests whether a Company’s assets exceed its liabilities and requires an examination of the balance sheet. The Liquidity part assesses whether a Company is able to satisfy its debts as they become due and payable and requires a cashflow analysis.

Often, we hear of Technical Solvency which means that at a certain point in time, the Company’s assets when fairly valued, equals or exceeds the Company’s Liabilities. Commercial Solvency means that the Company is able to pay its debts as they become due and payable and is noted over a 12-month period.

Any Company should keep the following financial information, which could be used in determining the outcome of a Solvency and Liquidity Test: Accounting records; Financial Statements; Fair values of Assets and Liabilities; Fair values of contingent assets and contingent liabilities; as well as the use of reasonable and reliable valuation methods.

In terms of the Act, a Company will satisfy the Solvency and Liquidity test if it appears that the Company will 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 carried out, following a distribution.

There are 7 instances as per the Act, in which the Solvency and Liquidity test must be applied:

  1. Section 13: When a foreign Company wishes to transfer its registration to the Republic, in order to become a domesticated Company.
  2. Section 44: The provision of financial assistance in connection with the acquisition by the Company of its own securities.
  3. Section 45: Loans to Directors and intra-group loans.
  4. Section 46: Distributions of any kind, including dividends.
  5. Section 47: Issues of capitalisation shares with a cash alternative.
  6. Section 48: Share buy-backs.
  7. Section 113: Mergers and amalgamations.

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