Balance Sheet Tests or Solvency Tests – or Both?

One of the standard requirements of company law is the restriction of distributions to shareholders in order to protect the legitimate interests of the company's creditors. As lawful dividends don't have to be paid back when the company runs into losses at a later stage, we need a measurin...

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Bibliographic Details
Published in:European business organization law review 2006-03, Vol.7 (1), p.181-198
Main Author: Schön, Wolfgang
Format: Article
Language:English
Subjects:
Balance sheets
Cash flow
Commercial law
Directors
Dividends
Equity capital
Insolvency
Investments
Solvency
Stockholders
Studies
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Summary:One of the standard requirements of company law is the restriction of distributions to shareholders in order to protect the legitimate interests of the company's creditors. As lawful dividends don't have to be paid back when the company runs into losses at a later stage, we need a measuring rod in order to decide on the availability of funds for distribution. The traditional balance sheet test is running into criticism due to the rigidity of the old rules and the conflicts between the philosophy of IAS/IFRS and the concept of creditor protection. Newly offered devices like the solvency test aim at giving a better view of the business prospects of the company but they suffer from a limited time horizon and a wide range of discretion for directors. This makes them particularly problematic when long-term obligations have to be addressed. In the end, a combination of balance sheet test and solvency test seems to be a reasonable solution.
ISSN:1566-7529
1741-6205
DOI:10.1017/S1566752906001819