Your client, Zaheer Khan, is a shareholder of Mainmines Ltd and he is unhappy with a distribution made to shareholders of Mainmines Ltd because after the payment, the company was not able to pay him for goods delivered to the company.

Question

Explain to your client the solvency and liquidity test as it is applied in terms of the 2008 Companies Act?

Answer 1

Under the 2008 Companies Act, the solvency and liquidity test is a crucial assessment made by companies before they can make distributions to their shareholders. This test helps to ensure that a company has sufficient financial resources to meet its obligations and maintain its solvency, even after making a distribution to shareholders.

The solvency test requires the company's board of directors to consider both the assets and liabilities of the company. They must determine whether, at the time of the distribution, the company will be able to pay its debts in full, including any foreseeable future obligations. This assessment is necessary, as it prevents a company from making distributions that would render it insolvent or unable to meet its financial responsibilities.

The liquidity test, on the other hand, focuses on the company's short-term ability to pay its debts as they become due. It requires the directors to consider whether, after making the distribution, the company will have sufficient liquid assets to meet its current and foreseeable liabilities.

In the case of Mainmines Ltd, it seems that the distribution made to shareholders may have violated the solvency and liquidity test. Since the company was unable to pay your client for the goods delivered, it suggests that the board of directors may not have adequately considered the company's financial position and future obligations before making the distribution.

Your client, Zaheer Khan, may have grounds to voice his concerns and seek a resolution from the company. He can ask for an explanation from the board of directors regarding their assessment of the company's financial position at the time of the distribution. If it's determined that the distribution was made negligently or in violation of the solvency and liquidity test, legal action may be taken to recover the payment owed.

It is important for companies to prioritize the solvency and liquidity test to protect both the shareholders and the company itself. By ensuring that distributions are made only when the company can reasonably afford them, the risk of insolvency and financial difficulties can be minimized.