WHAT IS A SOLVENCY RESOLUTION?

30-Second Read

• Under the Companies Act 1993, a company must satisfy the solvency test before it can pay a dividend, buy back shares, reduce capital, or, in some cases, pay drawings to a working shareholder.
• The solvency test has two parts, not one. The company must be able to pay its debts as they fall due. Its assets must also exceed its liabilities, including contingent liabilities.
• Directors who vote in favour of a distribution must sign a certificate. It confirms the company passes this test immediately after the distribution.
• Getting this wrong carries real consequences. A director who signs a certificate without reasonable grounds can face personal liability — in serious cases, fines or imprisonment.
• LTCs running a land-and-build-to-rent project are often technically insolvent during construction, which is exactly when this becomes relevant.

We work through both parts of the solvency test, when a certificate is required, and what happens if it’s wrong. There’s a worked example too.

What Is the Solvency Test?

The Companies Act 1993(opens in new tab) sets out a two-part solvency test in section 4. A company satisfies it only if both parts are true:

1. The liquidity limb: the company can pay its debts as they become due, in the normal course of business.
2. The balance sheet limb: the value of the company’s assets exceeds the value of its liabilities, including contingent liabilities.

Both limbs need to hold at the same time. A company can have assets that comfortably exceed its liabilities on paper. It can still fail the test, though, if it can’t actually pay its bills as they fall due — cash flow and balance sheet strength are two different questions, and the law tests both.

Why Directors Need to Care

Two specific duties in the Act make this a director’s problem, not just an accounting exercise:

• Section 135 — a director must not let the company carry on business in a way likely to create a substantial risk of serious loss to its creditors. Courts have confirmed this is an objective test, not just a matter of the director’s own good intentions.
• Section 136 — a director must not agree to the company taking on an obligation. This applies unless they believe, on reasonable grounds, that the company will be able to perform it.

Both duties sit on top of the solvency test itself. Both carry personal consequences for directors who don’t take them seriously.

When Is a Solvency Certificate Required?

Under section 52(opens in new tab) of the Act, a company can’t make a distribution unless the board is satisfied on reasonable grounds. It must believe the company will still pass the solvency test immediately afterward. Directors who vote in favour must sign a certificate. It states their opinion that the test will be satisfied, and their grounds for that opinion.

“Distribution” is defined widely. It covers the obvious cases — paying a dividend, reducing capital, buying back shares. But it also includes incurring a debt to, or for the benefit of, a shareholder. In some circumstances, this extends to paying salary or drawings to a working shareholder too. This is exactly why your accountant may ask you to sign a resolution. It can apply even for something that doesn’t feel like a formal “distribution” in the everyday sense of the word.

The relevant date for assessing solvency is the date of the resolution itself, not the date funds actually change hands.

What Happens If You Get This Wrong

This isn’t just paperwork. A director who signs a solvency certificate without reasonable grounds for that belief can be held personally liable, if the distribution later needs to be recovered. In serious cases involving a fraudulent or misleading certificate, the Act provides for significant fines or imprisonment. Directors can rely on professional advice when forming their view. That only holds, though, if they’ve acted in good faith and made proper inquiry — not simply signed on request without genuinely considering the position.

LTCs and Construction-Phase Insolvency

If you have an LTC running a land-and-build-to-rent project, it’s common for the LTC to be technically insolvent during the construction phase — the build costs are incurred before the property has any completed value or rental income to offset them. This is precisely the situation where a solvency resolution tends to come up. It connects directly to the kind of shareholder current account issues we cover in Changing Shares in LTCs: Considerations, where an insolvent LTC can create real tax consequences on top of the solvency question itself.

Worked Example

Daniel’s LTC is mid-construction on a new rental property. The LTC has spent $400,000 on the build so far, funded by shareholder loans, but the property won’t be complete and valued for another four months. On paper, right now, the LTC’s liabilities (the shareholder loans) exceed its assets (partially completed construction). So it fails the balance sheet limb of the solvency test. Daniel’s accountant explains that while the LTC is in this technically insolvent state, any distribution — including certain payments to shareholders — needs careful consideration. The accountant flags that a solvency resolution may be needed before specific transactions can proceed.

Checklist

• ✅ Confirm whether your company currently passes both limbs of the solvency test — liquidity and balance sheet
• ✅ Check whether an upcoming transaction counts as a “distribution” under the Act’s wide definition, not just an obvious dividend
• ✅ Don’t sign a solvency certificate without genuinely turning your mind to the company’s financial position
• ✅ If your LTC is mid-construction on a build project, expect the solvency question to come up before any distribution-type payment
• ✅ Get your accountant’s input on the specific numbers before a resolution is put in front of you to sign

Free Download

Here is a generic solvency resolution you can use.>> (click here)

Common Questions

Does a solvency resolution mean my company is in trouble? Not necessarily. It’s a routine legal requirement before certain transactions, including many that are perfectly normal and healthy. It’s about confirming the position formally, not a sign of distress on its own.

What if I sign a certificate and it turns out to be wrong? If you didn’t have reasonable grounds for your opinion at the time, you can be held personally liable for the distribution. This applies regardless of whether you intended any wrongdoing.

Does this apply to LTCs the same way as other companies? Yes. An LTC is still a company under the Companies Act for these purposes, even though it’s tax-transparent for income tax.

What if my LTC is running at a technical loss during a build — do I need to worry immediately? Not immediately. It’s worth understanding the position before any distribution-type payment is made, though, rather than discovering the issue after the fact.

Summary

A solvency resolution exists because the Companies Act requires a company to pass a two-part test — able to pay its debts as they fall due, and assets exceeding liabilities — before it can make a distribution to shareholders, a category defined more broadly than just dividends. Directors who vote in favour must sign a certificate confirming their belief the company will still pass the test afterward. Getting that wrong carries real personal consequences. LTCs running a construction project are a common example of exactly when this becomes relevant. The numbers can look technically insolvent well before the project is finished.

Talk to EpsomTax.com About Your Solvency Position

If you’ve been asked to sign a solvency resolution and aren’t sure what it actually means for your specific company, don’t just sign it on trust. Contact us on 0800 890 132, and we’ll walk through your company’s actual position before you sign anything.