CIPC Compliance (Section 4, 44 and 45): Solvency and Liquidity Test and how it applies to Financial Assistance and director loans.
Section 4 of the Companies Act 71 of 2008 refers to what a Solvency and Liquidity test are and how such a test should be done. This section does not specify when and if such a test should be done and also not what the impact is should a company not pass such a test.
What is a Solvency and Liquidity Test?
A basic explanation of the terms is as follows:
A solvency test is an exercise performed by the directors of the company where they confirm that the assets of the company exceed the liabilities of the company (both fairly valued).
A liquidity test is where the directors calculate if the company will be able to pay its liabilities as part of their ordinary business activities in the next 12 months.
When should such a test be performed?
Such a test should be performed by the directors, in the case where the company provides financial assistance for:
- Taking up share capital of the company. (Section 44)
- Loans/advances to the directors, shareholders or related parties. (Section 45)
Also when the company:
- Declares a dividend.
- Buy back the shares of the company.
Impact should the test not be passed
In general the consequence is that if a director is party to the above transactions and the company did not pass the Solvency and Liquidity test, and the director did not vote against such a transaction, the director may be help personally liable for all debt of the company.
Practical consequence for SMME business
Such a solvency and liquidity test must be performed by the directors when any of the above transactions are entered into. Often directors will lend and borrow money between themselves and their companies without taking into account the Solvency/Liquidity rules or even performing the tests. Not only is non-performance of the tests a contravention of the Companies Act but if such a test is not passed the separation of liability between directors in their personal capacity and the creditors of the company is removed, exposing them to personal risk.
Directors should bear in mind that as part of the new CIPC Annual return declaration they confirm that Solvency and Liquidity tests were performed when required.
