Should Creditors Rely on the Solvency and Liquidity Threshold for Protection? A South African Case Study

Abstract

AbstractMany jurisdictions internationally have adopted some form of solvency-based threshold to protect creditors from opportunistic or abusive distributions being paid from corporate capital. When a legislative “test” for distributions involves an enquiry that is too heavily based on a company's balance sheet, and thus on the integrity of the financial reporting standards underpinning its preparation, the utility of such thresholds becomes questionable on a similar basis to that on which the effectiveness of the capital maintenance doctrine has been challenged. Even the addition of a “liquidity” threshold that shifts the emphasis away from a company's balance sheet appears to presume that a corporation's financial health can be accurately determined from its financial statements. This article explores the difficulties involved in so-called “solvency-based” thresholds for distributions and considers other sources of creditor protection that may be more reliable.