Balance Sheet Tests or Solvency Tests — or Both?

Abstract

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 do not have to be paid back when the company runs into losses at a later stage, we need a yardstick 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 longterm obligations have to be addressed. In the end, a combination of the balance sheet test and the solvency test seems to be a reasonable solution.