Balance Sheet Tests or Solvency Tests - Or Both?
Max Planck Institute for Tax Law and Public Finance, Department of Business and Tax Law
European Business Organization Law Review (EBOR), Vol. 7, 2006
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 don't have to be paid back when the company runs into losses at a later stage, we need a measuring rod 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 long-term obligations have to be addressed. In the end, a combination of balance sheet test and solvency test seems to be a reasonable solution.
Keywords: company law reform, distributions, dividends, accounting law, creditor protection, legal capital, balance sheet, solvency test
JEL Classification: K20
Date posted: February 19, 2007