Solvency and Liquidity Test
Also known as: S&L Test, Solvency Test, Liquidity Test, Section 4 Test.
What is Solvency and Liquidity Test?
The solvency and liquidity test is the statutory threshold under Sections 4 and 46 of the Companies Act 71 of 2008 that a company must pass before making a distribution, share buy-back, or financial assistance. The company must be able to pay its debts as they become due (liquidity) and its assets must equal or exceed its liabilities (solvency).
Drafted and reviewed by
Attorney & Founder, My-Contracts.co.za · Legal Practice Council of South Africa (LPC F17333)
Definition and context
The solvency and liquidity test is a cornerstone of the Companies Act 71 of 2008, replacing the narrower "distributable reserves" test of the 1973 Act. Under Section 4, a company satisfies the test if, immediately after the relevant transaction, (1) the assets of the company, fairly valued, equal or exceed the liabilities of the company, fairly valued (the solvency limb); and (2) it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months thereafter (the liquidity limb). The board must consider all reasonably foreseeable financial circumstances at the time of the assessment.
The test gates a wide range of corporate actions. Section 46 prohibits any distribution (dividend, return of capital, share buy-back, or incurring of a debt toward shareholders) unless the board has acknowledged by resolution that the test has been applied and that the company reasonably appears to satisfy it immediately after the distribution. Section 44 applies the test to financial assistance for the acquisition of securities in the company or its related bodies; Section 45 applies it to loans or other financial assistance to directors or to related companies. Failure to satisfy the test renders the transaction voidable and exposes directors to personal liability under Section 77 for breach of fiduciary duty and the solvency-and-liquidity requirements.
In practice, the directors' solvency-and-liquidity resolution is the critical compliance document. Best practice is to attach the last audited or management financial statements; a forward-looking 12-month cash-flow forecast supporting the liquidity limb; a note of any material contingent liabilities; and confirmation that no reasonably foreseeable adverse event has been excluded. The test must be re-applied immediately before each distribution, not relied upon from an earlier assessment. Directors' fiduciary duties under Section 76 require independent assessment — reliance on management representations alone is insufficient if directors had reason to doubt their accuracy. Where a distribution breaches the test, Section 77 makes directors jointly and severally liable for any resulting loss to the company.
Where this term lives in law
Companies Act 71 of 2008
Sections: 4, 44, 45, 46, 76, 77
Governs the incorporation, governance, and winding-up of companies in South Africa.
Frequently asked questions
What is the solvency and liquidity test under the Companies Act?
Section 4 of the Companies Act 71 of 2008 requires two limbs: (1) solvency — the fairly valued assets of the company must equal or exceed the fairly valued liabilities; and (2) liquidity — the company must appear able to pay its debts in the ordinary course for 12 months after the transaction. Both limbs must be satisfied; a transaction that meets one but not the other fails the test.
Which transactions require a solvency and liquidity test?
Distributions including dividends and share buy-backs (Section 46), financial assistance for the purchase of securities (Section 44), loans or other financial assistance to directors and related companies (Section 45), and certain share issues and schemes of arrangement. Each requires a fresh board acknowledgement that the test has been applied.
What happens if directors breach the solvency and liquidity test?
Under Section 77 of the Companies Act, directors who authorise a distribution or financial assistance in breach of the test are jointly and severally liable to the company for any resulting loss, damage, or costs. The transaction itself may be void or voidable. Directors may also face disqualification under Section 162 and personal liability to creditors in insolvency proceedings.
Can directors rely on the auditor's view of solvency?
Directors may have regard to advice from the auditor or CFO, but the statutory duty under Section 4 is the board's own — directors cannot delegate the assessment. Independent interrogation of the cash-flow forecast and balance sheet is required. Under Section 76(5), a director may rely in good faith on information from competent internal advisors, but not where circumstances suggest reliance is unreasonable.
Contract templates using this term
4 templates reference Solvency and Liquidity Test.