Solvency test

What it means

The solvency test is an assessment the statutory body must carry out before any payment to shareholders, particularly before paying a profit share or an interim dividend, returning an additional contribution from capital funds or reducing share capital. The Commercial Code prohibits such a payment if it would cause the company to become insolvent.

Insolvency means either inability to pay or over-indebtedness. A company is unable to pay if it cannot meet its money obligations to more than one creditor when due, and over-indebted if its liabilities exceed the value of its assets. The test therefore looks not only at accounting profit but also at liquidity and future cash flows.

The solvency test differs from the capital test, which checks whether equity will remain above a set threshold after the payment. Both conditions are assessed together. Profit in the financial statements is a necessary condition for a payout but not a sufficient one: a company can be profitable and still lack cash for debts falling due.

How it works in practice

Before a payout we recommend drawing up an overview of liabilities due in the coming months, expected receipts and available resources, ideally a cash flow forecast for at least 12 months. On that basis the director judges whether the company will still pay on time after the payout. The assessment should be recorded in writing and attached to the profit distribution resolution.

For interim dividends the test is especially important, because payment is made before year-end and the profit is not yet final. Likewise in groups, where the parent often draws cash from subsidiaries, the test must be carried out for each company, not just for the group.

If a payout proves unlawful, shareholders must return what they received. Directors are liable for the damage caused, and in a subsequent bankruptcy their conduct is examined closely. Documenting the test therefore also protects the director.

What to watch out for

The most common mistake is paying out the whole profit right after the financial statements are approved, regardless of the current situation. The statements are months old, and liquidity may have worsened or new liabilities appeared in the meantime. The test should be done as of the payment date, not the balance sheet date.

Beware of hidden distributions too, such as loans to shareholders on unfavourable terms, buying assets from a shareholder at an inflated price or paying for services not provided. These may also be restricted, and in insolvency the bankruptcy trustee will challenge them.