BHS was owed £6,177,000 by its shareholder RAL. The loan was repayable in instalments and if RAL failed to pay any instalments the whole sum, plus default interest, became payable. The loan instrument said, amongst other things, that set off was not permitted and that any amendments or variations to the loan instrument had to be made in writing. On 21 July 2016 a loan instalment of £100,000 became due and after RAL failed to make the payment BHS issued a winding-up petition.
RAL claimed that the set-off clause in the loan instrument should be "ignored": RAL was due monies from BHS under a management services agreement (MSA) and in practice these payments had been netted off at all times against the instalments due under the loan instrument. RAL argued that the practice was so extensive that the court should treat the no set-off clause as of "no effect". RAL did not give any evidence, other than an envisaged right of set off, that there had been a mutual mistake and the loan instrument should therefore be rectified. The judge found that from an objective standpoint the loan instrument represented the intentions of the parties and, therefore, the no set-off clause was binding, notwithstanding previous practice.
RAL argued that even if the no set-off clause was binding that it had a genuine and serious cross claim against BHS in relation to amounts due from BHS, under the terms of the MSA, which exceeded the amount of the instalments due. The judge acknowledged that this was a ground for striking out and dismissing a winding-up petition, however, in this case the cross claim would fail as the invoices which RAL relied on had been issued to another company within the BHS group. Set-off requires mutuality and here there was no mutuality because the parties to the claim and cross-claim were different.
Finally, RAL argued that it was not insolvent- the court disagreed. The judge found that it was settled law (following Eurosail) that the balance sheet test for insolvency and the cash-flow test stand side by side and that the cash-flow test looks to the near future as well as the present. The judge ruled that RAL had no present income stream from which to pay the monies due to BHS, and this could not be described as a "momentary inability to pay as a result of temporary illiquidity". RAL also owed a significant sum to Arcadia. Although it wasn't strictly necessary to rule upon whether RAL was balance sheet insolvent, after the finding of cash flow insolvency, the court went on to rule that RAL was also balance sheet insolvent as it was unable to provide sufficient evidence to substantiate the value of assets it claimed to have.
Sally Williamson is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com