In a recent article for AIRA Journal, Boris J. Steffen examines the Ability-to-Pay Test, a key framework used in bankruptcy and fraudulent transfer litigation to determine whether a company could reasonably meet its financial obligations as they came due.
The test is rooted in the Bankruptcy Code’s goal of ensuring fair treatment among creditors and preventing debtors from improperly favoring certain stakeholders. It evaluates whether a company had, or reasonably believed it would have, sufficient resources to pay its debts as they matured.
Boris outlines two core components of the analysis. The subjective test examines what management knew or reasonably should have known about the company’s financial condition, while the objective test evaluates financial realities such as liquidity, leverage, payment history, delinquent obligations, collection activity, and cash flow performance.
The article also discusses the wide range of information considered in an ability-to-pay assessment, including budgets, forecasts, debt repayment schedules, capital expenditure plans, restructuring initiatives, financing arrangements, and other operational and financial data. Drawing on bankruptcy case law and guidance from the U.S. Department of Justice, Boris highlights how these inputs help advisors evaluate a company’s financial viability.
From a practical perspective, the analysis begins with assessing the reasonableness of management’s projections. Analysts then examine a company’s ability to service debt under multiple operating scenarios, testing how changes in performance, economic conditions, and financing assumptions may affect future liquidity. In certain circumstances, quantitative tools such as the Black-Scholes option pricing model can be used to estimate default risk and supplement traditional solvency analyses.
Ultimately, the Ability-to-Pay Test serves as an important tool for courts, creditors, restructuring professionals, and valuation experts in assessing solvency, evaluating fraudulent transfer claims, and determining whether a business had sufficient resources to meet its obligations.
Read the full article in AIRA Journal.