Articles

Chapter 6 of the South African Companies Act 71 of 2008 reviewed

Corporate Rescue and Insolvency August 2010
By Keith Braatvedt

South African Law has been based on a "creditor friendly approach". Inevitably, in terms of the creditor friendly approach the prospect of corporate rescue thinking does not exist and the emphasis is on liquidation and protection of the rights of creditors. Until recently, criminal sanctions (now repealed) existed for non payment of debts. The trend away from this approach began with the realisation that insolvency (bankruptcy) is a risk of capitalism and failure of a business enterprise must not be considered as a crime.

Rescue mechanisms in South Africa have existed for almost a century through the Companies Act provisions relating to judicial management (ss 427 to 440). The test is whether the company could surmount its difficulties and become a successful concern. Procedurally, the judicial manager was appointed by the Master of the High Court. This and the fact that the judicial managers in South Africa have emphasised the protection of creditors only led to very few judicial managements in South Africa being successful.

The emphasis has now moved to the development of a commercial process, through legislation, which will lead to a successful business rescue. Fundamentally, the huge shift in emphasis is to an administration of the distressed company, by itself, under the independent supervision of a "business rescue practitioner", appointed by the distressed company (or the court in certain cases) in terms of s129(3)(b).

The new Companies Act 71 of 2008 (Chapter 6 being called "Business Rescue and Compromise with Creditors") was signed by the State President in April 2008 and is expected (but nobody is sure) to come into effect in November 2010.

Shortly put, the legislation says that business rescue means proceedings to facilitate the rehabilitation of a company that is financially distressed by providing for: the temporary supervision of the company, and of its management of its affairs, business and property; the temporary moratorium on the rights of the claimants against the company.

The development and implementation, if approved, of a plan ("business rescue plan") to restore the company by restructuring the affairs, business, property and debt and other liabilities of the company, to maximise the likelihood of the company continuing in existence on a solvent basis or if this is not possible to obtain a better return for creditors or shareholders than would result from immediate liquidation of the company

This legislation is long overdue, everybody recognising that the existing corporate rescue statutory procedure is not performing and functioning properly. The Chapter 6 legislation is very detailed and complex. As one commentator correctly says, "…. the devil lies in the detail". I have heard critics saying that the legislation is unworkable and that it will only take a judgment of the High Court of South Africa to put paid to business rescue efforts. Leaders of business have told me that business rescue procedures, whatever their form, will not help a company that is hopelessly insolvent. Academics who are interpreting the legislation narrowly have come up with some startling conclusions and in some instances have declared the legislation to be totally unworkable. In my view, the critics are missing the point which is that the legislation is an important step forward and is nothing other than an attempt to provide a legislative framework to assist the normal day to day informal creditor workouts happening in the commercial world.

I cannot emphasise enough that the process is designed for economically viable business. A company that is commercially insolvent (cannot pay creditors in the normal course of business) or actually/balance sheet insolvent must be liquidated. The South African model must not be seen as a substitute for liquidation. The intention is for small to medium sized businesses to get a "breathing space" within which to operate, while enjoying protection from creditors and while operating under the control of the business rescue practitioner. This will allow a more flexible environment in which the company can operate.

The negative aspects of the legislation are striking and have lead to organisations contending that the legislation will drastically affect the sanctity of contracts in South Africa. Section 136(2) of Chapter 6 has potentially disastrous consequences. The section says that, "… during business rescue proceedings, the practitioner may cancel or suspend entirely, partially or conditionally any provision of an agreement to which the company is a party at the commencement of the business rescue period, other than an agreement of employment".

In accordance with the ordinary meaning of s136(2) the business rescue practitioner can "cherry pick" by deciding which provision of a contract will be cancelled and which provision will remain. Banks and secured lenders have emphasised to me that in terms of s136(2) the practitioner can then elect, in a loan agreement, to suspend payments to be bank while leaving in tact the provisions in terms of which the distressed company has the right to receive and use the loan capital – obviously a real and major concern.

The legislation specifies that a party to an agreement that has been suspended or cancelled can assert a damages claim. However, this would only be a concurrent claim.

There has been criticism regarding the appointment of the business rescue practitioner. Cynics have said that it is equivalent to "allowing the wolf to look after the sheep". The cynicism is based on the fact that the business rescue practitioner can be appointed by the distressed company. Furthermore, the legislation does not specify that the practitioner needs to have any experience in the field of operation of the distressed company. The powers of the business rescue practitioner are far reaching in that he has full management control of the company in substitution for the board of directors and pre-existing management (s140(1)(a)). If a well qualified, experienced and independent business rescue practitioner is appointed he can only effectively perform his functions by getting the co-operation of the board of directors. The legislation says that the business rescue practitioner can remove pre-existing management and appoint new management but has to apply to court to remove an existing director.

The legislation says that the existing directors are obliged to co-operate with the business rescue practitioner including the preparation of documents, information and delivery of all books or records. It will therefore be extremely difficult for the business rescue practitioner to operate effectively if there are ulterior motives or if the bona fides of existing management are in any way in question.

Commentators in South Africa have correctly said that the role of a business rescue practitioner is new and unique and commentators question how successful practitioners will be in the early years once the legislation comes into effect. The reason for this is that up to now the emphasis has been on judicial management and liquidation where the judicial managers and liquidators report to the Master of the High Court.

An interesting aspect is the fact that the business rescue practitioner can charge an hourly rate based on tariff but can also charge a contingency fee which the legislation says has to be reasonable, whatever that may mean.

Of course the challenge is for the Regulatory Board, which will be set up in terms of the draft regulations, to develop an accreditation process for business rescue practitioners. However, the timing period for this is two years which creates big challenges for the practitioners.

Critics have said that the practitioner has unfettered powers and can almost do what he likes. I believe that apprehension along these lines is unwarranted and unnecessary because s134(2) of the legislation, when dealing with the protection of property interests, says that the practitioner may not unreasonably withhold consent in terms of s134(1)(c), having regard to the purposes of the chapter (business rescue and compromise with creditors, the circumstances of the company and the nature of the property and the rights claimed in respect of it). It is important to note that the legislation says that "no person may exercise any right in respect of any property in lawful possession of the company, irrespective of whether the property is owned by the company, except to the extent that the practitioner consents in writing" (s134(1)(c)).

Another issue that is fundamental to the legislation is the funding necessary for the rescue. Business people correctly comment that no rescue plan can work unless there are proper plans in place for financing the rescue. Obviously, the banks and institutional lenders who are exposed must take a business decision on whether they will continue to finance. The ranking in this event is very important namely that the rankings in a business rescue scenario are different from a liquidation scenario. The legislation says that the business rescue practitioner's remuneration ranks first. Thereafter, the claims that arise out of business rescue proceedings rank next. After this, the ranking is post commencement finance which include unpaid employees whose contracts are not terminated (as in the case of liquidation) but continue after the distressed company has been placed in to rescue. Thereafter the secured claims and finally the unsecured claims would be paid.

This change in ranking has clearly created concern. Personally, I am of the view that a very low business rescue success rate can be expected until there has been a change in thinking and the mechanics and practicalities of business rescue in terms of the South African legislation is better understood. Furthermore, as I have said earlier, the legislation is extremely detailed and there are huge interpretational problems which can lead to lengthy and costly litigation which could ultimately defeat the object.

There has been much talk about "pre-packaged business rescue". This would take place when all the affected parties are in fact on the same page and through the co-operation of the banks and institutional lenders the funding issues have already been decided. The advantage to this, of course, is that the business rescue plan can be voted on and implemented having in mind the economic viability of the company and not the preservation of the interests of the various affected persons.

The model is similar to the administrator in the UK and Australia but in my view the Chapter 6 South African legislation cannot and should not be compared to the Chapter 11 legislation in the US because the cornerstone of Chapter 11 in the US is that management remains in control whereas the South African legislation specifies that the business rescue practitioner takes over management in substitution of the board of directors.

The company's resolution to begin business rescue may not be adopted if liquidation proceedings have been initiated by or against the company. If liquidation proceedings have been instituted by or against the company and an application (to court which is the second method of putting a company into business rescue) is brought, the liquidation proceedings are suspended until the business rescue application is finalised.

Most importantly, if any affected party believes that there is no prospect of rescuing the company that affected party (either a creditor, shareholder or trade union/employee) may apply to court for an order setting aside the resolution taken by the company on the basis that it is not reasonable that the company is financially distressed or that there is no reasonable prospect of rescuing the company. In such an application the court may set aside the appointment of the practitioner on certain grounds and in addition if the court considers that it is just and equitable to do so. In this event, the court can make such appropriate order including placing the company under liquidation.

This is a particularly important part of the legislation because it can be used by affected parties where there is no prospect whatsoever of rescuing the company and the appointment of the practitioner and the intention behind the rescue effort is lax bona fides and will never succeed.

Apart from s136(2) there are other negative aspects to the legislation. However, a positive approach is to view the legislation as an aid to the long accepted practice of trying to rescue ailing companies in the commercial world.

It must be remembered that the business rescue practitioner is an "officer of the court". To this extent the process is court driven and the actions of the business rescue practitioner ultimately can be judicially tested. One of the most important criteria is to see what role the South African courts will play in the development of what I consider to be a positive piece of legislation.

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