Business rescue assessment in the Covid-19 era

According to Rory Voller, the Commissioner of the Companies and Intellectual Properties Commission (CIPC), as at 13 May 2020, which at the time many did not realise was still the early days of the pandemic, more than 150 companies had already applied for business rescue since the start of 2020, which number has likely increased.

While the role and purpose of a modern company is the subject of ongoing debate, it is trite that a primary objective of a company remains to maximise profit. In circumstances where a company experiences a decline in profit, the company may face the prospect of having to close prematurely.

Such a premature closure has a negative effect on the community in which the company operates and on the economy as a whole, and will result in job losses which, in turn, is detrimental to the socio-economic well-being of South African society.

Against this backdrop, Adams & Adams law firm associate attorney Cohen Grootboom assessed whether the business rescue procedure in chapter 6 of the Companies Act, 71 of 2008 (the Act) has effectively achieved the purpose of the process as set out in section 7 (k) of the Act to “provide for the efficient rescue and recovery of financially distressed companies, in a manner that balances the rights and interests of all relevant stakeholders”.

The assessment is conducted by considering the purpose and underlying rationale for business rescue. Grootboom then briefly compared the respective focus of businesses rescue with its predecessor judicial management, as well as liquidation proceedings.

This is followed by an analysis of the effect of business rescue on the different categories of stakeholders and Grootboom’s conclusion that, although various faults can be identified with the business rescue process, the stated purpose of section 7(k) is indeed effectively achieved during business rescue proceedings.

Some of his findings are listed below.

 Rationale for Business Rescue

In considering whether the business rescue procedures achieve a specific purpose of the Act, it is useful to first enquire on the purpose and underlying rationale for business rescue itself. The provisions dealing with business rescue proceedings are mainly contained in chapter 6 of the Act, which defines business rescue as “proceedings to facilitate the rehabilitation of a company that is financially distressed”.

The Minister of Trade and Industry, Ebrahim Patel, explained the rationale for business rescue as follows:

“[the Act] introduces the principle that the idea of business rescue schemes rather than summary liquidation are more preferable, with the idea in mind that it is better to try and save a business in distress rather than summarily close it down because creditors exceed debtors, the possibility of restoration being more equitable for all interested parties than the current somewhat immediate, maybe too early in some instances, brutal settlement and distribution process.”

“Rescue” in this context refers to the reorganisation of the company to restore its profitability and avoid liquidation.

The effect of the provisions of chapter 6, is that if a company faces financial distress, and there is a reasonable prospect of salvaging the company, rehabilitation may be facilitated through filing for business rescue, the implications of which include:

• The management of the company is placed under the temporary supervision of a business rescue practitioner
• There is a temporary moratorium on the rights of claimants (creditors, employees) against the company; and
• A proposal to rescue the company must be developed and implemented.

However, it is essential that there be a reasonable prospect of success and the proceedings must be instituted timeously.

A critical criterion for the instituting of business rescue proceedings is that the company concerned must be ‘financially distressed’ which is defined in section 128(f). The definition essentially contemplates that a company must not be in a position to meet, or must have a difficultly paying off its financial obligations to its creditors.

Business recuse is a relatively new concept in South African jurisprudence, having first been introduced in 2011 with the promulgation of the Act. Prior to 2011, a company that was financially distressed was mainly required to either undergo judicial management or liquidation, both of which were generally creditor – as opposed to debtor oriented.

Judicial management is a method of debt restructuring where an independent judicial manager is appointed to manage the affairs, business and property of a company under financial distress. Judicial management was governed by the Companies Act 1973 and was abolished, as it was found to be largely ineffective, and was replaced with business rescue in terms of the Companies Act 2008.

The objective of liquidation proceedings is fundamentally different from that of business rescue proceedings. Liquidation proceedings are not aimed at rescuing a financially distressed company, but rather to permanently bring an end to the company.

Business rescue shifts the focus from a primarily pro-creditors interest approach to a much broader range of interest.

This is not to say that business recuse does not have its own shortcoming, especially the manner and extent to which it is currently being implemented in South Africa. Some of the criticism of business rescue include difficulties in raising post-commencement finance; the process is prone to abuse by creditors, rescue practitioner or even the companies themselves; and there is still a relatively low success rate.

 

Section 7(k)

The purpose of the Act is set out in section 7.  Section 7(k) can be described as one of the subsections which contain the “human rights” element.  Although the restoration of profitability lies at the heart of the business rescue process, the Act, through the provisions of section 7(k) also endeavours to protect and balance the, often competing, interests of the various stakeholders. Section 7(k) provides that one of the purposes of the Act is to “provide for the efficient rescue and recovery of financially distressed companies, in a manner that balances the rights and interests of all relevant stakeholders”

 

The concept of “stakeholders” is not defined in the Act, and it submitted that the ordinary meaning should be attributed to the word, read together with the definition of “affected person” in terms of section 128(1)(a) which includes shareholders, creditors, and employees. With this in mind, it is useful to consider the effect of business rescue proceedings on each of these categories of stakeholders in order to determine whether this process has effectively taken the interest of these stakeholders into account.

 

Interest of Stakeholders

Employees

One of the primary objectives of business rescue is to preserve employment. Importantly, employees of the company who are employed immediately before the proceedings commence will continue to be employed on the same terms and conditions, save to the extent that there are changes in the ordinary course of attrition or the employees and the company agree different terms and conditions, in accordance with applicable labour laws.  With reference to retrenchment proceedings, any retrenchment of employees contemplated in a business rescue plan is subject to certain provisions of the Labour Relations Act, 1995 and other relevant employment-related legislation.

Furthermore, in terms of section 31(3) of the Act, trade unions are also entitled, through the CIPC and under conditions as determined by the CIPC, to be given access to company financial statements for purposes of initiating a business rescue process in respect of the company. The above interests of employees are not subordinate to the maximisation of creditors’ wealth.

In the light of the above, and the further rights which employees are vested with in terms of section 144 of the Act, there can be little doubt that the business rescue procedure prescribed by the Act has significant regard to the interest of employees.

 

Creditors

The introduction of business rescue ushered in a broader stakeholder-oriented approach, as opposed to the creditor-oriented approach of judicial management. However, the Act still endeavours to ensure that creditor’s rights are not overlooked in a way that would undermine the core principles and purposes of the Act. Unlike judicial management, business rescue does not require the company to be restored to solvency. The aim of business rescue is to dispose of the company for the maximum value as a going concern in order to fully benefit all interested stakeholder.

Section 7 should not be interpreted as supporting an interpretation leading to the acceptance of a business rescue plan at all costs.

The court does not simply rubber-stamp the business rescue process, but critically considers a wide range of factors.

 

Shareholders

Shareholders are affected persons with direct and indirect interests in the affairs of the company in terms of the Act. In terms of section 137(1), the classification or status of any issued securities of a company may not be altered during business rescue proceedings, save to the extent the court directs otherwise. Securities may, however, be transferred in the ordinary course of business, which will enable normal share trading to continue. Although shareholders do not play a vital role in the approval of the business rescue plan, especially where their rights are not altered by the recuse plan, it is argued that shareholders stand to gain the most if the distressed company is successfully reorganised or if its profitability is restored, in that the shareholders benefit from the increased value of the shares in the company.

With regards to the directors of the company, they continue to exercise their functions as directors during the proceedings, but in terms of section 137(2), subject to the practitioner’s authority.

 

 Contracts in general

A final aspect that should be noted, relates to the treatment of contracts generally. The provisions of section 136(2) read with section 136(2A) confers the business rescue practitioner with the right to cancel or suspend any provision of an agreement to which the company is a party when the proceedings commence, entirely, partially or conditionally, despite any contrary provision in the agreement. A party to an agreement that has been suspended or cancelled (or where any provision has been suspended or cancelled) may pursue a claim against the company for damages only.

The purpose of these provisions is to assist the practitioner where a contractual obligation of the company cannot be fulfilled, or it is difficult for it to do so, and the progress of the business rescue proceedings and the rescue plan will be aided by cancelling or suspending the obligation and converting it into a monetary claim.

The idea behind section7(k) is that it would be more beneficial to the company, its shareholders, creditors, and employees to preserve the business together with the experience and skill of its employees in achieving either of the objectives set out in the Act. From the above, therefore, it is clear that the Act requires the business rescue practitioner to consider a wide array of factors, precisely as required in terms of the provisions of Section 7(k). In other words, when implementing the rescue plan the business practitioner must take into account the effects of the plan, inter alia, on employees, creditors, shareholders and the company.

In these circumstances, Grootboom said the business rescue procedure in chapter 6 effectively balances the rights and interests of the relevant stakeholders as required by section 7(k).