Avoiding insolvency


 What you need to know about Business Rescue under the New Companies Act

South Africa is one of the few countries without a well-established business rescue regime. However, according to the Institute of Directors in Southern Africa (IoDSA), this is all set to change in April 2011 when the new Companies Act is scheduled to come into effect, giving directors an alternative to liquidation or judicial management, which has proven to be largely counter-productive when dealing with problem debtors.

“Business rescue is not a form of insolvency, rather it is designed to avoid it,” says non-executive director Nigel Payne, who writes on behalf of the IoDSA. “Companies will no longer be either alive or dead; there will be an additional state of business rescue, albeit of short duration.”

According to Payne, the draft Amended Act’s previous provisions have been modified and now appear to be workable, specifically having reversed the position where creditors could have been stripped of their rights, including the value of security, now making business rescue a more creditor-driven process.

“The proposed amendments reduce the risk that unscrupulous operators will be able to use business rescue to defraud their creditors, although credit contracts will still require clauses to provide protection in the event of business rescue,” he says.

Which companies qualify?

Companies qualifying for business rescue will have to prove financial distress, but with a reasonable likelihood of being rescued. Business rescue can be initiated by the company’s own board, which would then select a business rescue practitioner, or by a court following a petition by creditors, in which case the court would appoint the business rescue practitioner.

“The intention of business rescue is that it happens quickly – within three months, unless the court grants an extension – so that the rescued company can be returned to normal trading in a healthy state,” says Payne. “That means the choice of business rescue practitioner and court availability will be crucial to its success; but we’ve seen from the FIFA 2010 World Cup that our courts are able to react quickly when they put their minds to it.”

It’s all in the timing

According to Payne, directors will have to give careful consideration to business rescue as failing to act timeously could result in them being sued for not giving the company a chance to be rescued.

“Conversely, if the board procures business rescue in circumstances where there is no reasonable prospect of rescue, the directors could be charged with fraud and even held civilly liable for reckless trading,” he says, noting that business rescue relates to the company and does not interrupt any potential action against its directors or officers.

The requirement for the board to be satisfied that there is a reasonable prospect for a successful business rescue implies that the support of the major financiers and creditors, and perhaps even of a major customer, will have to be obtained in advance. “This provides the creditors with a measure of protection,” adds Payne. In addition, the amendments provide that the business rescue practitioner will only be able to suspend contracts for the duration of the proceedings, as opposed to cancelling them, (although this could be done by application to court) which at least protects the secured creditors.

Consequences of business rescue

The consequences of business rescue include a moratorium against any legal proceedings against the company, but do not introduce the provisions of insolvency, which prevents set-off, preferential payments and the like. “Creditors will also not be able to act against the property of the rescued company in their possession e.g. a cession of book debts,” he says. “Anyone who has guaranteed the debts of the rescued company may find the guarantee being called upon immediately, unlike in the case of suretyship.” Credit agreements are thus likely to be amended to seek guarantees.

Under business rescue the board is not divested of its powers as it is under insolvency, but the business rescue practitioner can instruct the board to take certain actions, in which case the directors would not be liable for the consequences of such actions.

Contracts will have to be carefully considered in the light of the potential for business rescue, including clauses that escalate potential future liabilities into current liabilities in the event of business rescue, thus enabling the creditor to vote on the business rescue plan. “The impact on your ability to claim under credit guarantee insurance should also be considered – it is likely the insurers will not be willing to pay whilst the debtor is undergoing business rescue,” he says. “But this could affect the timing clauses for a claim under your policy and may even affect how you will be able to vote on the business rescue plan.”

According to Payne, there will still be a place for liquidation, specifically where there is no reasonable prospect of a successful rescue, or where there is an impeachable transaction that would be set aside on liquidation, but only if this occurs within 6 months.

“Given the many implications, it should be apparent that directors and management need to urgently apply their minds to the business rescue proposals,” concludes Payne.

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