As with all things in life, not everything in business is always smooth-sailing. A company or entity may find itself in financial distress due to any number of cumulative and individual reasons. The business rescue procedure, introduced by the Companies Act 71 of 2008 (“the Act”), may provide a way to overcome dire financial circumstances through time and a more cautious approach to management.

The business rescue route may provide flailing companies with a much needed lifeboat- an opportunity to restructure, reorganise and streamline its affairs and arrangements with its creditors and simultaneously save many jobs, allowing it to continue as an economically viable entity.

However, whilst the Act may have the right intentions, business rescue may not be as effective as the legislature intended. This article explores some of the shortcomings of the business rescue process.

A brief look at Business Rescue
The Act provides a stay on all liquidation and/or other legal proceedings against a company undergoing business rescue. This temporary postponement of any current or pending litigation often has wide-ranging consequences on the company’s employees, creditors and various other stakeholders.

Essentially, the business rescue process aims to place the company under the temporary supervision of a business rescue practitioner who will temporarily attend to the management of its affairs, undertakings and property. This supervision is combined with the abovementioned temporary suspension on legal proceedings and the implementation of an approved business rescue plan with an objective of restructuring the company’s affairs, assets, equity and debts and liabilities.

Qualification for Business Rescue
The Act defines “financially distressed” as a company that, at any particular time, appears reasonably unlikely to pay its debts as and when they become due and payable in the ensuing six months. This is also referred to as commercial insolvency. The term is also applicable to a company that will immediately become insolvent during the course of the ensuing six months, also referred to as factual insolvency.

A crucial requirement for a company to be eligible for the protection business rescue affords is its ability to prove reasonable prospects of recovery.

Companies are placed under business rescue in one of two ways:-

1. voluntarily by way of a special resolution of the board of directors; or
2. by way of an formal application to a High Court made by an affected person.

The Act defines “affected person” as a shareholder, employee (or registered trade union representing employees) or creditor of the company, or any person with a vested interest in the company. These persons are afforded various rights throughout the rescue process.

The Appointment and Powers of a Business Rescue Practitioner
Section 138 of the Act provides for the appointment of a business rescue practitioner. It sets out that the practitioner should be a person of good moral standing with an astute financial background. Further, the practitioner should not have any conflicts of interests with the company concerned and should preferably be in the accounting, legal or business management profession. This specification has been criticised where the company in need of rescuing is one in a highly specialised field of expertise. For instance, a practitioner who has a legal, accounting or business background will not necessarily have the requisite skill and knowledge to fully understand the intricacies and manage the affairs of a mining company.

Generally, though, companies undergoing business rescue are categorised as large, medium or small and the size of the company determines the experience and seniority of the practitioner appointed. This categorisation is done according to Regulation 127 of the Regulations to the Act (2011). Arguably, the size of the company should not determine the seniority of the practitioner, but rather the complexity of the business it conducts.

There are a vast array of duties placed on a business rescue practitioner, which all aim to further his/her principle job of attempting to reduce the burden and debt the company currently faces. The practitioner is required to conduct inquires and investigations into all of the company’s financial affairs, business operations and property and consider whether or not the company has reasonable prospects of success.

The practitioner is also required to draft a business rescue plan, which will then be voted for or against by the secured creditors of the company. If and when the plan is approved, the practitioner must then supervise its implementation.

The business rescue practitioner is required to notify the court, company and affected persons if there is no reasonable prospects that the business rescue procedure will be successful. Conversely, the practitioner is obliged to notify all parties if the opposite is true, ie. that the company is no longer in financial distress.

Additionally, if the practitioner discovers evidence of voidable transactions conducted by the company prior to rescue proceedings, or if the company or one of its directors have failed to perform a material obligation relating to the company, he/she is required to bring it to the attention of senior management and supervise the rectification thereof.

The practitioner is obliged to alert all abovementioned interested and affected parties if he/she unearths any evidence of fraud, conflicts of interest, reckless trading or any other contravention of the laws and, further, to forward any and all evidence of such activities to the appropriate authorities. Again, it is necessary for the practitioner to bring it to the attention of senior management and supervise the rectification thereof.

Along with the numerous duties placed on practitioners, the Act also gives them extensive power. Not only is the practitioner considered an officer of the court, he/she also is afforded power that, for all intents and purposes, is equivalent to the full control and management of the company. He/she may also delegate various functions to any person previously part of the pre-existing management, or even a director. Furthermore, the practitioner has the power to appoint and remove any person related to the management of the company, though in some instances they may need to approach a court for approval.

The effects of Business Rescue
The interests of employees during business rescue are regulated by section 136 of the Act which provides that all employees employed prior to the commencement of proceedings shall remain employed on the same terms, with the exception of where differing terms and conditions were agreed upon by the employee and the company and compliant with South African labour laws.

Many have criticised the fact that, by and large, the position of directors and shareholders remains the same during business rescue. During the proceedings, any alteration in the issued securities of the company is only valid by way of court order. This is not applicable, however, to any transfer of securities during the ordinary course of business.

In terms of the effect of business rescue proceedings on creditors, they need to comply with their obligations and supply goods and services and in the same manner as prior to proceedings. This is done under the supervision of the business rescue practitioner. Creditors are obliged to fulfil their obligations unless an agreement exists that regulates the relationship between the company and the creditors in the event of future insolvency or business rescue.

That being said, it is understandable that the unsecured creditors of a company undergoing business rescue proceedings would be cautious and wary of continuing to supply goods and provide services in the same manner as before, as their claims would only be settled after those of preferential creditors.

Arguably, however, it was the intention of the legislature that our law move away from a more creditor-favoured approach and that the provisions in Chapter 6 seek to balance the interests of all relevant stakeholders in the company. This, for the most part, has been apparent through extensive judicial interpretation. Subsequently, our courts are less than tolerant of abusive or misleading business rescue applications that are brought merely as a delay tactic and an attempt to stave off inevitable liquidation.

This, however, was not always the case.

Swart v Beagles Run Investments 25 (Pty) Ltd 2011 (5) SA 422 (GNP)
In one of the first cases dealing with business rescue, the North Gauteng High Court was tasked with considering a compulsory business rescue application in terms of section 131 of the Act.

The sole director and shareholder of the respondent company had applied for an order to place the company under business rescue. He alleged that, although the company was in financial distress as defined in Chapter 6 of the Act, he needed time to dispose of several of its assets in order for it to pay all of its creditors off in full.
A number of the company’s creditors intervened and opposed the application, citing that the respondent director’s conduct constituted an abuse of the business rescue process and, further, that it amounted to an attempt to delay, or avoid outright, the payment of the company’s debts. It was also alleged that the company had been partaking in reckless trading for some time.

Despite the Court correctly identifying and interpreting the aspects of the present matter in need of consideration and attention, it concluded that when weighing up interests of various stakeholders, as the Courts are required to do, the interests of the creditors should prevail.

The Court went on to state that, when determining whether an applicant company or affected person meets the requirements under section 131 of the Act, the new business rescue procedure in Chapter 6 is “a new innovation and without precedent in our law, in particular with regard to case law”. Unfortunately, in an effort to find guidance, the Court looked to the provisions of the Companies Act 61 of 1973 (“the Old Act”) that set out judicial management under section 427. This, regardless of the fact that Chapter 6 of the Act makes no mention of the term judicial management, nor is it a requirement under business rescue proceedings.

Despite this unfortunate interpretation and, with all due respect, lapse in judgement, the Court ruled against the business rescue application and rightfully found that it had constituted an abuse of process as discussed above.

Sinking Ships – Business Rescue in need of modification?
Many critics have argued that South African business is not as mature as its overseas counterparts in that the common perception is that the necessity of restructuring is a mark of failure. It is submitted that a large number of business rescue procedures have fallen short of the mark due to the companies in question waiting too long to attempt it. This could be due to underhanded reasoning, or perhaps merely the fear of losing control in the process.

While most would agree that the business rescue approach is a significant improvement when compared to judicial management, there is, arguably, room for improvement. One such issue is the timelines given to practitioners for their investigations, reporting and drafting of business rescue plans. Another issue relates to abuse of the process and delaying inevitable liquidation, as discussed above.

It has been argued that, notwithstanding the overall effectiveness of business rescue, an opportunity still remains for tweaking and amendments to the legislation. The success of business rescue may depend on the judiciary and its interrogation of the conditions in which individual companies find themselves on a case by case basis.

To a large extent, many of the issues of concern prior to the commencement of the Act, and Chapter 6 in particular, have already been interpreted and resolved by our Courts. These include the fact that the moratorium of legal proceedings does not apply to sureties and that SARS is not a preferential creditor in business rescue.
In his thesis written for an LLD in business rescue, Eric Levenstein puts forward some compelling suggestions regarding improvements to business rescue proceedings.

One such amendment is the need for business rescue practitioners to conduct a pre-assessment exercise to determine the likelihood of success of the business rescue, before actually embarking on it and incurring further costs on behalf of the company.

After the pre-assessment exercise, the practitioner should then report his/her findings to all of the stakeholders concerned. This would, arguably, alleviate pressures placed on practitioners and directors alike in that it would mean the directors would only have to decide on whether or not to proceed with business rescue. This would also ensure the process is more efficient and alleviate time-constraint related pressures.
An independent pre-assessment report would place the board of directors in far better stead in the determination of the necessity of business rescue.

A further suggestion is in relation to an analysis of the exact financial circumstances of the company conducted by a team comprised of legal and accounting practitioners to determine whether or not it is in actual financial distress and for this team to compile a peremptory report and submit this report to all stakeholders.

Another recommendation is for potential and current practitioners to engage in formal training and accreditation in conjunction with the Commission for Intellectual Property and Companies (CIPC). Initiatives such as these may assist in improving the standard and quality of practitioners and may go even further and incentivise and encourage experts in specialised fields to become licensed business rescue practitioners.

To ensure a quick assessment of the financial circumstances, it is further suggested that amendments to the legislation should allow business rescue practitioners to question and interview the company’s directors, management, staff and any other relevant person in order to assist him/her in their investigation into the company’s affairs. This could assist the practitioner in determining whether the company’s financial distress was due to bad management or other factors.

CIPC’s role should also be enhanced in order for it to effectively manage applications with appropriate scrutiny regarding the reasonable aspects of the company’s rescue. Policing and supervising of dishonest, inept and incompetent practitioners is also required.

Clarification is also needed regarding post-business rescue financing. Arguably, the entity or individual who provides capital to a company undergoing business rescue should be ranked as a preferential creditor. Notwithstanding numerous judgements regarding business rescue, this remains an area of uncertainty.

Conclusion
The implementation and interpretation of business rescue procedures has, thus far, been above board. However, with slight amendments and a bit of tweaking, the procedure could be even more efficient and, perhaps, the wind in the sails of a sinking company.

Written by Robyn Smerdon, Bouwer Kobeli Morabe