Introduction

A new Companies Act (Act 71 of 2008) as amended (“Act”) became operative in our law on 1 May 2011. This Act introduced some novel provisions into our law – among them business rescue.

The business rescue provisions of the Act are designed to facilitate the rehabilitation of a company that is financially distressed by providing for:

• the temporary supervision of the company, and the management of its affairs, business and property, by a business rescue practitioner in substitution for the company’s board and prior management;
• a temporary moratorium (stay) on the rights of claimants against the company or in respect of property in its possession;
• the development and implementation, if approved, of a business rescue plan to rescue the company by restructuring its affairs.

There are two objectives which need to be met for a business rescue to be granted. The affairs of the company either need to be restructured in an attempt to ensure that the company continues to trade on a solvent basis or, failing this, the business rescue must at least provide a better return for the stakeholders of the company (i.e. creditors and shareholders) than would ordinarily result from a liquidation of the company.

Opportunities

With business rescue now more common in South Africa, we have seen increasing interest from venture capitalists, private equity funds and foreign investors in the business rescue space. The aforesaid entities are particularly interested in positioning themselves in order to possibly identify distressed assets that could be acquired through the business rescue process.

As an emerging market, South Africa offers opportunities for foreign and local investors and distressed funds to consider the purchase of valuable assets that might become available at heavily-discounted prices as a result of a company’s financial distress.

The business rescue process is fast becoming a mechanism for cash flush companies to take up opportunities by identifying valuable assets in distress, engaging with the business rescue practitioner and working towards the acquisition of either the company or its assets. The final acquisition proposal is what is ultimately placed in a business rescue plan and put to the vote by creditors and shareholders (the latter only if their rights are affected).

The transactions that one can conclude during business rescue vary. The business rescue practitioner may put forward a proposal to rescue the company. This may involve a sale of the assets of the company, a sale of the business of the company or a sale of shares of the company.

Industry examples

We have recently seen a Chinese company acquire a new satellite television station, TopTv, and the acquisition by Paramount of South Africa’s oldest aerospace company, Advanced Technologies and Engineering (ATE), through business rescue. Other acquisitions have occurred in various sectors with a large retail apparel group, Meltz, having been acquired out of business rescue. Cape Town-based golf estate Pearl Valley exited from business rescue after having been successfully acquired through the mechanisms available in the business rescue process. There are many other business rescues in the pipeline where similar transactions are currently being negotiated; particularly in the mining sector.

These acquisitions have resulted in the market and stakeholders (including creditors) becoming confident in the business rescue process and the ability for business rescue to be a real and viable option for parties that seek strategic acquisitions in South Africa of good value assets with significant upside for the acquirer.

The business rescue process is one which requires an early identification of a distressed asset, the immediate availability of cash to fund the acquisition, as well as a commitment to propping up the company by introducing funding to pay ongoing expenses and overheads while the company is going through its restructuring and acquisition process related to business rescue.

Business rescue thus provides new opportunities for merger and acquisition activity in South Africa. From our experience, it is common for third parties to acquire shares in the distressed company. In such an instance, the shares are often sold for nominal value, with funds made available to pay creditors’ claims at a reduced and compromised amount (higher than liquidation value). More often than not, the third party which acquires the shares of the company in distress is often able to acquire valuable assets at discounted prices.

Entry into business rescue

A company can be placed under business rescue in two ways; voluntarily, by the passing of a resolution by the board of directors of a company (by simple majority) or compulsorily, with an application to court by any affected person (i.e. employee, trade union, shareholder or creditor) of the company. With regard to the latter, if there is no reasonable prospect of rescuing the company the court may dismiss the application and place the company in liquidation.

When to apply for business rescue

Suitable candidates for business rescue are companies that are “financially distressed” and who have “reasonable prospects” of being rescued.

Financial distress

The test for business rescue, born of the definition of “financial distress”, is a forward-looking test, being whether or not the company will become commercially insolvent (i.e. unable to pay its debts when they fall due) or factually insolvent (i.e. its liabilities exceed its assets) in the ensuing six months. From the test, it is clear that business rescue is concerned with impending insolvency and not current insolvency. If a company is already insolvent, business rescue is not appropriate and the company should be placed into liquidation.

Reasonable prospects of success

Furthermore, the company must be capable of being rescued. This means that the company must be able to achieve one of the two outcomes of business rescue referred to above. Whether a company commences business rescue voluntarily (i.e. by passing a board resolution) or following an application to court (i.e.by an affected person), one must be able to illustrate why there is a “reasonable prospect” of rescuing the company.

In considering business rescue applications, our courts have provided guidance as to what is required in order to show that there is a “reasonable prospect” of rescuing a company. It has been held that for there to be a “reasonable prospect” of rescuing a company, one ought to indicate the cause of the demise of the company and provide the makings of a reasonable rescue plan. In support of this, one would need to provide concrete and objectively ascertainable facts, which facts are beyond mere speculation, indicating that the remedy proposed is reasonable and sustainable.

Directors and business rescue

When a company is “financially distressed”, directors are obligated to consider either passing a resolution to place a company under business rescue or publishing a section 129(7) notice.

A section 129(7) notice (as it is commonly known) is a notice in which a company effectively publicises that notwithstanding its “financial distress”, it believes, for the reasons delineated in the notice, that it is not necessary to pass a resolution for the commencement of business rescue. Careful consideration should be given when sending out this notice as it may give rise to unintended consequences (i.e. potentially an “Act of Insolvency”)

Business rescue is relevant to directors in that they can be held personally or criminally liable for their conduct. One such instance in which a director may be held liable for his or her act or omission is if the director conducts the company recklessly, with gross negligence, with intent to defraud or for a fraudulent purpose. A failure by a director to place a company under business rescue when the company is “financially distressed” may fall within the ambit of either of the aforesaid.

Important features of business rescue

Moratorium

One of the most important elements of the business rescue process is the moratorium imposed on the institution of legal proceedings. The Act makes provision for a general moratorium on legal proceedings, including any enforcement action, against a company, or in relation to any property belonging to the company, or lawfully in its possession, during business rescue proceedings.

The moratorium is designed to provide the company with time while the business rescue practitioner attempts to rescue the company through the preparation and implementation of the business rescue plan. Without this element, a creditor would be able to enforce its rights during the process or apply for the liquidation of the company. This would be in conflict with the very spirit and purport of business rescue proceedings and is accordingly not permissible in terms of the Act.

Post-Commencement Finance and interim funding

During business rescue, funding may be generated from various sources including, but not limited to:

• loans from shareholders;
• funding from current financiers or lenders of the company;
• new funding from new financiers or lenders;
• new funding from services rendered by current employees or suppliers of the company during the company’s business rescue.

All of the aforesaid would constitute Post-Commencement Finance (“PCF”), a new concept introduced by the Act. The Act distinguishes between two types of PCF: that which becomes due and owing to employees for rendering services to the company during business rescue, and funding which is provided to a company during the company’s business rescue by means unrelated to employment.

Some of the benefits of providing PCF include the fact that:

• it provides financiers with a measure of control over the process in that if there is no PCF, the company will not be in a position to trade during business rescue and will need to consider options other than business rescue, such as liquidation;
• it may be provided to the company in distress in exchange for security taken over unencumbered assets of the company. PCF funders are generally considered to rank in priority to the claims of previously-secured creditors and unsecured creditors, but behind the claims of the practitioner and the employees for services rendered during business rescue;
• it will be paid in preference to the claims of unsecured PCF and in the order incurred;
• the order of preference will remain in place, even if the company is placed in liquidation.

Adoption of a plan

A business rescue plan must be approved by creditors, and if necessary, by shareholders if their rights are affected. Once the plan is approved, the plan is implemented by the business rescue practitioner. The plan will provide details of the manner in which the practitioner envisages that the company will be rescued. A business rescue plan might include the proposal made by the third party acquirer of the shares, assets or business of the company in distress, or will contain a plan proposed by the practitioner for rescuing the company.

A proposed business rescue plan will be approved on a preliminary basis if it is supported by the holders of more than 75% of the creditors’ voting interests that were voted. Of the aforesaid votes, 50% of the votes must be cast by independent creditors. Broadly speaking, a creditor is independent if it does not wholly own or control the company in distress.
Exit from business rescue

Business rescue proceedings will end when:

• a court sets aside the resolution or order that began the business rescue proceedings;
• a court converts the business rescue proceedings into liquidation proceedings;
• a business rescue practitioner files a notice of termination of business rescue proceedings with the companies office;
• a business rescue plan has been -

(i)           proposed and rejected and no affected person has acted to extend the proceedings in any manner contemplated by the Act; or

(ii)          adopted and the business rescue practitioner has subsequently filed a notice of substantial implementation of the plan.
Discharge of debt

A business rescue plan that is adopted is binding on the company, the creditors of the company and every holder of the company’s securities whether or not such a person was present at the meeting, voted in favour of the adoption of the plan or, in the case of creditors, had proven their claims against the company. Once a business rescue plan is implemented in accordance with its terms, a creditor who has voted in favour of the plan will lose its right to enforce its claim against the company unless the business rescue plan provides otherwise.

The intention is for the company to trade going forward with a “clean bill of health”. A third party thus has the opportunity to acquire assets, shares or the business of the company with no debt or creditors’ claims going forward; unless otherwise provided by the business rescue plan.

Involvement of attorneys

Attorneys are well placed to assist all role players involved the business rescue process. In our experience, each role player, be it a creditor, shareholder, employee of the company in distress, the business rescue practitioner itself, or third party acquirer, requires the assistance of external legal counsel when considering its position within the process. Werksmans is at the forefront of business rescue advisory services in South Africa and has a team dedicated to advising all role players on all aspects of the business rescue process.

Written by Eric Levenstein (Director) and Lauren Barnett (Associate), Werksmans Attorneys