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Keep your creditors close, but your lawyers closer

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Keep your creditors close, but your lawyers closer

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27th September 2021

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Although companies in financial distress, and their creditors, are often reluctant to pay for legal advice, having legal guidance to navigate the intricacies of the business rescue process can help to avoid costly mistakes

The Covid-19 pandemic, coupled with slow economic growth, has motivated many companies to rightfully adopt cost-saving measures to increase cash flow with the hope of staying afloat in these challenging times. Legal costs, even when times are good, are a grudge spend. When times are bad, the legal spend is similar to squeezing blood out of a rock - clients simply prefer to use the cash to pay creditors who are knocking on the door.

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As insolvency and business rescue attorneys (our first confession), and arguably having a biased view, we see a growing trend of clients seeking legal assistance (the grudge spend) when it is too late, and the damage has already been done.  

Boards of Directors and Business Rescue

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The Boards of Directors of companies often wait until their business is past the point of no return, when banks will not want to provide additional funding and the banker-client relationship has broken down to the extent that all the banking facilities are being called up and the company has no cash on hand.

At this time, suppliers have already cut off any credit facilities and purchases are now on a COD basis, straining cash flow even further. By now, the company may have been trading in insolvent circumstances for a period of time, rendering the Board potentially personally liable for the debts of the company under the reckless trading provisions of the Companies Act. 

The Board may, in a knee-jerk reaction to the loss of the banking facilities, decide to place the company under business rescue supervision and either hopefully (1) save the business; or (2) achieve a better return for creditors than they would receive under liquidation. Given that 10 cents in the rand is seen as a good return under a liquidation, the bar for entry into business rescue is not there to jump over but rather to stumble across.

Directors and Business Rescue Practitioners

Given the sleepless nights of the overstretched Board, the resolution to commence business rescue is often rushed and a business rescue practitioner (the Practitioner) is hastily nominated in the resolution.  The Practitioner marches to a different drumbeat, in terms of extensive powers granted under the Companies Act, and the Board may have handed over all management and powers to an outsider over whom they have no control.  

If it emerges that the Practitioner does not have the necessary skills, the only option would be for a costly Court application to be launched to have the Practitioner removed. To make matters worse, the Practitioner may decide to oppose the application and use the companies already limited financial resources as the war chest.

Such a situation could have been prevented if legal advisors were brought on board sooner (pun intended).  To ensure that there is an impartial but trustworthy relationship between the Practitioner and the client, the legal advisors will often arrange meetings between various Practitioners and the client. The Practitioner's extended team will also be introduced.  This will ensure that, through the engagements with and oversight of the legal advisors and the client, the Practitioner has the necessary skills and experience to attend to the matter. It also ensures that the Practitioner genuinely believes the business can be saved or a better return achieved.  This is different from the Practitioner simply taking the appointment to generate fees, as is often seen in practice. 

Ultimately, business rescue is not a process that should be entered into lightly.

Creditors and Business Rescue

A second confession is that we often act for the creditors in the business rescue environment. Creditors also often come too late to seek legal advice, understandably wanting to avoid throwing good money after bad.  However, being unaware of business rescue concepts like general moratorium and suspension of contracts can also be problematic.

Creditors, the Business Rescue Plan and Enforcement Action

Most business rescue plans are a minefield of legal jargon and intricacies, where rights of creditors and shareholders are affected. While most creditors are aware that they may not receive payment of their full claim in a business rescue, or that their enforcement rights against the company may be novated, many are not aware that the business rescue plan could novate the rights which they have against sureties. 

Creditors and the Suspension of Contracts

In addition, things become more complicated when the Practitioner seeks to suspend the company's obligations under a contract. As a supplier, what do you do with the 10 000 bespoke pink swing ball sets in your warehouse that the company has ordered in terms of your supplier contract, but will not pay for in light of the Practitioner's suspension of the obligation? Are you stuck with damages claim and the pink swing ball sets? Simply, yes.

If you are an essential supplier to the business, can you be treated differently and how do you obtain the best deal?  While all creditors should be treated equally, certain creditors may be more equal than others.

These are just some of the reasons why your attorney should be close by during these tumultuous times. With proper guidance, the directors, creditors, and Practitioners can emerge from a business rescue less bruised and battered.

Written by Julian Jones (Partner) & Caellyn Eedes (Associate) from Webber Wentzel

 

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