South Africa has been experiencing very slow economic growth and international rating agencies have subsequently downgraded South Africa’s investment outlook to “junk status”. This, and a myriad of other factors, have negatively impacted South African businesses, especially small and medium business enterprises. Many of these struggling enterprises are now at a crossroads: do they continue trading and hope that things will improve, whilst risking incurring further debts, or do they cut their losses and give up? This article will briefly explain what the difference is between business rescue and liquidation, two legal avenues which are available to financially distressed companies.
Failing companies traditionally only had the option to liquidate. The Companies Act 71 of 2008 (hereinafter referred to as “the Act”) has created another option in the form of business rescue proceedings. Companies which are in financial distress can be placed under business rescue where after a business rescue practitioner will be appointed. The main objective of business rescue proceedings is to reorganise and restructure the business in order to make it a more profitable and stable entity. This is achieved by placing the company and the management of its affairs, business and property under temporary supervision. Furthermore, it provides for the development and implementation of a business rescue plan.
Business rescue proceedings can, similarly to liquidation proceedings, be launched on a voluntary basis or by way of a court application brought by creditors or other affected persons. A company must be in financial distress before it can file for business rescue. A company will be deemed to be financially distressed for purposes of this Act if:
“(i) it appears to be reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months; or
(ii) it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months”.
Companies meeting either of the requirements as set out above will thus be eligible to commence with business rescue proceedings in order to rehabilitate the financially distressed company. Some of the most prominent effects of a company being placed under business rescue are the following:
- A general moratorium on legal proceedings against the company is imposed. Creditors will accordingly not be able to institute civil claims against the company or execute on any court orders already granted.
- A guarantee or surety previously given by the company in favour of any other person may not be enforced by any person against the company.
- The company may only dispose of its property in the ordinary course of its business in a bona fide transaction which is at arm’s length.
- The business rescue practitioner can “cancel or suspend entirely, partially or conditionally any provision of an agreement to which the company is a party at the commencement of the business rescue period, other than an agreement of employment.” This places the business rescue practitioner in a powerful position to alleviate some of the financial commitments of the struggling company by renegotiating payment schemes with the company’s creditors.
The ultimate objective of business rescue proceedings is to save companies. This should, if possible, be the preferred course of action for a financially distressed company since it has the potential to preserve jobs and to reinstitute a stable and solvent company which can contribute to the South African economy.
The objective of liquidation proceedings is fundamentally different from that of business rescue proceedings. Liquidation proceedings are not aimed at rescuing a financially struggling company, but rather to permanently end the company. It is important to note that liquidations of insolvent companies are still done in terms of the Companies Act 61 of 1973 (hereinafter referred to as “the Old Act”).
A company is regarded as being insolvent if its liabilities exceed its assets, or if it is unable to pay its debts as and when it becomes due.
Liquidation of a company results in the establishment of a concourses creditorium and the company will cease to trade and its assets will be frozen. All civil proceedings against the company will stop as well as any execution processes against the company. The Master of the High Court will appoint a liquidator who will be responsible for collecting all of the company’s assets and to distribute same between the creditors after the costs of the liquidation have been paid.
Liquidation and business rescue proceedings, although applicable in similar circumstances have very different objectives and one should thus consider these objectives when choosing one or the other. Business rescue proceedings should be strongly considered where there is a reasonable prospect that the company may be able to trade on a solvent basis again. However, it does sometimes happen that a company is completely “down and out” and that there are absolutely no prospects of the company ever being able to service its debts and/or to trade on a financially viable manner again. In such cases, one should liquidate the company in order to protect the remaining assets in favour of the creditors. You should consult a knowledgable attorney if your company is financially distressed in order to determine the best way forward.
- Companies Act 71 of 2008.
- Companies Act 61 of 1973.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.