Background:
The South African economic landscape is frequently disrupted by unpredictable external factors that significantly affect the business environment, complicating efforts to expand and improve profitability for companies. These challenges expose businesses to the risk of insolvency and potential liquidation, particularly when they are unable to meet their financial obligations as they become due or are over-indebted.
Several remedy procedures exist to assist South African companies to overcome the challenges relating to their inability to pay their debts. This article will analyse two such procedures, namely business rescue and liquidation proceedings, with a focus on the key differences between these procedures.
What is Business Rescue?
Business rescue refers to proceedings aimed at facilitating the rehabilitation of a financially distressed company, as defined in section 128 and governed by the provisions of Chapter 6 of the Companies Act No. 71 of 2008 (“Companies Act“). The primary purpose of business rescue is to give companies facing financial difficulties the opportunity to restructure and potentially return to solvency. Instead of winding up the company’s affairs and selling off assets as in liquidation, business rescue seeks to provide a path for financial recovery. This is achieved through section 128(1)(b)(iii) of the Companies Act, which stipulates that a business rescue plan must be developed and implemented to address the company’s liabilities and operations in a manner that maximizes the likelihood of the company’s continuation as a viable enterprise. Once a company has filed for business rescue, a business rescue practitioner is appointed to oversee and supervise the management, affairs, and operations of the company.
A business rescue practitioner furthermore has the power to assume full managerial control of a financially distressed company. Although the board members are required to continue fulfilling their duties, this is contingent upon the approval of the business rescue practitioner. The business rescue practitioner possesses the authority to delegate powers to members of the pre-existing management, remove any individual from the management team, or appoint a new member to management. The business rescue practitioner is additionally tasked with developing and implementing a business rescue plan, which must be presented to affected parties in accordance with the provisions of the Companies Act and which sets out the manner in which the financial health of the company will be restored.
Key factors to be considered during Business Rescue proceedings:
When considering business rescue, both the company and affected parties must evaluate several key factors to ensure a successful process. First, the company’s financial position must be assessed, determining whether business rescue is a viable option as outlined in Section 128(1)(f) of the Companies Act. The likelihood of rescuing the company, which involves restoring its solvency or achieving a better return for creditors and shareholders than liquidation, is paramount. Secondly, stakeholders must examine the expertise and credibility of the appointed business rescue practitioner, as their role is central to the development and implementation of a rescue plan.
Pertaining to creditors, during the process of business rescue the creditors are entitled to receive notice and participate in court proceedings, decisions, or meetings, either formally or informally. Creditors are entitled to participate in the decision-making process regarding the approval, amendment, or rejection of the proposed business rescue plan. Should the creditors not reach an agreement on the proposed plan, they may present an alternative plan or make an offer to acquire the interests of the dissenting creditors. Additionally, creditors can form a committee and consult with the practitioner during the preparation of the rescue plan. Voting rights depend on the nature of the creditor, the value of their claim and whether their claim is secured or unsecured.
What is Liquidation?
In contrast to business rescue proceedings, liquidation is the legal process aimed at bringing an end to a company that can no longer pay its debts or meet its financial obligations with no aim to rescue the company in question. Liquidation proceedings can be categorised as either voluntary or compulsory, and the applicable process is governed by the Companies Act. For a solvent company, liquidation can be initiated voluntarily by its shareholders through the adoption of a special resolution. This resolution must be submitted to the Companies and Intellectual Property Commission.
The company’s assets are then sold, and the proceeds are distributed among creditors in a specified order of priority. Once this process is complete, the company is formally dissolved and ceases to exist. Liquidation is generally seen as the final step for a financially troubled company and signals the end of its operations. The directors will lose control of the company once a liquidator is appointed, and any ongoing contracts or business relationships are terminated.
In the case of voluntary liquidation, shareholders must pass a special resolution to liquidate the company, after which they can appoint a liquidator of their choice. Conversely, in a compulsory liquidation, the court appoints a liquidator when a company is placed into liquidation through a court order, often initiated by a creditor or the company itself due to insolvency.
Additionally, if business rescue proceedings fail, the business rescue practitioner may recommend that the company be liquidated, prompting any affected party to petition the court for a liquidation order. Once appointed, the liquidator takes control of the company’s assets, overseeing the winding up of its affairs, settling debts, and distributing any remaining assets to shareholders.
Key factors to be considered during Liquidation proceedings:
When a company enters liquidation, several important factors must be considered. The company’s assets will be sold to repay creditors, therefore understanding the asset realisation process is crucial. The priority of creditor claims must be properly recognised and directors are required to fulfil their legal duties by cooperating with the liquidator and providing all necessary documents and information.
In relation to creditors, liquidation functions as a mechanism for recovering a portion of the debts owed to them, however, unsecured creditors frequently receive only a minimal fraction of their claims. The creditors are classified into four categories, which determine the priority of their claims. Secured creditors, with security interests over specific assets, are repaid first through the sale of those assets. Preferential creditors such as employees and the South African Revenue Services follow and have statutory protections ensuring their claims are prioritised. Unsecured creditors, such as suppliers or service providers are next and face a higher risk of limited recovery. Shareholders are last in line and will only receive payment if any assets remain after all creditors’ claims have been settled.
Concluding remarks:
In conclusion, the decision between pursuing business rescue or liquidation is critical for a financially distressed company and must be made with careful consideration of the company’s specific circumstances. Business rescue offers the potential for rehabilitation and continued operations, but it requires a realistic prospect of recovery and compliance with statutory obligations. On the other hand, liquidation marks the end of a company’s legal existence, with assets being sold to repay creditors. A company should opt for business rescue when it is financially distressed and there is a reasonable prospect of rehabilitating the business and restoring its profitability, thereby preserving employment and maximising value for creditors.
Ultimately, the decision between business rescue and liquidation depends on the company’s financial condition, the potential for recovery, and the interests of creditors and stakeholders.
VDMA’s team of experts are at your disposal for any corporate and commercial law assistance that you or your business may require.
Published 30 September 2024