Section 129 of the South African Companies Act, 71 of 2008 (“Companies Act”) makes provision for a company's board of directors to voluntarily initiate business rescue proceedings when they reasonably believe the company is financially distressed and there is a reasonable prospect of rescuing it. A company is considered financially distressed when it appears to be reasonably unlikely that it will be able to pay its debts or may become insolvent within the next six months. If the board reasonably believes there is a prospect of rescuing the business, either by restoring solvency or achieving a better outcome for creditors than liquidation, they may pass a resolution to commence business rescue. As part of the requirements, the resolution must be filed with the Companies and Intellectual Properties Commission (“CIPC”), a business rescue practitioner must be appointed within five business days, and affected parties must be notified.
These procedural steps are critical, as clarified in the case of Panamo Properties (Pty) Ltd v Nel NO and Others, where the directors failed to comply fully with the notice and appointment requirements and later challenged the validity of their own resolution. The Supreme Court of Appeal held that such non-compliance does not automatically invalidate a business rescue; rather, an affected person must apply to have it set aside, and the court will assess whether it is just and equitable to do so. Accordingly, a duty is placed on the board of directors to make a forward-looking test of the company’s financial position and make an informed decision. This test requires directors to be proactive and to undertake the test regularly and rigorously. Where a company is financially distressed, failure by the board to pass the resolution (or notify affected parties why such a resolution has not been passed, notwithstanding that the company is in financial distress) may attract personal liability against the respective directors on the board under the Companies Act.
The liquidity of the business is central to the requisite test, and in this regard, it is important to understand two related but distinct concepts, namely commercial and technical insolvency. If a company cannot pay its debts as and when they fall due for payment, the company is commercially insolvent. Technical insolvency is where a company’s liabilities exceed its assets. The distinction was clearly illustrated in FirstRand Bank Ltd v Tshabalala; In re: FirstRand Bank Ltd v Phumelele Events Management (Pty) Ltd, the court considered a company that claimed to be solvent based on the value of its assets, yet was unable to meet its debt obligations as they became due. FirstRand Bank applied for liquidation based on the company’s commercial insolvency. The court reaffirmed the principle that a lack of liquidity, regardless of balance sheet strength, is sufficient grounds for winding up. It held that the ability to pay debts when they become due is the key test.
Once a company is insolvent, it ought to be wound up by way of liquidation. Liquidation is aimed at ceasing the operations of a business in order that its assets may be collected, at the hands of a liquidator, for purposes of disposing of them for the benefit of the creditors of the company. At the end of the liquidation process, creditors who have proved a claim against the company are paid a distribution in order of preference as per the Insolvency Act.
The key difference between liquidation and business rescue is that the latter is aimed –
- in the first instance, at rehabilitating a company that is financially distressed so that it can continue to operate in a solvent state; and
- in the second instance, and if it cannot continue to operate on a solvent basis, re-arranging its affairs such that it can result in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company.
Accordingly, even if a company can currently pay for its debts as and when they fall due, its liquidity must be scrutinised, considering, amongst others, work in progress, debtors and creditors age analyses for the next six months. Furthermore, if it appears that a company will become insolvent (commercial or technically so) within the next six months, it will be incumbent on the board of the company to file for business rescue so the affairs of the company can be re-arranged before the eventuality of insolvency manifests.
The prescripts of the Companies Act, insofar as the timing is concerned, are designed to avoid a situation where a company files for rescue in circumstances where, in fact, the company is already insolvent and a candidate for liquidation as opposed to business rescue.
According to available statistics reported by the CIPC, 36% (thirty-six) of business rescue cases that were terminated in the final quarter of 2023 achieved substantial implementation. Objectively viewed, this paints a bleak picture for the effectiveness of business rescue, further adding to the negative perception of business rescue.
It bears mention that “substantial implementation” means that the business rescue plan has been implemented to the extent that the practitioner believes that the company can now continue to operate on a solvent basis, or that the objectives of the plan have otherwise been achieved. However, this does not necessarily mean that the company has returned to full financial health, only that the plan’s key milestones have been met.
Based on anecdotal experience, most boards pass the resolution to place companies into business rescue when the scales have already tipped passed the point of “financial distress”, and this could be one of the reasons why the statistics are bleak. Boards appear to wait until companies are on the brink of insolvency as opposed to at least 6 (six) months before, compromising the successful conclusion of the rehabilitation process.
This delay in decision-making can be attributed to several factors, including a lack of understanding of the business rescue process, reluctance to admit financial difficulties, or hope that the company’s fortunes will improve without intervention. Unfortunately, such delays often result in the company’s financial position deteriorating further, reducing the likelihood of a successful rescue and increasing the risk of liquidation.
Boards of companies are accordingly reminded to always undertake requisite liquidity tests to ensure that any financial distress is determined at the correct time to allow for a successful rehabilitation of the company. Regular financial monitoring, early engagement with financial advisors, and a willingness to act decisively are essential for maximising the chances of a successful business rescue and preserving value for all stakeholders.
Boards are encouraged to consult with financial and legal professionals at the earliest signs of distress and to treat regular liquidity assessments as a core governance responsibility.
