Business rescue aimed at facilitating the rehabilitation of financially ailing companies

August 1st, 2023
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Rey NO and Another v Adowa Student Accommodation Co-Ownership and Others (GJ) (unreported case no 2022/26787, 3-4-2023) (Dosio J)

Chapter 6 of the Companies Act 71 of 2008 (the Act) introduced the concept of business rescue aimed at facilitating the rehabilitation of financially ailing companies. Notwithstanding business rescue’s commendable intent it inevitable contrasts with other legal principles in its operation and application, things were no different in the case of Rey NO.

Factual background

On 13 September 2019, Adowa Infrastructure Managers (the second respondent) contracted TSK Bartlett (the second applicant) for the construction of student accommodation (the contract). As per the contract, the second applicant furnished a construction guarantee (the guarantee), which was issued by Lombard Insurance (the sixth respondent).

By 11 February 2022, the contract had progressed past the stage of practical completion. On 9 September 2022, the second applicant commenced voluntary business rescue proceedings. Thereafter, Christopher Raymond Rey (the first applicant) was appointed as the business rescue practitioner.

On 22 September 2022, the second respondent cancelled the contract alleging that by commencing business rescue the second applicant had breached the contract, particularly clause 36.1.4 and 36.1.6 (the impugned clauses). Thereafter, the second respondent called up the guarantee.

As consequence thereof, the first and second applicants (collectively ‘the applicants’) approached the Gauteng Local Division of the High Court (the court) for an interim order on an urgent basis to interdict the sixth respondent from honouring the guarantee.

Legal issues

The applicants argued that the respondents had unlawfully called up the guarantee and that the impugned clauses were void and unenforceable.

Concerning the former the applicants argued that the guarantee could only be called up in terms of clause 5.1 and 5.2 thereof, which only entitled the respondents to call up the guarantee in the event of the second respondent’s liquidation or default. They argued that the contract was only a month away from completion with little remedial work to be performed and that the commencement of business rescue would not affect their ability to complete the contract, therefore, they were not in default.

On their text, the impugned clauses does entitle the respondents to cancel the contract for breach at the instance of the applicants’ commencement of business rescue. The applicants argued that the Act provides that at the commencement of business rescue, all contracts remain in place subject to the business rescue practitioner’s election to suspend them.

It was further argued that the purpose of the business rescue is to allow the company in rescue to continue trading to facilitate its rescue, therefore, the impugned clauses by enabling the cancellation of the contract because the company has commenced business rescue, flies in the face of the Act in a way that is so unfair that its contrary to public policy, which renders them void and unenforceable and, the respondent’s reliance on them to cancel the contract and call up the guarantee is likewise void.

The applicants argued that they were, in the circumstances, entitled to the interim order pending the outcome of an order declaring the impugned clauses as void and unenforceable, in which event, the demand would be unlawful, therefore, the sixth respondent was prohibited from honouring the guarantee.

The respondent argued that the second applicant’s commencement of business rescue, was in breach of the contract, specifically the impugned clauses. That breach entitled them to cancel the contract at their election, which election they exercised. After the cancellation, they were entitled to call up the guarantee and the sixth respondent was likewise obliged to honour the guarantee.

They further argued that any dispute between the applicants and the respondent is independent of the contractual obligation between the second and sixth respondents arising out of the guarantee. Therefore, any such dispute cannot be a bar on the sixth respondent to honouring its contractual obligation to pay in terms of the guarantee.

The respondent argued that the applicants’ argument, which contends that the respondents can be restrained, from presenting the construction guarantee because the cancellation clause is unenforceable is bad in law as a lawful cancellation is not a prerequisite for the sixth respondent to honour the guarantee.

Judgment

The court held that the prerequisites for granting an interim interdict are the following –

  • prima facie right;
  • an apprehension of irreparable harm if the interim interdict is not granted;
  • the balance of convenience must favour the granting thereof; and
  • there must be no satisfactory remedy available.

Thereafter, the court considered the nature and character of the guarantee through case law and held that the guarantee –

The court relying on the judgment of Cloete Murray and Another NNO v FirstRand Bank Ltd t/a Wesbank 2015 (3) SA 438 (SCA) held that the business rescue moratorium does not extend to the cancellation of contracts entered before the commencement of business rescue. Therefore, the respondents were entitled to cancel the contract, and the court was not convinced that such cancellation contradicted the spirit of the Act or that it precipitated an unlawful demand. However, even if the cancellation was unlawful, the courts have been clear that a lawful cancellation is not a prerequisite for calling up the guarantee.

The court held that even if at the declaratory stage the court finds that the impugned clauses are void and unlawful as alleged, this would not provide a defence to the calling of the guarantee because the guarantee is independent of the contract and any dispute relating to the contract is no bar for the honouring of the guarantee unless the applicants can prove the respondents non-compliance with the terms of the guarantee or fraud.

Considering the absence of proof of fraud and non-compliance, the court held that the applicant’s prospects of success for the declaratory order are weak, and the balance of convenience does not favour them. The court also found no evidence to support the proposition that the impugned provision was contrary to public policy. Consequently, the court dismissed the application.

Conclusion

It appears that the parties had different perspectives on the matter. The applicants seem to have viewed it from the lens of a business rescue matter while the respondents seemed to have looked at it through construction law lenses. This case underpins the view that as noble as the business rescue regime is, it is not to be afforded supremacy over other laws or legal principles without proper consideration of the circumstances.

Mdumseni Gambushe LLB (UKZN) is a legal practitioner at Venns Attorneys in Pietermaritzburg.

This article was first published in De Rebus in 2023 (Aug) DR 33.

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