By Blair Wassman
Since the inception of the Companies Act 71 of 2008 (the Act) in May 2011, the concept of business rescue remains rather contentious. It has been the alternative to liquidation of several well-known entities, such as 1time and Top TV. While some companies have struggled to get rescue proceedings off the ground there are a few success stories, but these remain in the minority. The limited two-year time frame since 2011 has shown that instituting such proceedings is fairly onerous given that the guidelines in ch 6 of the Act are not always clear and certain benchmarks are yet to be determined.
Recently, it has become apparent that courts are no longer faced with simplistic applications as envisioned by s 131 whereby any affected person can, on application to the High Court, apply to have a company placed under business rescue. Competing applications for liquidation and business rescue are now both running the litigation race and vying for a win. While this area of law is still largely uncharted, the courts have been faced with some cases that attempt to narrow the parameters and set the benchmarks.
Commencement of business rescue
The process of business rescue begins either by means of a resolution of the board of directors of the company (s 129) or, alternatively, through successful application to the High Court by an affected person (s 131). While different parties may commence the proceedings the main requirements are essentially the same.
By resolution
The board of directors may pass a resolution to commence business rescue proceedings providing that the two built-in ‘requirements’ of s 129 are met. The board of directors must therefore have reasonable grounds to believe that the company is financially distressed and that there appears to be a reasonable prospect of rescuing the company. Section 128(f) defines financially distressed as follows:
‘“[F]inancially distressed”, in reference to a particular company at any particular time, means that –
(i) it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become 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.’
This definition makes use of the concept of commercial insolvency, namely the inability of a company to service its debts as they become due during a prescribed period of time, and not factual insolvency, where the company’s liabilities exceed its assets, in determining the financial distress of the company. This is important as it encourages companies to use the proceedings at the first sign of financial difficulty and gives them an alternative prior to reaching insolvency.
The second stage is to prove that a reasonable prospect of success exists. The wording in the Act itself does not, however, provide the standard of proof. It would appear that one need not prove that the rescue will succeed, but merely that reasonable prospects exist. The prospects should thus be objectively assessed and possible and should certainly be demonstrated in any application for business rescue.
An additional requirement is that business rescue proceedings may be launched only if no liquidation proceedings have been initiated by or against the company (s 129(2)(a)).The business rescue proceedings also have no force until the resolution has been filed (s 129(2)(b)).
The time constraints are stringent and the court has indicated a zero tolerance to non-compliance. In Advanced Technologies and Engineering Company (Pty) Ltd (in business rescue) v Aéronautique et Technologies Embarquees SA and Others (GNP) (unreported case no 72522/11, 6-6-2012) (Fabricius J) the court held:
‘It is clear from the relevant sections contained in chapter 6 that a substantial degree of urgency is envisaged once a company has decided to adopt the relevant resolution beginning business rescue proceedings. The purpose of s 129(5), is very plain and blunt. There can be no argument that substantial compliance can ever be sufficient in the given context. If there is non-compliance with s 129(3) or (4) the relevant resolution lapses and is a nullity. There is no other way out, and no question of any condonation or argument pertaining to “substantial compliance”.’
By court order
In terms of s 131(1) any ‘affected person may apply to a court at any time for an order placing the company under supervision and commencing business rescue proceedings’. An ‘affected person’ as defined in s 128(1)(a) is ‘(i) a shareholder or creditor of the company; (ii) any registered trade union representing employees of the company; and (iii) if any of the employees of the company are not represented by a registered trade union, each of those employees or their respective representatives’.
Before a court will consider granting an order in favour of the applicant, various requirements have to be met.
First, the applicant is to notify each affected person in the prescribed manner and serve a copy of the application on the company as well as the commission (s 131(2)(a) and (b)). Secondly, the court will only make an order provided it is satisfied in terms of s 131(4)(1)(a)(i)-(iii), that ‘(i) the company is financially distressed; (ii) the company has failed to pay over any amount in terms of an obligation under or in terms of a public regulation, or contract, with respect to employment-related matters; or (iii) it is otherwise just and equitable to do so for financial reasons and there is a reasonable prospect for rescuing the company’.
Should it not be satisfied, the court may dismiss the application together with any appropriate order, including a liquidation order (s 131(4)(1)(b)).
The case of Southern Palace Investments 265 (Pty) Ltd v Midnight Storm Investments 386 Ltd 2012 (2) SA 423 (WCC) highlights the higher threshold concerning succeeding with a rescue in involuntary circumstances.
Termination and time frames
Business rescue proceedings do not have an automatic termination through effluxion of an allocated time period. However, provision is made in s 132(3) that if proceedings have not ended within three months of initiation, a monthly progress report must be submitted. This submission is to be delivered to court or the commission as well as to each affected person. Due to the lack of a time clause with regard to the life-span of rescue proceedings it may, theoretically, continue indefinitely. This is undesirable in that a company may enjoy the benefits of the moratorium for extended periods of time with no consequence for not paying its debts. This will result in rather unhappy creditors and possibly disgruntled employees and shareholders as well.
While it may seem unlikely that the procedure would be allowed to continue indefinitely the practical reality of regulating many applications must be considered. The difficulty is that many applications will need to be monitored and an increasing amount of applications may over time allow for ‘slips through the cracks’ with regard to the monthly progress reports.
Alternative methods of termination include the setting aside of the resolution or where, in terms of s 132(2)(a), the proceedings have been converted into liquidation proceedings. Further, the termination may occur through application for termination by the business rescue practitioner or if a business rescue plan has been adopted, together with the practitioner filing substantial implementation of that plan, or the business plan has been proposed but rejected without an affected person extending the proceedings in terms of s 153.
One must bear in mind the consequences or effects of an indefinite business rescue on affected persons and, in particular, on creditors. The moratorium has the effect of suspending and preventing any legal proceedings. While this provides some breathing space for the company to re-arrange its debt and financial structure, it provides no relief for any aggrieved party as the moratorium can potentially continue indefinitely. The courts will therefore also consider this aspect when determining whether to grant an order in favour of business rescue.
A positive measure within the Act to combat abuse of process is that the time constraints from the initiation of business rescue are fairly onerous, but these may be extended either by obtaining consent from affected parties or through application to court. In AG Petzetakis International Holdings Ltd v Petzetakis Africa (Pty) Ltd and Others (Marley Pipe Systems (Pty) Ltd and Another Intervening) 2012 (5) SA 515 (GSJ), the applicant requested that the court grant a postponement in respect of the business rescue proceedings to allow for the filing of a supplementary affidavit that would address the issues of reasonable prospects of success.
Coetzee AJ deliberated the importance of the reasonable prospects being included in the founding papers given its materiality to such an application. The argument put forward by Petzetakis Holdings did not provide any substantial averments as to reasonable prospects. The judge concluded that ‘[b]efore a court can make the rescue order which would give rise to the practitioner’s opportunity to work out a rescue plan it must be satisfied that there is a reasonable prospect of rescuing Petzetakis Africa or, … that there is a prospect that the future rescue plan will achieve the alternative object of s 128(b)(iii), namely a better result than immediate liquidation. On the evidence as presented and the known evidence to be presented in the event of a postponement as disclosed, the court cannot be so satisfied.’
This may appear to be a robust approach but one must be mindful that there are certain minimum requirements and, while the court does have a discretion in assessing them, they must at the very least be present.
The balance of convenience and reasonable prospects
The requirements for business rescue are not only contained in ch 6 of the Act. The courts will also look to s 7(k) for guidance, especially when adjudicating competing applications. Section 7(k) highlights one of the purposes of the Act, namely provision ‘for the efficient rescue and recovery of financially distressed companies, in a manner that balances the rights and interests of all relevant stakeholders’.
This concept has recently been adjudicated in the judgment of Newcity Group (Pty) Ltd v Pellow NO and Others, China Construction Bank Corporation Johannesburg Branch v Crystal Lagoon Investments 53 (Pty) Ltd and Others (GSJ) (unreported case no 12/45437, 16566/12, 28-3-2013) (Van Eeden J), where the judge was tasked with adjudicating competing applications for liquidation and business rescue (see also 2013 (Dec) DR 15). Newcity Group brought an application in terms of s 131 whereby any affected person may apply to a court to place the company under supervision in line with the requirements mentioned above. Newcity Group as a shareholder of Crystal Lagoon was an affected person, and as such brought an application to place Crystal Lagoon in business rescue.
The judge observed that an application in terms of s 131 differs from one brought by special resolution in terms of s 129(1) given that there are other requirements in addition to financial distress. These are that ‘the company has failed to pay over any amount in terms of an obligation under or in terms of a public regulation, or contract, with respect to employment-related matters; or it is otherwise just and equitable to do so for financial reasons’.
Van Eeden J pointed out that these jurisdictional requirements are ‘qualified by a further, and thus overriding requirement, which is that “there is a reasonable prospect for rescuing the company”, regardless of which jurisdictional requirement is present in each instance’. He stressed that the Act favours business rescue over liquidation. However, in light of the Southern Palace case referred to above, the rescue plan will surely not succeed if the rescue plan does not address the ‘cause of the demise or failure of the company’s business and offers a remedy therefor that has a reasonable prospect of being sustainable’.
Van der Merwe J has also confirmed in Propspec Investments (Pty) Ltd v Pacific Coast Investments 97 Ltd and Another 2013 (1) SA 542 (FB) that a prospect of success must be evident and further that, while it is only an ‘expectation’, it should be one that rests on a ground that is objectively reasonable. Arguments advanced by Van Eeden J in favour of the liquidation stemmed largely from the historical nature of the matter, given that the company had been in business rescue before and that at various junctures in the process business rescue had ceased and provisional liquidation orders had been agreed to by the parties involved. It would appear that the parties in favour of the liquidation wanted finality and the court acknowledged that it had been established that certain creditors were being preferred.
Arguments in favour of the rescue were two-fold:
On the issue of changing the management, the court decided that this would not achieve the standard of reasonableness as there would be a large expense incurred effecting this change and no evidence was led as to how this exercise would be funded. In addition, no evidence was presented that the company had any grievance with the management. As a result the court was not satisfied that this averment addressed the cause of the demise of the company nor did it provide the objective grounds for success.
The argument advanced of third-party investment was contested given that the company had previously been in business rescue and provisional liquidation for more than a year and that investors mentioned as far back as 2011 had not materialised.
The company claimed that creditors and shareholders would receive a better return than in the alternative scenario of liquidation. The court did not share these sentiments as no facts had been advanced to support this contention, save for a submission made in respect of the difference in costs between liquidators and business rescue practitioners.
Ultimately, the court dismissed the application for business rescue and granted a final order for the winding up of the company. Van Eeden J concluded that, in his view: ‘[N]ot one of the two objectives of business rescue is present. Even if one were, I would in any event have exercised my discretion against granting the application given the remoteness of a business rescue plan being approved and the rights and interests of the stakeholders. There is presently no viable business rescue plan – one must still be developed. The passing of more than a year without any solution renders the reasonable prospect of a plan being developed remote. It seems the reasonable prospects of rescuing the company have been exhausted … [a]s already stated, I do not think it has been demonstrated that Newcity, the shareholder, will receive a better return if business rescue is ordered and the biggest creditor is in favour of liquidation. A creditor will normally know best whether a better return will be achieved by business rescue or not. In my view balancing the rights and interests of these stakeholders require that finality now be reached.’
It would appear that Van Eeden J considered the logistics of succeeding with business rescue if the potential majority creditor would oppose any rescue plan. He had the unenviable task of balancing the rights of interested parties, but based his decision on the consequences of business rescue, such as the moratorium on legal proceedings, as well as to give effect to ch 6 and s 7(k) of the Act.
Conclusion
It has become apparent that the courts are not allowing frivolous applications to succeed and, as a result, are setting the standard or benchmark to succeed with rescue proceedings on grounds that are material, factual and objective. The consequence of this is that one should exercise caution when considering business rescue and not use this instrument as a quick fix to avoid debt. One should consider the impact on all stakeholders involved and whether or not the support of all stakeholders would be achieved in seeking business rescue.
The procedure is able to succeed only with the voting support of the affected parties, in particular the creditors and if one therefore does not have the support of the stakeholders the process may be thwarted before it even begins. If the process does become litigious it would seem that the courts are placing a great deal of weight on the balance of interest and rights of all those involved.
This approach is welcomed to prevent abuse of the process and to ensure that business rescue is utilised for its proper purpose. While the test for achieving the minimum standard remains flexible, parties are still required to identify and provide objectively reasonable prospects accompanied by factual support to ensure success. It is undeniable that, should an applicant fail to provide reasonable prospects, the application is doomed to fail.
Blair Wassman BA LLM (UJ) is a candidate attorney at Fairbridges in Johannesburg.
This article was first published in De Rebus in 2014 (Jan/Feb) DR 36.
