Article written by Stef de Gouveia, Candidate Attorney, checked by Ash Butler, Associate and released by Keane Robinson, Senior Associate
21 May 2021
Introduction
Business rescue entails the rehabilitation of a company that is financially distressed. In terms of section 128(f) of the Companies Act [1] (the “Act”), a company is deemed to be financially distressed, if:
(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 the company will become insolvent within the immediately ensuing six months.
The purpose of business rescue is to maximise the likelihood that a company will continue in existence on a solvent basis. The key to business rescue will be the successful development and implementation, if approved by creditors, of a business rescue plan to rescue the company by restructuring its affairs.
In the event that it is not possible for a company to continue to exist on a solvent basis, the implementation of a business rescue plan should result in a better return for the company’s creditors or shareholders than would result from an immediate liquidation of the company.
In saying such, the commencement of business rescue proceedings results in a number of subsequent effects on the creditors, more specifically, their rankings and ability to recover debts owed to them.
Legal proceedings during Business Rescue
The commencement of business rescue proceedings gives rise to the operation of a general moratorium on the rights of creditors to enforce their claims against the company in business rescue, claims in respect of property belonging to the company or claims against property lawfully in the possession of the company.
Proceedings may be brought against a company only in certain circumstances, which includes where there is written consent of the business rescue practitioner or with the leave of the court. It is also important to note that, no claim will prescribe during the period in which the company is in business rescue, as prescription is suspended for the duration of business rescue proceedings.
Position of Creditors during Business Rescue Proceedings
In order for business rescue proceedings to be successful, there must be post-commencement finance, which refers to any finance generated after business rescue proceedings have commenced and cause the biggest hardship to unsecured creditors. When it comes to paying creditors, the ranking order of creditors is determined by a number of things, most importantly, post-commencement finance.
The ranking of creditors’ claims in terms of business rescue proceedings is regulated by Section 135 of the Act, which provides as follows:
“
(1) To the extent that any remuneration, reimbursement for expenses or other amounts of money relating to employment becomes due and payable by a company to an employee during the company’s business rescue proceedings, but is not paid to the employee-
(a) the money is regarded to be post-commencement financing; and
(b) will be paid in the order of preference set out in subsection (3)(a).
(2) During its business rescue proceedings, the company may obtain financing other than as contemplated is subsection (1), and any such financing-
(a) may be secured to the lender by utilising any asset of the company to the extent that it is not otherwise encumbered; and
(b) will be paid in the order of preference set out in subsection (3)(b).
(3) After payment of the practitioner’s remuneration and expenses referred to in section 134, and other claims arising out of the costs of the business rescue proceedings, all claims contemplated-
(a) in subsection (1) will be treated equally, but will have preference over-
i. all claims contemplated in subsection (2), irrespective of whether or not they are secured; and
ii. all unsecured claims against the company; or
(b) in subsection (2) will have preference in the order in which they were incurred over all unsecured claims against the company.”
In terms of the Act, the first claim to be paid is the remuneration of the business rescue practitioner, expenses and other claims arising out of the costs of the business rescue proceedings. Although the phrase “and other claims” is not defined in the Act, it has been commonly accepted that these expenses will include all the costs that were incurred in order to facilitate the continuation of the business while undergoing the business rescue process. This includes employees for any remuneration which became due and payable after the business rescue proceedings began.
After the aforementioned claims have been paid, creditors arising from post-commencement finance stand to be paid next. These claims qualify for preferential payment in the order in which they were incurred, however all secured claims will be preferred over all unsecured creditors of the company. All secured creditors are ranked on the same level and will benefit from their security depending on the extent of its realisation of the underlying asset.
The next ranked creditors are unsecured, post-commencement creditors, in the order in which such claims were incurred. These creditors rank below business rescue costs and post-commencement secured creditors, but above all other creditors including preferent creditors prior to business rescue proceedings commencing.
After unsecured, post-commencement creditors come ordinary preferent creditors and thereafter the final and lowest ranked creditors are those of concurrent ranked creditors. It is unlikely that the lowest ranked creditors’ claims will be satisfied owing to the fact that the final liquidation account of the company in business rescue would in all likelihood be exhausted.
In conclusion, it is clear that business rescue proceedings may negatively impact creditors who originally provided finance to a company, prior to business rescue proceedings commencing. On the other hand, although post-commencement finance may be a greater risk to such a creditor (as the company is already failing at the time the finance is advanced), post-commencement creditors will rank above all pre-commencement creditors and will have a better chance of recovery.
In short, the ranking of creditors can be summarised as follows:
- the practitioner for remuneration and expenses, and other persons for costs of the business rescue proceedings;
- employees for any remuneration which became due and payable after business rescue proceedings began;
- secured lenders or other creditors for any loan or supply made after business rescue proceedings began (post-commencement finance)
- unsecured lenders or other creditors for any loan or supply made after business rescue proceedings began (post-commencement finance);
- secured lenders or other creditors for any loan or supply made before business rescue proceedings began; and
- unsecured lenders or other creditors for any loan or supply made before business rescue proceedings began.
Value
Understanding the position of creditors during business rescue proceedings as considered in the Companies Act.
[1] No. 71 of 2008
