Ellerines, a subsidiary of African Bank Investments Limited, recently came under the media spotlight when the furniture dealer – operating at a loss and heading for bankruptcy – applied to have business rescue procedures enacted to avoid liquidation.

This meant that a moratorium on the obligations of the distressed company kicked in, which allowed for the appointment of a licensed business rescue practitioner to guide the struggling company out of its financial difficulties.

Ellerines had parts of its assets sold to other businesses and certain stores closed down. The intervention prevented job losses that would have occurred had outright liquidation taken place.

Rescuing businesses in financial distress – also called ‘restructuring’ (whether formally or informally) – is well known globally. SA has followed jurisdictions including the US, Canada, the UK and Australia, where formal laws exist to rescue firms. In many other countries it is conducted informally.

With the latest Companies Act 71 of 2008, a new dispensation for ‘business rescue and compromise with creditors’ was written into law to replace the earlier ‘judicial management’ system, widely seen as ineffective. A business needs to be a closed corporation or propriety limited firm to qualify for restructuring under the law. But it can also enter into an arrangement with all its creditors where the business trades as a sole proprietor or under a partnership. The firm will therefore not trade under the protection of company laws.

Legislation allows a financially distressed firm to be restructured through ‘the temporary supervision of the company, and the management of its affairs, business and property’, says Ramsay Webber director Gareth Cremen.

This is in addition to ‘a temporary moratorium on the rights of claimants against the company or in respect of property in its possession, the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and equity in a manner that maximises the likelihood of the company continuing in existence on a solvent basis. Or, if that is not possible, a plan that would achieve a better return for the company’s creditors than the payment they would have received if the company had been liquidated immediately’, he says.

A firm can be placed under business rescue either by a resolution from within (the directors) or court order from an interested party (such as staff).

In an article on BDO South Africa’s website, Rhodes University associate professor Matthew Lester explains that ‘an unnecessary number of companies expired ignominiously’ as the old system was not widely used and didn’t offer a viable alternative to liquidation.

‘The effect of going into business rescue is that no legal proceedings can be commenced or proceeded with (unless agreed to by the business rescue practitioner or the court), and the practitioner has the power to suspend any contract to which the company is party. Nor may any guarantee or surety by a company in favour of any other person be enforced against the company without the leave of the court,’ he says.

‘If there is a time limit on any right to proceed against a company, this is suspended for the duration of the business rescue proceedings.’

Besides the advantage of being a viable alternative to liquidation, the process has the potential to preserve stakeholder value and lessen job losses for companies in distress. That is, if these companies take action timeously, says Alastair Macduff, director of BDO Innovation and CEO of the Turnaround Management Association, which has a membership of over 60 business rescue practitioners out of the total national of 160 registered practitioners in SA.

Macduff says that since December he has seen a marked increase in the number of firms wanting to apply for restructuring to solve financial distress. ‘The biggest reason for this is the knock-on effect to their cash flow from their customers that are struggling or are already in business rescue, which points to a national crisis of companies failing in the country today.

‘But the problem is that companies wait too long before they approach us. Management tends to be in denial and leaves it too late to approach a turn-around specialist. Business rescue is not an option if the company is dead on arrival and it’s too late for any turnaround strategy to be applied. Liquidation is then inevitable.

‘The potential for a successful business rescue process is dependent on approaching the problem early enough to see if post-commencement finance can be arranged before going into business rescue.

‘In many cases we have declined appointments as business rescue practitioners due to companies waiting too long before taking action. Business rescue practitioners must do pre-business rescue assessments before accepting appointments. This would lead to a far greater number of successful business rescue cases and the threat to the economy would be greatly diminished,’ says Macduff.

The greatest reasons for businesses going into financial distress are inadequate management, lack of financial accounting, and poor cash flow control coupled with management in denial, he adds.

South African Restructuring and Insolvency Practitioners Association spokesman Hans Klopper, who is also the CEO of business rescue specialist firm Independent Advisory, supports this. He says business rescue is a process whereby creditors are placed in a better position than had an immediate liquidation occurred.

‘In cases where businesses with a sustainable business model run into financial distress, the prospects of saving such a business is now substantially better than before. Factors such as bad management, a bad business model and an unfortunate, honest mistake all lead to financial distress,’ he says.

‘Under those circumstances, the machinery of the new Companies Act is now available to do a cost-effective, quick business rescue filing, and in so doing, gains protection against legal action by creditors. This gives the rescue practitioner an opportunity to develop and publish a business plan.’

‘The problem is that companies wait too long before they approach us. Management tends to be in denial’

ALASTAIR MACDUFF, DIRECTOR OF BDO INNOVATION AND CEO OF THE TURNAROUND MANAGEMENT ASSOCIATION

Klopper says that during Eskom’s 2007/2008 load shedding and power cuts, many engineering and manufacturing companies, which were heavily dependent on power supplies, experienced financial problems. This was due to production cuts. 

These firms had to go into formal liquidation when business rescue was not yet an option. He says the effects of the current spate of load shedding on smaller companies is not yet known.

So at what point should a company embark on business rescue proceedings in terms of SA’s new legislation?

According to the Association of Certified Accountants (ACCA), a firm is considered distressed when it seems unlikely to be able to pay its debts as they become due over a period of six months, or where it is likely that the company will become insolvent in the six months thereafter. In this case, it qualifies to apply for business rescue.

‘Business rescue does not necessarily entail a complete recovery of the company in the sense that it will have regained its solvency, its business restored and creditors paid. Sometimes a business rescue process results in a management buy-out or a takeover of the distressed company.

‘A company may find itself in distressed circumstances due to a conspiracy of circumstances, which can be overcome given time and careful management,’ according to the ACCA.

Lester says business rescue is not suitable for companies ‘where the corpse has to be wheeled off into insolvency. If the condition is not terminal, recovery is possible, provided appropriate rescue remedies can be administered by competent experts’.

However, he also warns that courts will not tolerate directors using the law to sidestep their responsibilities to the company. ‘If the court finds no reasonable grounds for believing that the company is in financial distress, it can order costs against any director who voted in favour of the resolution to commence business proceedings.

‘A practitioner is also empowered to get a court order to remove a director if the director obstructs the proceedings in any way or fails to comply with the act,’ he says.

Lester says as a first step, the board can initiate business rescue proceedings, provided that liquidation has not yet been set in motion.

‘An effected party can also start business rescue proceedings through a court application. Within five days of filing a business rescue resolution, the company must notify each party affected by this of its resolution. The notifications must also be done according to a prescribed manner stipulated in the act.

‘Furthermore, the company needs to appoint a licensed business rescue practitioner, also within five days of the resolution. Once business rescue proceedings have commenced, a company may not start liquidation proceedings unless the business rescue proceedings have lapsed or until these proceedings have ended. Each affected party is entitled to sit in on the hearing of the application and can, on certain grounds, lodge an objection to the court.’

He says this needs to occur after the resolution has been adopted and before the business rescue plan has been taken on board. If the court sets aside the appointment of a practitioner, it must appoint an alternate practitioner recommended by – or acceptable to – the majority of the independent creditors’ voting interests who were present at the hearing before the court.

Lester also says that staff who are employed immediately before business rescue takes place must be able to continue to work in the company based on the same terms and conditions, unless they agree to different rules that are in accordance with the prevailing labour law.

‘If retrenchments are contemplated as part of the business rescue plan, it must be done in accordance with all applicable labour laws.

‘Any remuneration and other employment-related payments that become due during the business rescue proceedings and don’t get paid, are regarded as “post-commencement financing”.

‘It will be paid out in order of preference above ordinary claims against the company. Employees therefore enjoy a measure of legal protection under this dispensation,’ he says.

By Louise Brougham-Cook
Image: Gallo/GettyImages