Business Rescue – What is it and how does it work?

Business Rescue was introduced to the South African business landscape in chapter 6 of the Companies Act, Act 71 of 2008 (“New Act”).

As defined in Section 128(1)(b) of the New Act, the mechanism of business rescue is to facilitate the efficient rehabilitation of a company that is financially distressed in a manner that balances the interests and rights of relevant stakeholders.

This is achieved by proving for:
  1. A temporary supervision of the company, and of the management of its affairs, business and property;
  2. A temporary moratorium (“stay”) on the rights of claimants against the company or in respect of the property in its possession; and
  3. Rescue Plan: the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximizes the likelihood of the company continuing in existence on a solvent basis or, if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company.

What is the goal of business rescue?

According to the Act, business rescue proceedings are intended to facilitate the rehabilitation of financially distressed companies, where there are reasonable prospects of rescue, or when there are better returns for creditors and shareholders through the rescue proceedings than would be achieved through company liquidation or winding-up of the company’s affairs.

The process is aimed at returning a distressed company into a viability and profitable going concern, saving jobs and ensuring its economic contribution.

When is a company determined to be in financial distress?

Under the New Act, financial distress is determined through a 6 month forward looking test.

The Act defines “financially distressed” (section 128(1)(f)) to mean that:

  • 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 – Impending Commercial Insolvency
  • it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months – Impending Factual Insolvency

What is a business rescue plan?

After consulting with all affected parties, creditors and company management, the business rescue practitioner will prepare a business rescue plan. The business rescue plan will include details relating to the background of the company and how it landed in financial distress. Based on these findings, the business rescue practitioner will present one or more proposals, including any conditions or assumptions, for the rescue or rehabilitation of the company.

The business rescue plan will include how employees of the company will be treated once the plan is carried out, as well as its liabilities, contracts and assets.

What happens when the business rescue plan is approved?

Once the business rescue practitioner has procured approval for the plan by vote or court order, it is binding on the company, all creditors and every holder of the company’s securities.

Once the plan is approved, creditors will lose their right to enforce due debt, or a part of it, since they have effectively acceded to the discharge of the debt. Furthermore, unless the business rescue plan provides otherwise, creditors will be precluded from enforcing debt that arose prior to business rescue.

How are business rescue proceedings initiated?

Voluntary Business Rescue

Regulated under section 129 of the Companies Act, the directors of a company, or close corporation, may pass a resolution to voluntarily place their company in business rescue.

All businesses that are financially distressed and want to take a decision to start rescue proceedings need to submit several forms and documents with the Companies and Intellectual Property Commission (“CIPC”). Once a company files its resolution to commence business rescue proceedings it needs to adhere to strict time periods.

Compulsory Business Rescue

Regulated by section 131 of the Companies Act, an affected person (creditors, employees, shareholders) may make a formal application to court to place the company under business rescue. All affected persons must then be notified by the order of the court that the company will commence with business rescue proceedings.

Once compulsory business rescue proceedings are initiated, a voluntary business rescue application can longer be filed.

A compulsory business rescue commences once application papers have been lodged with the court.

What the best time to commence with business rescue?

Many businesses facing financial distress tend to ignore distress indicators and choose to believe they can trade out of the problem. However, the most important contributor to a successful restructuring process is early identification of warning signs and taking the appropriate action.

It is advised that companies flag potential underperformance and distress indicators early and engage restructuring activity as soon as possible to ensure success.

How long is the business rescue process?

Set out in the provisions of the New Act, the business rescue process is designed to run for a period of 3 months. From time to time, with the support of the majority of creditors, proceedings may be extended depending on the complexities of the business.

Factors that may contribute the business rescue extension may include:

  • The business rescue practitioner trying to find a purchaser for the business or its assets
  • The fulfilment of conditions precedent, following the adoption of a plan
  • Uncooperative creditors or shareholders
  • Acquiring regulatory approvals relating to the adopted and supported plan
  • Litigation

How is a company managed when in business rescue?

When a company is placed in business rescue, the business rescue practitioner is conferred full management control of the company in substitution for the board of directors and pre-existing management. Effectively, the pre-existing management may continue to function as before, but subject to the authority of the business rescue practitioner.

How is a company in business rescue funded?

Without some degree of financial support, it is unlikely that even the best business rescue plan will succeed. Working capital is a critical factor in determining the successful turnaround of a company or close corporation in business rescue. This financial support is called post-commencement finance (PCF).

The purpose of PCF is to ensure a distressed company can comply with its trade obligations whilst restoring the company to a solvent position. Post-commencement finance (PCF) is typically arranged and secured by the business rescue practitioner.

In accordance with section 135(1) of the Act, any remuneration, reimbursement for expenses or other amount of money relating to employment that becomes due and payable by a company to an employee during business rescue, is also considered to be post-commencement finance.

Who provides post-commencement finance?

Section 135(2) of the Act states that “during business rescue proceedings, the company may obtain financing other than as contemplated in subsection (1)”. Therefore, the Act does not prescribe who may provide finance. This essentially means that funding can be obtained from any willing investor and may include, but not limited to, financial institutions, foreign investors, current suppliers’, creditors or shareholders of the business.

Recognising how important financing is to the successful rehabilitation of a distressed company and the difficulty of obtaining it, the Act introduces attractive risk related investment opportunities for financiers and investors.

How are post-commencement financiers secured?

Post-commencement finance is secured by various financial instruments, but most common is the security against unencumbered assets or shares of the company under business rescue. An encumbered asset is one that is owned by one party but concurrently subject to a legal claim by another.

How are claims ranked against a company in business rescue?

Section 135 of the Act deals with the ranking of Creditors’ claims.

In order of preference, claims against the company rank as follows:

  1. The business rescue practitioner, for remuneration and expenses, and other persons (including legal and other professionals) for costs of business rescue proceedings.
  2. Employees for any remuneration that became due and payable after business rescue proceedings began.
  3. Secured lenders or other creditors for any loan or supply made after business rescue proceedings began. (PCF Financiers)
  4. Unsecured lenders or other creditors for any loan or supply made after business rescue proceedings began.
  5. Secured lenders or other creditors for any loan or supply made before business rescue proceedings began.
  6. Employees for any remuneration which became due and payable before business rescue proceedings began.
  7. Unsecured lenders or other creditors for any loan or supply made before business rescue proceedings began.

Typically, claims of secured creditors who provided funding prior to commencement of business rescue now rank after the claims of post-commencement financiers – both secured and unsecured. In some cases, pre-commencement secured creditors, in respect of encumbered assets, may rank above post-commencement finance creditors.

How are the employees of a company in business rescue affected?

One of the primary objectives of business rescue is to secure the employment of the company’s staff. In accordance with section 136 of the Act, apart from changes occurring in the ordinary course of attrition or if different terms and conditions are agreed between the employee and the company in accordance with labour laws, employees will remain employed by the company on the same terms and conditions that applied prior to the commencement of business rescue proceedings.

Any retrenchments contemplated by the business rescue practitioner will be subject to South African labour legislation.

Conclusion

2021 marks the 10th anniversary of business rescue legislation in South Africa. The effects of COVID-19 pandemic wreaked havoc on South African businesses, leaving many in severe financial distress. Now, more than ever, business rescue is an essential mechanism in protecting financially distressed companies and preserving employment.

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