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The restructuring of a company in financial distress may be an attractive option to many a business facing tight times. The Companies Act 2008, at Chapter 6, formally introduced the global concept of “business rescue” to South Africa. The aim, to rehabilitate ailing companies by providing a temporary suspension of claimants’ rights against the company to allow time to restructure the company’s debt, equity, assets, and/or other affairs.

Following the adoption of the required resolution, or a court order, a business rescue practitioner is appointed, who then takes full control of the ailing company during the rescue period. After gaining a full understanding of the affairs of the company, the practitioner is required to present a business rescue plan to the creditors for their vote. The outcome of the process is largely determined at this point, or at a reconvened voting meeting.

Directors should, however, be aware that under the Act they are duty-bound to take a positive step when the company is considered “financially distressed”. If a resolution initiating business rescue proceedings, as envisaged by the Act, is not adopted, then they must “deliver a written notice to each affected person, setting out the criteria referred to in section 128(1)(f) that are applicable to the company, and its reasons for not adopting a resolution contemplated in this section”. It is therefore mandatory for directors to take appropriate action if the company is deemed to be” financially distressed” – a failure to do so may result in a director being held personally liable for a claim against the Company.

Affected persons would include; creditors, shareholders, employees and trade unions. The rationale being that, in certain circumstances, the director may have allowed or promoted reckless trading by not adopting the required procedure under s129(7), and thus perpetuating business losses or increased creditor’s claims. Liability is not, however, automatic and will be assessed on the circumstances of each matter. Nonetheless, certainly not a situation that any director would want to face.

With so much turning on the term “financially distressed” – what does it mean?

The Act at s128 (f) states this to be, in reference to a particular company at any particular time, when;

“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;”

While there is some debate over the application of the above provisions, one recurring viewpoint is that commercial insolvency, namely the inability of a company to pay its debts as they become due and payable in the next six months, certainly does constitute financial distress and would trigger the duty of the director to take the steps required of him under the relevant business rescue provisions. The often-quoted scenario of a “temporary cash flow problem” may thus, as a result, have deeper significance than before.

In having regard to these specific director’s duties, and potential personal liability, directors of companies should be alive to the potential consequences of not acting when so required and, if in any doubt, seek the advice of their accounting or legal advisors.

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