Business failures are unfortunately expected to increase significantly, with our pre-existing economic woes now multiplied many times over by the pandemic and its knock-on effects.
As a company director you will know how vital it is to avoid any suggestion of reckless trading or of trading in insolvent circumstances, and if your business shows signs of financial distress it is imperative that you act quickly – not only to protect your own legal position but also to boost the chances of your company returning to profitability.
What’s the difference between liquidation and business rescue? How does business rescue work in practice? Read on for the answers…
“A stitch in time saves nine” (wise old proverb)
The COVID-19 pandemic and the resultant lockdown have opened up new avenues of profit for some businesses, but they have also subjected many others to the spectre of business failure.
Unfortunately, we can expect the level of bankruptcies to surge for some time to come, and the domino effect will multiply the numbers until our economy turns the corner.
If financial distress looms for your own company, bear in mind the very onerous duties imposed on directors by the Companies Act. One of those duties is to avoid any form of “reckless trading” or “trading in insolvent circumstances”, and if you drop the ball on that one you risk personal liability, claims for damages, and even criminal prosecution.
What action should you take? There is a lot at stake here so specific professional advice is indispensable, but it is essential to face realities and to take decisive action quickly. Your legal options are likely to be either liquidation or business rescue. Let’s compare them…
Business rescue v liquidation
Liquidation: If your company is terminally ill you will probably have no option but to put it out of its misery by applying for liquidation. In that event a liquidator is appointed to oversee the winding-up of the company, to sell its assets, and to distribute the net proceeds to creditors. Liquidation’s big advantage is in providing an orderly winding up of the company’s affairs, but there will be few winners emerging from the process.
All stakeholders are likely to lose out in a liquidation scenario. Shares become worthless, you lose your directorship, employees lose their jobs and, although they have preferent claims for outstanding pay, leave, etc, these could well be worthless. Creditors holding some form of security aside, other creditors (which would include you if you have a loan account) are left with concurrent claims – which are probably worthless too.
To top all that off, if you signed suretyship for any claims, you will be personally liable for them.
Business rescue: Business rescue on the other hand is designed to restructure the company’s affairs and business “in a manner that maximises 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.”
Either way all stakeholders stand to benefit, including you as a director, shareholder and/or loan account creditor. Your staff have a better chance of keeping their jobs, suppliers have a better chance of retaining your company as an ongoing customer, and the economy benefits from avoiding another business failure (SARS in particular will be happy to retain your company as a taxpayer!).
The success rate for business rescues is not high, but even if it is partially successful it is likely to be better than liquidation.
There have also been concerns expressed about the costs of business rescue, and although these concerns have been disputed, cost is perhaps a factor to be put in the balance with all the other factors mentioned above when deciding between the two options.
How does it work?
In a nutshell (this is of necessity just a brief overview of what can be a very complex subject) –
- Normally you would voluntarily place the company into business rescue with a board resolution; alternatively an outside stakeholder can apply for a court order (which you could oppose).
- A business rescue practitioner (often referred to as a “BRP”) is then appointed to take full management control of the company in substitution for the existing board and management, and to investigate the company’s affairs in order to “consider whether there is any reasonable prospect of the company being rescued”. The company is in the interim protected from legal action by creditors via a moratorium.
- As a director you “must continue to exercise the functions of director, subject to the authority of the practitioner”, plus you have “a duty to the company to exercise any management function within the company in accordance with the express instructions or direction of the practitioner, to the extent that it is reasonable to do so”. In other words, you must assist and cooperate with the BRP as required.
- The BRP convenes a first meeting of creditors to advise whether there is a reasonable prospect of rescuing the company.
- If rescue seems feasible the BRP will then formulate a business rescue plan and present it to another meeting of creditors for consideration and voting.
- If the business rescue plan is adopted and successfully implemented, the company is returned to the marketplace as a viable business.
- If it turns out that there is no prospect of rescue or if the business rescue plan is rejected without any extension of the business rescue proceedings, the court can convert the rescue proceedings into a full liquidation. It can also in some circumstances set aside the business rescue resolution or court order.
Timing is everything!
“A stitch in time” really does make sense here. Your chances of rescuing the business are statistically (and logically) much greater if you take action as quickly as possible after the threat of financial distress first rears its ugly head.
As to the legal position, our courts have put it this way: “… it is clear that the business rescue procedure is intended to be used at the earliest possible moment, i.e. when a company is showing signs of pending insolvency, but where it has not yet reached the stage of actual insolvency.”
Moreover the longer you leave it, the more likely you are to find yourself personally in trouble with the law and the higher the chance of all stakeholders losing everything.
Bear in mind that access to financing will be critical here, as will active support from major creditors both during the business rescue proceedings and in the longer term.
We also offer a full range of legal services ( https://www.lhtc.co.za/about-us/) through two of our dedicated legal service providers and national law firms, PGPS Attorneys and Tomlinson Mnguni James Attorneys