Is your business experiencing financial difficulties? Wait, you don't have to liquidate

Kgomotso Tabane, Attorney.

The economic effects of the corona virus are more devastating than the 2008/9 world economic crash. Because of how rapidly the virus spreads, a lot of countries have imposed lock down conditions in order to curb this spread. This means that a lot of businesses have had to stop operating and are therefore not earning any income.

According to a study conducted by Business Review, the coronavirus could impact 5 million businesses worldwide. In fact, some businesses are already expecting to close shop by mid-July, with 54% of businesses raising concerns over their ability to raise revenue, according to Stats SA.

Due to the tough economic conditions, many companies may choose to liquidate, which is a common procedure in the South African corporate sphere. However, there are different mechanisms that financially distressed companies can opt for instead of liquidation.

The different options available for financially distressed companies are as follows:

Business rescue which was introduced into the South African business regime through the new Companies Act, 71 of 2008 (the Companies Act). Financially troubled companies can use this lifeline in an attempt to survive and avoid liquidation. Business rescue gives the distressed company breathing space, through a court order imposing a moratorium on the payment of the company’s debts to its creditors and stakeholders for a specific period of time. This will allow the distressed company to turn its affairs around and get back to normal. In this regard, a business rescue practitioner is appointed to head the turnaround process, working closely with the directors and management of the company.

A compromise in terms of section 155 of the Companies Act is another option available to financially troubled businesses. Section 155 of the Companies Act sets out the procedure and requirements for a compromise to be proposed to the creditors of a debtor company. Once the requisite majority vote (75%) of the creditors has been obtained in favour of the compromise, there is little left for a disgruntled creditor to do. When the creditors vote to compromise their claims against the distressed company, it provides the company with a quick fix and an easy way to acquire immediate financial relief for a portion of its debt.

The outcome of a compromise is not far from that of a business rescue. However, according to Rhoodie and Bester, 2017, a compromise is more beneficial than business rescue because it makes provision for a creditor to retain its rights to go against the surety of the distressed company. During both proceedings, creditors are given powers to vote for or against the business’s proposed turnaround plans. One of the biggest shortcomings of a compromise, however, is that the directors can be held liable where the turnaround plan is unsuccessful.

Another option that can be followed in a distressed situation is a process called “out of court restructuring” or “work-out” which is a non-judicial process through which a financially distressed business and its significant creditors reach an agreement to adjust the obligations of the business. Out of court restructuring is an informal measure used to protect the interests of all the business’s stakeholders (Antonoff, 2013). Through this procedure, the business’s assets and liabilities are restructured through, for example, flattening the business’s structure or selling off some of its assets and subsidiaries.

Out of court restructuring is a mirror of the formal business rescue process without the involvement of the courts and a business rescue practitioner. Although this procedure is seldom used, it plays a vital part in the insolvency system and seem to have be more successful than formal business rescue. What makes the informal restructure more attractive is that the distressed company works closely with its creditors to restore the company’s healthy financial status. Furthermore, the out of court restructure is confidential, meaning that the integrity and dignity of the distressed company would not be compromised as it may be in a business rescue case.

Although out of court restructuring is quick and affordable, most distressed businesses opt for the legislated business rescue. This is because a formal, legislated process gives stakeholders greater comfort and security, and provides for the appointment of a qualified and trained business rescue practitioner which they can trust.

Lastly, a distressed company may enter into standstill agreements with its creditors to pause fulfillment of its obligations for a while, so that it does not breach its agreements.

A debt standstill agreement will ordinarily include the following provisions:

a) The period of the standstill;

b) Whether the standstill will apply to the payment of the capital debt or the interest;

c) Appointment of a practitioner to turn around the affairs of the company on the verge of business rescue; and

d) A clause that allows the lender to cancel the agreement and call on their debt.

It should be noted that standstill agreements only bind parties that entered into it. Therefore, third parties could still apply to place the company under business rescue or liquidation.