Commercial Law: Are Business Rescue Proceedings Open To Abuse?

The Companies Act 71 of 2008 (“the Act”) came into effect on 1 May 2011. The introduction of the new Companies Act introduced business rescue as a new corporate rescue mechanism, aimed at rehabilitating financially distressed companies. Ten years after the introduction of business recue it is essential to recognise the success that it has had in providing financially distressed South African businesses with an alternative option to liquidation. Despite this success, however, it is important to re-evaluate the current state of business rescue in South Africa contrasted against an economy still in the midst of recovering from the impact of the Covid-19 pandemic.

Business rescue proceedings aim to provide a plan of rescue that facilitates the restructuring of a company’s affairs (and debt) in a manner that maximizes the chances of the company continuing on a solvent basis. Alternatively, if this is not possible, then business rescue must provide a better return for the company’s creditors than what would result from an immediate liquidation.

Business rescue proceedings can be instituted in two ways:  by way of a company resolution and a court order.

In terms of section 129 of the Act, the board of directors of a company can voluntarily institute business rescue proceedings if they believe reasonable grounds exist for its rescue. Thus, in terms of section 129 of the Act, the directors merely need to hold the subjective view that the company is financially distressed and that there is a reasonable prospect of its rescue. Due to the fact that voluntary business rescue requires no court order, nor the approval of shareholders or creditors, it is conceivable that resolutions in terms of section 129 are often passed to delay the inevitable liquidation of the company and to starve of creditors through the moratorium on creditors’ claims.

Alternatively, a court can grant an order in terms of section 131 of the Act for the commencement of business rescue proceedings if the court is satisfied that the requirements of section 131(4)(a) are met and that a reasonable prospect of rescuing the company exists.

Whilst the objectives of business rescue are laudable, the proceedings are however open to abuse due to the low requirements that must be satisfied which, coupled with the numerous advantages that the process offers, has left the procedure open to abuse. The most tempting advantage is the moratorium on creditor claims which runs for the duration of business rescue proceedings, which has the effect of suspending a creditor’s rights against the company.

Another avenue in which business rescue proceedings are often abused, stems from the fact that business rescue applications can be brought after the commencement of winding-up proceedings and, as such, are often brought solely to derail and delay the winding-up process. The institution of the business rescue application accordingly has the effect of suspending winding-up proceedings, the consequence of which results in the liquidators being prevented from discharging their statutory duties in relation to the winding-up of the company, one of which includes the sale of the company’s assets.

Business rescue proceedings can also potentially be used by directors of a company or members of a close corporation as a device to thwart the investigative powers of the liquidators, particularly the powers relating to the convening of a commission of enquiry. Thus, an enquiry into the affairs of the company which is convened by the liquidators or a creditor to examine pressing issues relating to the company’s directors and officers can be circumvented to the detriment of the creditors of the company.

The courts have held that business rescue applications should be brought in good faith and for proper purpose and must not be an abuse of process. In Molyneux & Another v Patel & Others the court stated that proceedings should be brought for the purpose of rescuing the company and not for an ulterior motive. It was further stated that abuse within this context indicates improper use, misuse and use for an ulterior or male fide motive and any such abuse must not be permitted by the courts, particularly where the intent is to frustrate creditors.

In Maryne Estelle Syme N.O Others v Southern Sky Hotel and Leisure (Pty) Ltd, Makgoba JP, concluded that the two business rescue applications brought after the respondent company was placed into liquidation was contrived to frustrate liquidation proceedings. He further reaffirmed the well-established dicta that business rescue proceedings are not meant for companies that are terminally ill.

In concluding, it is essential to recognise the lifeline that business rescue provides to financially distressed companies, particularly in an economy that is still in the midst of recovering from the devasting economic impact of the covid-19 pandemic. Notwithstanding this, however, creditors must not be lured into the potentially attractive facade of a business rescue without carefully considering the underlying reasons and circumstances surrounding the proposed rescue, as a failed business rescue that was orchestrated solely for male fide reasons will have the consequences of eroding any free residue that might have been available to satisfy the claims of creditors.

Written by Leelan Moodliar

This article is for general information purposes and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact us At DKVG Attorneys for specific and detailed advice.