The Companies Act 71 of 2008 makes provision for a financially distressed company to be placed into business rescue. In order to go into business rescue, a company must show that it is in fact financially distressed.
Defined in s128(1)(f), ‘financially distressed’ is where the company is “reasonably unlikely to pay all of its debts as they become due and payable within the immediately ensuing six months” or it “appears reasonably likely that the company will become insolvent within the immediately ensuing six months. Practically, this means that the company will not be financially sustainable in its present state. Many financially distressed companies have liquidity issues or cashflow problems, with the bottom line being it is an unreliable debtor. However, to succeed in rescue there must be a reasonable prospect of saving the business (s129). Failing such, it will either go into liquidation or follow the alternative rescue (i.e. in effect, a quick and informal sale of its assets).
One of the benefits of business rescue is “general moratorium on legal proceedings against the company” (section 133). This is done in order to give the company time and a fighting chance to return to commercial solvency. Unless a company trades in rescue and receives cash from such trading and/or has debtor recoveries to fund its expenses during rescue, it cannot be rescued. It can also look for a loan for a cash injection in the form of post-commencement finance.
Under normal circumstances, a lender would be reticent to lend money to a distressed business that may have a short or no future. In order to encourage lending, post-commencement financiers are effectively ‘bumped up’ the list of creditors. They are third on the list behind only the Business Rescue Practitioner and his/her expenses/advisors as well as any employees who are owed money by the company (s135(1)). It is even possible for these post-commencement financiers to obtain security for their loan provided that the asset over which they take security, has not already been encumbered.
However, there are risks with such lending which must not be ignored. If the business rescue is unsuccessful and the business is liquidated, the liquidation costs leapfrog these lenders on the list. In this regard, the case of Merchant West Working Capital Solutions (Pty) Limited v Advanced Technologies and Engineering Company (Pty) Limited and Another the Court highlighted the order of preference for claims. In its ranking, the Court stated: “Section 135(4) of the Act provides that if business rescue proceedings are superseded by a liquidation order, the above preference will remain in force except to the extent of any claims arising out of the costs of that liquidation”.
If there is more than one post-commencement lender, then these lenders are paid out in the order in which their loans were incurred. Such an idea was also referred to in the Supreme Court of Appeal’s case of Diener NO v Minister of Justice and Others where they quoted from the Act: “(b) in subsection (2) will have preference in the order in which they were incurred over all unsecured claims against the company”. In layman’s terms, they are basically saying a ‘first come, first serve’ approach. As such, it can result in it being risky for these types of lenders who were amongst the last to lend. Finally, there is the risk of there being insufficient funds for these lenders, after the Business Rescue Practitioner and his/her expenses as well as the employees has been paid out. A particularly high-risk scenario is where there are no unencumbered assets against which to secure the post commencement finance loan.
These risks can be allayed or even prevented by the lender. In all likelihood, good prospective post-commencement financiers will conduct their research and perform their due diligence before investing. Certainly, factors such as the prospects of success of rescue, the honesty of the Business Rescue Practitioner, the nature of the security to be given for the loan are the main criteria (and there are more) to be taken into account when making the decision.
There is no denying that post commencement finance is a high risk, high reward scenario. However, if the financier is thorough in his/her research and is willing to take a chance, then there is no reason why it cannot be turned into a profitable outcome - at least for the financier.
Assisted by Nicholas Potgieter (Associate) and Colin Strime (Director)
