By Katya Oberzhitsky (Associate designate) and Caitlin Wilde (Partner)
The COVID-19 pandemic has caused mass uncertainty for South African business owners, given the far-reaching economic ramifications it may have on our economy. Many business owners are concerned about what this means for the health and sustainability of their business in the coming months.
On the one hand, business rescue enables a company, with minimal or no cash-flow, to restructure, while obtaining some “breathing room”. On the other hand, liquidation may seem like the only option for financially distressed companies that are unlikely to recover from an insolvent state of affairs and trade successfully in the foreseeable future.
In this note, we take a closer look at the differences between these two mechanisms in order to assist business owners in making the most appropriate, and best commercial, decision for their businesses.
How does a business owner determine that their company is ‘financially distressed’?
Owing to the current economic climate, most business owners are feeling some form of financial pressure and concern about the future of their businesses.
“Will my business overcome this unstable period?”
“How am I going to generate income?”
“What about my creditors? How will I pay them?”
“What do I do with my employees?”
“Should I continue running this business or am I making it worse by trying to keep it going?”
Understanding the difference between business rescue and liquidation is the starting point in answering such questions.
Being ‘financially distressed’, in reference to a particular company at any particular time, really means that 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 immediate six months; or
- reasonably likely that the company will become insolvent within the immediate six months.
So what does Business Rescue really mean?
Business rescue is a rehabilitation mechanism, through which a company can restructure its business, contracts, debt affairs, other liabilities and assets.
The business rescue plan, which is implemented by an appointed business rescue practitioner and is later approved/adopted by its creditors, allows the company to trade on a solvent basis during periods of insufficient cash-flow and until such time as the company is no longer financially burdened (a time period forecasted in the business rescue plan).
What does the Business Rescue Plan entail and how is it implemented?
The business rescue plan details the manner in which the company can effectively restructure its business, the management of all of its debt and trade affairs, as well as possible restructuring of its contracts (those that have already been executed or partially executed).
It aims to enable the company to generate income and ultimately produce a greater monetary return for the company’s creditors.
The business rescue plan should:
- demonstrate why business rescue is the preferable course of action, as opposed to liquidation; and
- balance the rights and interests of all relevant stakeholders.
What are the benefits of Business Rescue?
Whilst appointing a business rescue practitioner may be daunting for many business owners, fearing that the director(s) will lose total control over the company and the day-to-day management of their business, this is not the case.
Business rescue allows a director of a company to continue exercising his or her duties, whilst under the temporary supervision/guidance of the business rescue practitioner. The director and business rescue practitioner are expected to work together in order to revive the company’s unfavourable economic conditions, by implementing a well-developed and sustainable business rescue plan.
Other advantages of business rescue include:
- protection of the company’s assets against creditors, by placing a temporary moratorium (suspension) on all creditor’s claims against the company;
- a temporary moratorium (suspension) on all legal proceedings against the company;
- protection of employees by allowing them to remain employed while the company is restructured; and
- enabling the business rescue practitioner to (entirely, partially or conditionally) suspend contracts entered into by the company for the duration of the business rescue proceedings (with the exception of employment contracts).
How does Liquidation differ to Business Rescue?
Liquidation is a last resort and ultimately results in the demise of the business, but should be preferred if it would result in a better return for creditors than business rescue. The purpose of liquidation proceedings is to dispose of an insolvent company’s assets and utilise the proceeds of the sold assets to settle creditor claims.
Prior to the commencement of liquidation proceedings, it is important for directors to consider the following:
- what the company stands to lose should it be liquidated;
whether any directors/shareholders will be held personally liable for the debts of the company (for example, where money is owed to the South African Revenue Service (SARS) or if the directors have engaged in reckless trading);
- whether there has been misconduct or fraud which has contributed to the company’s insolvency, and which should be investigated thoroughly through the liquidation process; and
- whether the directors of the company have signed any sureties/guarantees, to which they may be held liable.
A company should be placed into liquidation if it does not satisfy the solvency and liquidity test (as opposed to merely being financially distressed), such that the company is:
- “factually insolvent” – its assets exceed its liabilities; and
- “commercially insolvent” – it is unlikely to be able to pay its debts, as they become due in the ordinary course of business, in the ensuing twelve months.
Other key differences between business rescue and liquidation include:
- all assets of the company are realised in liquidation, whereas in business rescue, the practitioner may consider that only certain assets (if any) are appropriate to realise as part of the rescue plan;
- a company in liquidation should immediately cease all trading, whereas business rescue looks to recover the business and ultimately restore it to a position where it may trade ordinarily; and
- legal proceedings against the company are suspended until the appointment of a liquidator, whereas business rescue provides a temporary moratorium on all legal proceedings.
Although the proceedings and implications of business rescue and liquidation are distinct, the fact that a company has opted for one of these courses of action does not preclude it from later terminating such course and proceeding with the other. Most often, this occurs where it becomes apparent, during business rescue, that rehabilitation of the business is reasonably unlikely.
Both types of proceedings can be launched voluntarily – and should be, where the financial distress, or solvency and liquidity test, are satisfied.
While COVID-19 has the potential to disrupt the continuance and sustainability of many business operations in South Africa, every business owner should consider which of these two mechanisms, mindful of their respective purposes and procedures, better suits their company’s current financial circumstances and foreseeable prospects.