Business Rescue and Suretyship

/ / 2020, community Schemes, COVID-19, News

By Tayla Bruce, Candidate Attorney and Lee Binneman, Partner

1. Introduction

The COVID-19 pandemic will leave a long-lasting impact on businesses worldwide.  The rapid spread of the illness and the subsequent nationwide lockdown imposed in South Africa have forced businesses to take practical and pro-active steps to mitigate losses and ensure their survival. Naturally, the success or failure of these businesses is inherently linked to the subsistence and welfare of their stakeholders, which include an entity’s employees, shareholders, owners, sureties, creditors and debtors. Regrettably, not many companies will have to consider the prospect of entering into business rescue, in order to effectively react to the current state of uncertainty. 

This article explores the topic of business rescue and the subsequent effect that this process has on suretyships, either in favour of or by the entity placed into business rescue.

2. Business Rescue

Chapter 6 of the Companies Act, 71 of 2008 (“the Act”), allows for the restructuring and/or rehabilitation of companies that are considered to be financially distressed. According to the Act, a company is deemed to be financially distressed if it appears to be reasonably:

  • unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months; or
  • likely that the company will become insolvent within the immediately ensuing six months.”

Business rescue proceedings, which are aimed at facilitating and rehabilitating a financially distressed company, ensure:

  1. the temporary supervision of the company and the management of its affairs, business and property by a business rescue practitioner;
  2. a temporary moratorium (stay) on the rights of claimants against the company or in respect of property in its possession; and
  3. the development and implementation of an approved business rescue plan which aims to re-structure the company’s affairs, business, property debt, other liabilities and equity in a manner that increases the likelihood of the company continuing on a solvent basis. Alternatively, if this continuation is not possible, the business rescue plan strives to achieve a better return for the company’s creditors or shareholders than if the company had to enter into liquidation.

3. Moratorium and Suretyship

Section 133 of the Act provides that during business rescue proceedings, no legal proceedings, including enforcement action, against the company or in relation to any property owned by the company or lawfully in its possession, may be commenced or proceeded with, unless certain conditions are present.

Furthermore, section 133(2) provides that during business rescue proceedings, a guarantee or surety by a company (our emphasis) in favour of any other person may not be enforced by any person against the company, except with the leave of the court and in accordance with any terms that the court considers just and equitable in the circumstances.

It follows that the Act prohibits a third party from enforcing a suretyship provided by the company, against that company, for so long as it is in business rescue. This principle was confirmed in the case of Investec Bank Limited v Bruyns 2011 JDR 1563 (WCC) (“Investec Bank”).

It is vital to note, however, that this statutory moratorium does not limit the liability of suretyships provided in favour (our emphasis) of the company. The Investec Bank decision re-affirmed that this moratorium is a defence that avails only the principal debtor to the contract and not the surety who signs for the benefit of the principal debtor. In other words, the moratorium will protect a company going into business rescue from creditors claiming against it, but this protection will not extend to sureties who have signed for the benefit of the company.

4. Limitation of a Surety’s Liability

The fact that the statutory moratorium does not extend to a surety signed for the benefit of a company, may result in many sureties being called upon to perform their obligations in accordance with the suretyship agreement, entered into with a company’s creditor. So, what steps, if any, may be taken by the company or surety in order to limit the enforcement of liability against the surety?

The common law position provides that where a principal debtor is released from its obligation in terms of a debt, the sureties in respect of that debt will too be discharged of such liability. This will be the applicable position, considering the Act is silent in this regard. 

However, section 154(1) of the Act stipulates that:

“A business rescue plan may provide that, if it is implemented in accordance with its terms and conditions, a creditor who has acceded to the discharge of the whole or part of a debt owing to that creditor will lose the right to enforce the relevant debt or part of it.”

This principle was upheld in the matter of in DH Brothers Industries (Pty) Ltd v Gribnitz NO & Others 2014 (1) SA 103 (KZP), where the court stated that where a business rescue plan has provided for a discharge of the main debt, to which the creditor has agreed or “acceded”, the liability of a surety for that debt would also cease to exist.

In the case of Tuning Fork v Greeff 2014 (4) SA 521 (WCC), it was found that should a business rescue plan provide for the discharge of a principal debt and the claim against the surety is not preserved in the business rescue plan or the suretyship, the surety is discharged from its liability, as in accordance with the common law position.

More recently, in the matter of Hitachi Construction Machinery Southern Africa Co (Pty) Ltd v Botes and Another (205/2018) [2019] ZANCHC 7 (15 March 2019), it was found that the liability of a surety is unaffected by the business rescue, unless the business rescue plan itself makes specific provision for the discharge of the suretyship.

Accordingly, having regard to the abovementioned case law and section 154 of the Act, it is evident that a surety may escape liability for so long as two conditions are met in the business rescue process. Firstly, it is essential that the approved business rescue plan, prepared by the business rescue practitioner, expressly provides for the compromise or discharge of the creditor’s claim of the debt against the surety. Secondly, the suretyship agreement entered into, between the creditor and the surety, must be silent on the enforceability against the surety in the event of the company being placed into business rescue. Put differently, the suretyship must not preserve the right of the creditor to pursue the surety, even if the principal debt against the company in business rescue has been compromised.

It is evident that in cases where the business rescue plan and the deed of suretyship do not make provision for the effects of business rescue and compromise in relation to enforceability of sureties, the common law position will remain.

5. Conclusion

It is important that sureties (both natural and juristic persons) are aware of the effects and implications of the business rescue process, in respect of amounts owing by the company to such claimants. Importantly, when entering into a surety agreement, it must be borne in mind that there exists a potential limitation on the application of the moratorium, as set out in section 133 of the Act, and that claimants may still institute action against a surety for the recovery of amounts owing by an entity in business rescue, unless the conditions as set out hereinabove are met. 

In this regard, it is advised that you approach   attorneys who are well-versed in the intricacies of business rescue and the impact thereof on an entity’s contractual relationships.

As always, Schindlers Attorneys remain available to assist clients in navigating these complexities.

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