With the introduction of business rescue by the new Companies Act (which came into effect on 1 May this year), a company director is obligated to either pass a resolution for business rescue or for liquidation, as soon as he or she becomes aware that the company is trading in a financially distressed situation or notify all stakeholders of the basis for not doing so.
Although making creditors aware of the company's financial difficulty is mandatory, Eric Levenstein, director at Werksmans Attorneys, points out that it could prove to be a double edged sword.
He explains, "Directors need to be aware of the notifications that they are now required to give to creditors, warning them of the fact that their company is financially distressed. If a director decides not to place a company in financial distress into business rescue, then he or she is under a statutory obligation to deliver a written notice to each affected creditor, confirming that the company is financially distressed, but is not being placed into business rescue. Although reasons for such a move must be provided, it could potentially put the company at further financial risk as many creditors may refuse to provide essential goods or services if there is a chance that they will not be paid."
"This point is evident in the Act which informs creditors that if they supply a company with goods on credit after being forewarned of financial distress, then it is at their own risk."
If a director is clearly made aware of the fact that his or her company is financially distressed and decides not to send out the required notice, such action could be seen to be reckless and he or she could be held personally liable for the debts of the company and face criminal prosecution.
The definition of 'financial distress' means that either it appears unlikely that the company will be able to pay all of its debts as they fall due and payable in the next six months; or it appears to be reasonably likely that the company will become insolvent within the next six months.
Levenstein concludes, "In the current local and world financial markets, a frank and realistic review by directors of the financial position in which their company's trade will be essential for survival and to avoid personal liability".
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