South Africa: Business Rescue And Thresholds For Small Businesses

Last Updated: 1 December 2011
Article by Ashton Steenekamp

Regulation 127(1)(b) promulgated under the Companies Act 71 of 2008 (the Act) states that companies which are undergoing business rescue proceedings are classified into three groups, namely, large, medium and small companies. A "small company" is set out as being, "any company, other than a state owned or public company, whose most recent public interest score, as calculated in terms of regulation 26(2), is less than 100". Regulation 26(2) then goes on to state that at the end of each financial year, every company must calculate its "public interest score", taking into account various factors, inter alia the average number of employees of the company during the financial year, the amount of rands which the company has in third party liability and turnover during the year, calculated as one point for each R1 million or portion thereof. These provisions apply equally to both companies and close corporations.

The Act therefore sets out a method of calculating whether a business is classified as a small business or not.

Business rescue and various alternative options

The question which now arises is whether certain small businesses that are financially distressed should be placed under business rescue, or whether the company should simply be liquidated without going through the process of business rescue first. In assessing this question it is important to consider what the Act sets out as the purpose of business rescue. This is stated in section 128(1)(b) where it says that business rescue should create a plan to rescue the company through a restructuring of certain elements so as to maximise the likelihood of the company continuing to exist on a solvent basis or, if this is not possible, to result in a better return for the company's creditors or shareholders than what would result from the immediate liquidation of the company.

These two alternative purposes are what should be considered by the board of a small company or by an affected person of the small company when deciding whether to place the company under business rescue in terms of section 129 and section 131 respectively. The reason for considering these two purposes is because business rescue proceedings can be expensive and if they do not result in either of the above purposes being achieved and the company is subsequently placed under liquidation, then the costs incurred will be in addition to those incurred for the liquidation, thus resulting in creditors or shareholders receiving a much smaller sum of money than they would have received if business rescue had not been pursued and the company had immediately been placed under liquidation.

When deciding whether to place a small company under business rescue there are various other options that should also be considered. Firstly, section 155 of the Act allows a company, whether financially distressed or not, to propose an arrangement or compromise of its financial obligations to its creditors in accordance with the requirements of the section. This procedure should be seen as an alternative to placing the company under business rescue, and has many advantages. For example, the board of the company remains in charge and thus there would be no additional costs in having to pay a person external to the company to administer the process. It has been suggested though that due to the requirement that the company will in addition to obtaining the creditors' support, have to make an application to court for the court's approval of the proposal, small businesses will probably not find a compromise with creditors to be a viable alternative to business rescue.

A second alternative that could be considered are the various options that are available to a consumer in terms of the National Credit Act 34 of 2005. This Act will only apply to juristic persons whose asset value or annual turnover, together with the combined asset value or annual turnover of all related juristic persons at the time the credit agreement is concluded, is less than the current threshold determined by the Minister, being R1 million. If the small business falls within this category, then this Act will apply to it and its management will have various alternatives to business rescue available. These are referring the credit agreement to a debt counsellor, alternative dispute resolution agent, consumer court or ombud with jurisdiction. The purpose behind any of these options is for the parties to resolve any dispute under the agreement or to develop and agree on a plan to bring the payments under the agreement up to date.

A further alternative available to a very small business is that of an administration order in terms of section 74 of the Magistrates' Court Act 32 of 1944. It has been said that this type of order is the predecessor of debt counselling as provided for in the National Credit Act. Despite its antecedents the section 74 administration procedure has not yet been done away with. As the Magistrates' Court Act specifically refers to a "debtor" and does not classify such, it can be presumed that so long as the small business's debts do not exceed the R50 000 threshold that has been determined by the Minister, this procedure may be applied as an alternative to business rescue. Two of the main differences between an administration order and debt counselling are that under debt review, the creditors are paid a sum on a monthly basis, whereas under an administration order, payments to creditors are only made every three months. Further, a clearance certificate will be issued once the debt has been paid off under debt review, but no certificate is issued under an administration order.

Small businesses and the possibility of thresholds in relation to business rescue

The question arises whether financial thresholds should be set, analogous to those in the Competition Act 89 of 1998, below which small businesses will not be allowed to enter into business rescue proceedings. The problem with creating a set turnover and/or asset value threshold is that contrary to the thresholds created for distinguishing mergers in competition law, which were created solely for the purposes of notification and adjudication, the thresholds created for business rescue would be used to determine a much more substantial result, namely whether a company will be allowed to attempt to continue trading or not. In addition, the Act provides for the court to have a discretion as to whether or not to allow a company to enter into business rescue. The importance of this is that the court will be in a position to take the circumstances of each individual case into account. Imposing monetary thresholds may cause the process to become too objective and could result in the subjective factors relating to the company's unique circumstances being overlooked – essentially fettering the discretion of the board of directors and of the court. There is in any event a backstop – an affected person can apply to court to set aside either a resolution or a court order of business rescue, in terms of sections 130 and 131 respectively.

In the recent reportable judgment of Swart v Beagles Run Investments 25 (Pty) Ltd and others (26597/2011) [2011] ZAGPPHC 103 (30 May 2011), the Honourable Makgoba J stated that when an application for business rescue entails the weighing-up of the interests of the creditors and the company, the interests of the creditors should prevail. This statement specifically lends itself to the writer's view that there is no need for specific thresholds to be created. The court is in a much better position to consider the two purposes of business rescue as set out in section 128, one of which was specifically referred to by Makgoba J, while at the same time taking into account both the creditors and the company's circumstances when deciding whether it is a viable option for a small business to enter into business rescue instead of being liquidated immediately.

Thus, it is extremely important for the directors or members of a small business to exercise care when considering whether to enter into business rescue or not. They should consider all of the other various options available to them, the fact that there could be legal costs incurred as a result of an objection in terms of section 130, and whether the high costs of business rescue are actually worth the risk that if business rescue should fail and the company is placed into liquidation, both the costs of the failed business rescue and the liquidation costs will have to be paid to the detriment of creditors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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