South Africa: Can A Creditor's Ranking In Terms Of The Insolvency Act Be Negatively Affected By A Business Rescue Plan?

Last Updated: 10 January 2012
Article by Keith Braatvedt and Ashton Steenekamp

In this article the author considers whether the creditors of a company, which is placed under business rescue, can lose the ranking status bestowed on them in terms of sections 95 to 103 of the Insolvency Act 24 of 1936 (the Insolvency Act).

In terms of sections 95 to 103 of the Insolvency Act, there are three distinct types of creditors, namely in descending order of ranking, secured creditors who hold security for their claim over a specific asset or assets of the company; preferent creditors whose claims are not secured but that nevertheless rank above the claims of concurrent creditors; and lastly, concurrent creditors who do not hold any form of advantage over other creditors and are paid out of the balance of the free residue of the estate.

The abovementioned debate, in the writer's opinion, would seem to stem from section 154(2) of the Companies Act 71 of 2008 (hereinafter referred to as the Act) which provides:

"If a business rescue plan has been approved and implemented in accordance with this Chapter, a creditor is not entitled to enforce any debt owed by the company immediately before the beginning of the business rescue process, except to the extent provided for in the business rescue plan."

In terms of this section, once a business rescue plan has been approved and implemented, the plan is binding on every creditor and every holder of the company's securities, regardless of the creditor's ranking, and in accordance with section 152(4) of the Act regardless of whether the creditor was present at the meeting where approval of the business rescue plan was put to a vote, no matter whether they voted in approval of the proposed plan and irrespective of whether they have proven a claim or not. In addition every action that is taken in relation to the company from that point onwards is to be made in accordance with the business rescue plan.

A business rescue plan is in terms of section 150 of the Act, prepared by the business rescue practitioner after he has consulted with the creditors, affected persons and management of the company. Section 152(2) of the Act then sets out the votes which are required in order to approve the proposed plan. It states:

"In a vote called in terms of subsection (1) (e), the proposed business rescue plan will be approved on a preliminary basis if –

(a)    it was supported by the holders of more than 75% of the creditors' voting interests that were voted; and

(b)    the votes in support of the proposed plan included at least 50% of the independent creditors' voting interests, if any, that were voted."

There is a distinction drawn between "creditors" and "independent creditors", where an independent creditor is defined as "a creditor of the company, including an employee of the company who is a creditor in terms of section 144 (2) and is not related to the company, a director, or the practitioner, subject to subsection (2)".

This is where the debate arises. It could be argued that since the approval of all the creditors, particularly that of the secured and preferent creditors, is not required to approve and implement the business rescue plan, a situation could arise where a secured creditor, who failed to vote or who voted against the approval of the implemented business rescue plan, despite his security could be placed in a situation where he is unable to realise his security and furthermore has no control over the use of the asset which is the subject matter of his security during the period in which the company is placed under business rescue. The issue which could arise is the effect which this may have on the secured creditor in two instances:

  1. if the plan requires all the creditors to compromise their claims, to a percentage lower than the recovery which the secured creditor could reasonably have expected in a liquidation; or
  2. if business rescue should fail and the company is thereafter placed in liquidation.

I shall use an example to illustrate the latter situation: The company placed under business rescue is a flower shop. One of the company's secured creditors holds security in the form of a motor vehicle which is used for the delivery of flowers. The secured creditor attends the meeting and votes against the approval and implementation of the proposed business rescue plan. Despite this, the plan is approved in accordance with section 152(2) and is thus implemented. A term in the plan is that the motor vehicle, which is the subject of the secured creditors' security, will be used for double the amount of deliveries for which it has been used in the past in order to save costs on purchasing a further vehicle and paying another driver. The plan does not provide for the sale of the motor vehicle and in terms of section 154(2), the secured creditor may not realise the security. Despite the implementation of the plan, the company is not salvageable and is thus placed into liquidation. As a result of the motor vehicle being used excessively during the implementation of the plan, it has depreciated in value to a very large degree and thus the secured creditor's security has now been depleted substantially.

By the same token, the preferent creditors being SARS and employees in an insolvency scenario, could potentially be outvoted by other creditors and find their claims compromised under the business rescue plan to a recovery lower than they would have received had the company been liquidated.

The argument that thus arises is that while the objectives of the business rescue plan were bona fides and were to salvage the company so that it would be in position to fully repay all of its creditors, this does not always come to fruition and thus a secured creditor may end up in a much worse position than it would have been if the company had simply been liquidated in the first place. In that instance, the creditor would have been in a position to realise the security for a much larger sum of money. Thus, while the business rescue plan may have been approved and implemented and this may be very beneficial to concurrent creditors, its benefits may be lost on certain secured and preferent creditors.

On the whole it may be said that the voting provisions in the Act tend to favour the majority of creditors in value rather than on the basis of ranking under the Insolvency Act.

Despite the situation described above, the writer is of the opinion that the Act makes adequate provision for the input and participation of all creditors prior to the acceptance and implementation of a business rescue plan. Section 145 of the Act is an important section to take note of in this regard. It entitles the creditor inter alia, to be given notice of "each court proceeding, decision, meeting or other relevant event concerning the business rescue proceedings, to participate in any court proceedings arising during the business rescue proceedings, to formally participate in a company's business rescue proceedings to the extent allowed in the Act and to informally participate in those proceedings by making proposals for a business rescue plan to the practitioner". In addition sub-section 3 allows creditors to "form a creditors' committee, and through that committee (the creditors) are entitled to be consulted by the practitioner during the development of the business rescue plan". Section 147 then sets out how notice of the first meeting of creditors must be given.

In relation to a business rescue plan providing for an asset which is the subject-matter of security to be sold, in addition to the sections set out above which specifically provide for the creditors' participation in the formation and approval of the plan, section 150(2)(b) sets out that in Part B of the proposed plan "the order of preference in which the proceeds of property will be applied to pay creditors if the business rescue plan is adopted" must be set out in the plan. Thus, the secured creditor would have an opportunity to ensure that its rights are being recognised, and if in its opinion they are not, then to utilise the rights given to it in sections 145(2) and 152(1) of the Act to rectify this.

In light of these sections, if the business rescue practitioner acted in accordance with the Act, the secured creditor should have received ample notice of the meeting and ample opportunity to make proposals in relation to the proposed plan.

Therefore, it is the writer's opinion that while the example situation as set out above may occur in practice, in most instances if the secured creditor found himself in such a situation, it would be as a result of its negligence in either not attending the meeting wherein the proposed plan was voted for, or in that it failed to adequately utilise the various rights which the Act provides it with to ensure that a situation as set out above does not occur.

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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