South Africa: Moratorium On Claims In Business Rescue Proceedings

Last Updated: 21 November 2013
Article by Mzo Tshaka

One of the new concepts introduced by the new Companies Act ("the Act")1 is the concept of business rescue2. This concept finds its foundation in one of the stated purposes of the Act, which is to "provide for the efficient rescue and recovery of financially distressed companies, in a manner that balances the rights and interests of all relevant stakeholders"3. Amongst other things, business rescue is aimed at providing an alternative to a liquidation process, to make it easier for companies in financial difficulty to be rescued and to continue as commercially viable entities.

The focus of this article is on the implications of the moratorium that automatically applies when a company is placed under business rescue. However, before considering that issue in detail, it is important to have a brief look, generally, at the principles applicable in business rescue proceedings. Business rescue is defined in the Act as:

"proceedings to facilitate the rehabilitation of a company that is financially distressed by providing for:

(i) the temporary supervision of the company, and of the management of its affairs, business and property;

(ii) a temporary moratorium on the rights of claimants against the company or in respect of property in its possession; and

(iii) the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximizes the likelihood of the company continuing in existence on a solvent basis, or if it is not possible for the company to so continue in existence, results in a better return for the company's creditors or shareholders than would result from the immediate liquidation of the company"4

It is clear from the above definition that the trigger event for business rescue is a company that is "financially distressed". A financially distressed company is a company that appears to be reasonably unlikely to be able to pay all its debts as they become due and payable within the immediate ensuing six months or a company that appears to be reasonably likely to become insolvent within the immediate ensuing six months5.

It is clear from the definition of "financially distressed" that the main issue is the company's ability to pay its debts as they fall due and payable – what is generally known as a liquidity problem. It is also clear from the definition that at this stage the company is not yet insolvent but it is on the verge of being insolvent.

Given the fact that a financially distressed company is one that has a liquidity problem, one of the key features of a business rescue procedure is the reprieve granted to a financially distressed company from having to pay its creditors – albeit temporarily. For the duration of the business rescue proceedings, there is an automatic and general moratorium on legal proceedings or executions against the company6. In other words, the claims of the creditors are frozen.

It is however worth noting that although the moratorium would apply to all creditors; it does not extend to proceedings by regulatory authorities, like the South African Revenue Services7 - and there are a few other exceptions8.

Whilst there can be no gainsaying the importance of the breathing space afforded by the moratorium on a company that is financially distressed, I would argue that the consequences for the creditors of a company that is under business rescue can be as devastating. Consider a situation where company A supplies a large stock of goods to company B (who happens to be company A's biggest client) on 30-day payment terms. Should company B be placed under business rescue before paying for the goods supplied, company A will not be able to collect the amount due for the supplies (or demand the return of the goods even if it had reserved ownership) until the end of the business rescue proceedings, which can take months9. If company A is not able to receive payment from company B for a number of months, that may, in turn, result in company A being unable to pay its own debts as they fall due and payable.

In view of the fact that business rescue proceedings can be commenced relatively easily, e.g. by a board of directors at a board meeting, it is conceivable that a lot of companies can find themselves in the same predicament as company A in the example above.

Conclusion

It is advisable that companies who extend credit to other companies, in whatever form, remain cognisant of these potential risks and take the necessary steps to protect themselves in the event that their main client is not able to pay them for a number of months. Although not always feasible nor even practical, one useful tool in such situations is to have someone else signing personal suretyship agreements. Another option would be to consider if it is worthwhile to take up insurance to cover such eventualities.

Footnotes

1 Act No 71 of 2008 (as amended)

2 Dealt with in Chapter 6 of the Act

3 Section 7(k) of the Act

4 Section 128(1)(b)

5 Section 128(1)(f)

6 In terms of Section 133(1) the moratorium applies until the business rescue process ends

7 Section 133(1)

8 However, these are not relevant for the purposes of this article

9 The Act states that business rescue proceedings must be finalised within 90 days from commencement date, however, the Court has the power to extend the period on application

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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