South Africa: Deep Pits And Blue Skies - Restructuring In A Time Of Economic Woe

Last Updated: 21 July 2009
Article by Robert Driman and Riza Moosa

The worldwide economic meltdown caught many businesses unaware. Gearing quickly became over-gearing, leverage -- instead of being a catapult for new wealth -- became a noose, and business leaders had to scramble to keep their companies alive. Of critical importance is the injection of new capital to restore a balance sheet to solvency by ensuring that assets -- fairly valued -- exceed liabilities, or to generate cash flow to remedy technical solvency issues such as the ability to pay debts as and when they fall due.

In this climate, there are a number of commercial remedies available that would benefit a stretched company. These involve gauging whether the Company is able to raise further funding in the form of debt (by way of borrowing from banks or by disintermediation and directly accessing the debt capital markets) or by way of equity in the form of share capital. Funding so raised may be used to strengthen the balance sheet or for working capital purposes or may be used indirectly to refinance more expensive debt. In order to raise debt funding, the company will need to consider which of its assets it is able to offer as security in order to reduce the costs of raising such debt. Security may also be granted in relation to the acquisition of or subscription for shares in the company, subject to the financial assistance provisions in the Companies Act.

A company may therefore cede its book debts to a lender as security for a fresh loan, invoices can be discounted to produce cash flow, assets can be mortgaged or hypothecated, and sleeping assets can be brought to life. Share capital may be raised by issuing new shares of various classes, each with different rights, offering the new investors preferential rights whether in respect of voting or to receive distributions from the company. Expert legal and commercial advice would help in releasing hidden value even in difficult market circumstances and where credit is no longer freely given.  Investors and lenders will be careful in these circumstances to ensure that the security granted in their favour is not seen to prefer one creditor over the other or is subject to suspension during any so-called hardening periods in terms of the Insolvency Act.

Where all assets of a business are already deployed and cash flow can neither sustain fresh borrowings nor justify the issue of fresh shares or preference shares, the question which arises is whether the business would benefit from temporary protection from its creditors in order for it to generate cash flow or to release assets as security for further borrowings. At present only judicial management or provisional liquidation would provide a shield to the company against its creditors. Judicial management has tended to be ineffective because creditors would change their lending patterns and would no longer supply goods on account. Provisional liquidation has even less to recommend itself.

Changes to the Companies Act in the form of business rescue provisions will change this. While some commentators have been critical of the practical aspects of the proposed changes, in reality -- particularly where there are a number of significant lenders involved -- many of the methods of business rescue are already applied by creditor consortiums. The new legislation will give the force of law to these voluntary, but effective, remedies and will ensure an even hand to lenders with or without security, trade creditors, employees and other role-players.

In the meantime, companies facing solvency problems need to be properly advised how to deal with the issues. Directors and others dealing with the companies' problems may be at risk of personal liability. Giving selective or insufficient information to creditors or employees may be tempting but unwise. Specialised advice is required. Directors would be well advised to ensure that all affected parties obtain their own advice. In the meantime business rescue creditors' consortiums -- while cumbersome -- could well help by making sure that a balance is introduced that brings fairness into play to promote workable solutions.

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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