Is Business Rescue being used as intended?

Tuesday, October 16th, 2012

South Africa has recently received its second sovereign credit rating “downgrade”.  If businesses are going to be struggling within this economic climate it will mean lower revenue for the state, which in turn will mean that the state will be unable to fund its development/infrastructural plans, which means that unemployment will probably increase – finally, leading to an even more unhappy labour force (which is largely responsible for the downgrading of our credit rating anyway!) – which won’t have the money to spend, which will mean lower sales, and, and, and…….!

Clearly, this means we’re in a recession, and that it will probably be the biggest one we’ve faced as a new democracy.  Doing business will be tougher!  In recent months, we have seen a huge increase in the number of business failures within the small to medium sized business sector, and especially within the building and allied industries.  Some of them have happened because of the recession and often beyond the control of owner/directors – others have just been as a result of bad management.

And still others are just jumping ship, and using legislation to do it!

The new Companies Act in South Africa has made provision for what it calls “Business Rescue”. This has replaced the old, and useless, judicial management system. But, is it being used as it was intended?

It was never intended to be used as a form of insolvency, but to avoid insolvency.  Companies qualifying for rescue have to be financially distressed but with a likelihood of being rescued.  The intention of the process is that it done quickly (within 3 months if possible) so the rescued company can be returned to normal trading in a healthy state. The acid test of whether a company will be able to succeed under this rescue process is generally whether all its arrear creditors will be paid within a six month period.

The aim of this provision is essentially to allow businesses in distress some breathing space, to enable a qualified rescue practitioner time to ascertain whether the business is salvageable or not. This has far reaching effects on creditors, financial institutions, shareholders, employees and restructuring specialists.

In my experience, however, the inevitable result for businesses in this kind of distress – and especially in a recession – is that rescue is not possible.  I have a few reasons for saying this:

  • I do not believe that there is enough time, for even the most experienced practitioners, to ascertain with any degree of certainty, that the company can be rescued.  They have 10 days after being appointed to notify creditors and call a meeting of creditors.  Not even the most astute practitioner – in my humble view – and given the fact that a distressed company is usually in an administrative shambles – will be able to give an objective assessment in that time.  A cursory glance at management financial statements – which in the case of many small-to-medium companies will be dodgy at best – does not indicate what the company’s prospects are; what the company’s expense practices have been, and – what the owner/directors of those companies have been doing!
  • With even the best intentions, most directors/owners of small-to-medium sized companies are eternal optimists – they believe that they can ride out their problems; that if they just hang on a little longer, the tide will turn; that there is light at the end of the tunnel. (even though it’s usually the train bearing down on them!)  So, they wait, and they wait, and they wait – and it just gets worse!  By the time they consider business rescue, it’s usually too late. (or, quite often, the initiative is eventually taken away from them by one or more strident creditors, and this can have very serious consequences for directors.)

So, in my view, the Business Rescue process – in practice – will turn out to be just a prelude to liquidation.  If you’re a creditor in this situation, don’t hold your breath that things will turn around and that you’ll get paid what’s due to you!

However, for directors of companies, the process is vital!  If they continue to trade, knowing that they are unable to meet their short-term credit commitments, and don’t notify their creditors, they could end being held personally responsible for their companies’ debts. It’s known as reckless trading.  So, they have to make use of this legislation – or, at the very least, communicate to creditors about the state of the company and appeal to them for assistance in turning it around outside of this process.

There are some unscrupulous companies (owners/directors) who use these provisions in the Companies Act to evade their obligations.  They manage their businesses badly and milk them for personal gain, enriching themselves at the expense of creditors.  When they realise they can’t meet their short-term debts, they apply for business rescue – only because it buys them some time – and knowing that liquidation is inevitable anyway.  By the time that happens, they are safely protected by the Companies Act from any personal threat – and very often, after the liquidation process has begun, they start up again under a different trade name, but this time, without the debt burden. Shame__ on__ them!

I believe that the Business Rescue practitioner should be allowed to conduct a full investigation of the company, and of the directors and their remuneration and expense practices, before calling the meeting of creditors.  If the practitioner finds there have been financial shenanigans, he should advise CIPC – and creditors – that rescue is not possible for that reason.  That will go a long way towards preventing unscrupulous operators from manipulating the system.

The message for owner/directors is this: if your company is in distress, for whatever reason, don’t delay this process and risk your personal assets.  Apply for business rescue quickly; and at the very least, communicate with your creditors.

Section 22 of the new companies act is especially tough on directors who don’t play the game!