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The art of law - a company that is kept afloat financially by an outside party can nonetheless be said to be commercially solvent

Is a company that is being kept afloat financially through loans from its sole shareholder liable to be wound up by a creditor as "unable to pay its debts"?

The judgment in Dippenaar NO v Business Venture Investments No 134 (Pty) Ltd [2014] ZAWCHC 7, in which judgment was handed down by the Western Cape High Court on 5 February 2014, confirms the proposition - for which there was previously scant authority - that a company can be regarded as commercially solvent, and consequently not vulnerable to being wound up by a creditor, even though it is kept afloat only through the injection of funds by an outside party, in this case, its sole shareholder.

The company in question owned the frail centre in an upmarket lifestyle village in Stellenbosch and the issue before the court was whether the applicant creditor was entitled to a winding-up order on the grounds that the company was unable to pay its debts, alternatively whether, on just and equitable grounds, the company should be placed in final liquidation.

The company was currently controlled by its sole shareholder

While the liquidation application was pending, all the company's shares were purchased by Lipsotex (Pty) Ltd which then took over the management and control of the company.

The creditors of the company, as applicants, were seeking an order for it to be liquidated on the grounds that it was in financial distress and unable to pay its debts. The court below had been persuaded to make a provisional order of liquidation and the current proceedings involved argument, on the return day of that order, as to whether a final order of liquidation should be made.

The applicants argued (see para [54] of the judgment) that Lipsotex's take-over of the management of the frail centre did not affect the company's inability to pay its debts and that a number of creditors remained unpaid.

The applicants counter-argued (see para [17]) that reliance on funds provided to the company by its sole shareholder, Lipsotex, did not make the company solvent, inter alia because Lipsotex could withdraw the funding arrangement at any time.

The applicants contended (see para [18]) that the loans from Lipsotex merely meant that the company had incurred yet further debt, that there was no proof that Lipsotex had the financial resources to meet the company's liabilities, and that the company's business was therefore unsustainable.

The company argued (see para [20]) that it was able to meet its liabilities as they became due by means of capital provided by Lipsotex as its new shareholder, and that the company's attorneys were holding in trust sufficient funds to pay the applicants' claims. The company also argued (see para [24]) that Lipsotex was providing funds, not in the form of loans, but as an investment.

All in all, the company contended (see para [24]) that it was a solvent and actively trading entity with sufficient capital resources to meet its obligations as they fell due, albeit only by virtue of the funding provided by Lipsotex.

In the circumstances, was the company commercially solvent?

The court identified the central issue (see para [28]) as being whether, in these circumstances, the company was indeed commercially insolvent in the sense that it was unable to meet its day to day liabilities in the ordinary course of business. This, said the court, required account to be taken of whether there were -

"liquid assets or readily realisable assets available out of which, or proceeds of which, the company is in fact able to pay its debts".

This was the criterion of commercial solvency envisaged in Rosenbach & Co (Pty) Ltd v Singh's Bazaars (Pty) Ltd 1962 (4) 593 D & CLD at 597C-D.

The judgment in the present case raised the important question of principle as to whether a company can rebut an allegation that it is unable to pay its debts by showing that it is able to pay those debts by way of funds supplied from an external source, in this case, its sole shareholder.

In support of an affirmative answer to that question, the court cited the decision in Nepgen v Autoachiva (Pty) Ltd (2012] ZAGPJHC 17 where Gautschi AJ (relying on the decision in Helderberg Laboratories CC v Sola Technologies (Pty) Ltd 2008 (2) SA 627 (C)) held that -

'The mere fact that a company pays its debts using borrowed money does not render it unable to pay its debts.'

In this case it had been argued that the company in question was surviving on loans provided by friendly creditors.

The source of the company's funds is irrelevant, as long as the source is legal

In the present case, it was held (at para [38]) that it was irrelevant, in determining the company's commercial solvency, whether the value of a company's assets exceeded its liabilities, and that it did not matter where the company derived its funds, as long as the funding arrangement was lawful.

The court held (see para [39]) that, in the present case, the company had demonstrated that it could meet its liabilities as they fell due, even though its debts were being paid on its behalf by its sole shareholder.

The sole remaining question said the court in relation to commercial solvency, was whether the company "remains buoyant after having met those obligations".

The court said (at para [40]) that the scenario in the present case was akin to that of a holding company keeping its subsidiary afloat by assisting it financially until it was able to get out of its financial crisis, and that in the present case the funding being provided would ultimately be beneficial not only to the funder, as a shareholder, but to the company's creditors.

The court said (at para [40]) that it was mindful of the fact that the provider of the funds to the company in question had made no formal commitment to continue to provide such funding and could terminate its funding at any time. However, the court was of the view that it would not make sense for such a provider of funds to invest in the company and then walk away.

In the result, the court declined to order the company to be wound up.

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