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Not every financially distressed company is a suitable candidate for business rescue proceedings

The first High Court judgment on the business rescue provisions of the Companies Act of 2008

The decision of the Pretoria High Court in Swart v Beagles Run Investments 25 (Pty) Ltd [2011] ZAGPPHC 103, handed down on 30 May 2011, is the first reported decision involving the business rescue provisions in chapter 6 of the Companies Act 71 of 2008, and is a useful early indication of the attitude of the court to such applications.

The decision highlights many of the aspects of business rescue that can be the subject of controversy and contestation.

In this case, the company's sole director and shareholder had brought the application to initiate business rescue proceedings by seeking a court order placing the company under supervision as envisaged in s 131(4) of the Companies Act of 2008 on the grounds that the company was currently "financially distressed" and unable to pay its debts as they became due and payable. He contended that if the company were placed under supervision and if a business plan was implemented, all the company's creditors would be fully paid in due course and the company would be able to continue in business.

Creditors were divided as to whether business rescue proceeding should be commenced

One of the company's creditors supported the application to commence business rescue proceedings, whilst other creditors opposed the application.

The opposing creditors argued that the application was an abuse of the process of the court and was merely the culmination of stratagems to avoid payment of the company's debts and prevent the forced sale of its assets. They argued that the applicant had recklessly allowed the company to continue in business whilst it was insolvent. They argued also that the applicant had used the company as his alter ego and had operated the company without proper regard for the rights of creditors and the company's obligations.

One of the creditors had already applied for the company to be wound up and was now asking that that application be heard simultaneously with the present application, but the application for winding up was withdrawn when this creditor's claim was purchased by another of the company's creditors.

If the application had been successful the company would have been placed under provisional supervision as the first phase in business rescue proceedings, and a temporary moratorium would have been put in place in relation to the claims of the company's creditors. A business plan would have been proposed with a view to rescuing the company by restructuring its affairs, its business, its property and its debts and liabilities in a way that offered the prospect of maximising the prospects of the company's continuing in business on a solvent basis.

Alternatively, if it proved impossible to restore the company to solvency, the business rescue plan would try to achieve a better return for the company's creditors and shareholders than would be the case if the company were immediately placed in liquidation.

The question facing the court was whether, in all the circumstances of this particular case, the statutory requirements for placing the company under supervision had been met and, if so, whether the court should exercise its discretion to place the company under supervision, thereby commencing business rescue proceedings.

The court looked for guidance to the judicial management provisions of the old Companies Act

In considering this question - given the difficulty that this was the first case of its kind to come before the South African courts - the judge said that the judicial management provisions of the "old" Companies Act of 1973 provided useful guidance in the present matter. In terms of those provisions, it had to be shown that it was reasonably probable that the company was viable and capable of ultimate solvency and that it could, within a reasonable time, become a successful concern in the sense of carrying on business effectively and yielding a return to its shareholders and creditors.

It was common cause in the present case that the company was indeed financially distressed.

The court said that the creditors were correct where they contended that the application was an abuse of the process of the court; that it was simply an attempt on the applicant director's part to prevent the company's assets from being sold; and that the applicant had made false promises to pay the creditors.

The court turned down the application to place the company under supervision

The court held that it was clear that the company was insolvent and that its assets would be insufficient to pay its creditors - indeed this was so even on the figures supplied by the applicant director. The court described the company as "hopelessly insolvent" and said that it was questionable whether a business rescue plan was feasible.

The company had earlier made a (clearly suspect) loan of some R72 million to a related company of which the applicant was also the sole director, and the applicant had refused to give any information about this transaction, nor had he placed any material before the court to indicate that the loan would ever be repaid.

The application to commence business rescue had been launched on the basis that the company's assets exceeded its liabilities and that it would be able to continue with its business and sell certain assets to pay its debts.

It was however revealed that one of the creditors had taken possession of certain movable assets of the company and was entitled, in terms of s 134(1)(b) of the Act to retain such possession. Those assets would therefore not be available to the company for the earning of income. In any event the company had ceded the right to the income from its business to one of the creditors with the result that its income could not be utilized to pay other creditors.

The court came to the conclusion that the applicant's valuation of the company's assets was inflated and had to be rejected.

The court said that it had a discretion whether to place the company under supervision and thereby commence business rescue proceedings even if the requirements of the Companies Act in this regard had been fulfilled, and that the question to be determined was whether a case had been made out that the company would be able to carry on its business on a solvent basis or, alternatively, whether business rescue proceedings were likely to increase the dividend payable to creditors if it were later to be wound up.

The applicant had engaged in reckless trading and had not been forthright with the court

The court concluded that the applicant himself was the only party who was in favour of the company's carrying on business and that he had conducted its business in a reckless manner.

Nor had he given the court or the creditors any details regarding the R72 million loan to a company of which he was the sole director. It was clear, said the court, that the company had been financially distressed for at least a year, but that the applicant had done nothing about it, and had in fact incurred further debts.

The court said that where business rescue proceedings required the interests of the creditors and the company to be weighed up, the interests of the creditors should prevail.

In the result, the court held that there was "absolutely no basis" for contending that there was any prospect that the company would be able to carry on business on a solvent basis. All in all, said the court, no case had been made out that the business rescue proceedings would put the creditors in a better position than they would be in a winding up.

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