Business rescue under the new Companies Act is an improvement over judicial management
The strengths and weaknesses of business rescue under the new Companies Act.
The new 'business rescue' provisions in the Companies Act of 2008 have replaced the judicial management provisions of the now-repealed Companies Act of 1973.
Judicial management had been part of South African company law since the Companies Act of 1926. There is general agreement that judicial management was a good idea in theory but that, in practice, for a company to be put under judicial management usually turned out to be the kiss of death. The company was regarded as doomed, its credibility in the marketplace was irreparably damaged, and no-one wanted to do business with it.
There is no doubt that the business rescue regime of the new Companies Act is a significant advance over judicial management and - since the drafters of the Act looked far and wide at international best practice - it is probably as good as any business rescue regime anywhere in the world.
It is reasonable to expect that the success rate - that is to say, in restoring financially struggling companies to viability - will be higher with business rescue than was the case with judicial management. But it would be overly optimistic to think that successful business rescue under the new Companies Act will be the norm, rather than the exception.
There are several striking aspects of the new business rescue regime which represent a great improvement over judicial management.
Firstly, when a company went into judicial management, all the directors ceased to hold office and the company's management passed into the hands of the judicial manager. In hindsight, this seems very short-sighted. True, the directors of the company had not succeeded in managing it profitably or even viably. Perhaps this was their fault, perhaps it was not. (There are many reasons, other than bad management, why a company gets into financial trouble.) But, for all their faults, the directors at least knew the ins and outs of the company's business and it made no sense to discard all that accumulated knowledge. It was also unrealistic to expect that a newcomer, in the form of a judicial manager, could come into the business cold and make a success of it.
By contrast, in the business rescue regime, the board of directors of the company remains in place, but the directors must now work under the instructions of the business rescue practitioner. This will allow the business rescue practitioner to focus his attention on the critical changes that the company needs to make in the way it does business, while leaving the day to day management of the company to the board of directors.
The second major structural improvement that business rescue enjoys over judicial management is that, in business rescue, a wide range of stakeholders have a voice in the process - the shareholders, the creditors and the employees.
No-one should imagine that a business practitioner is going to find himself in anything other than a very hot seat. He is the miracle worker who is supposed to do what the company's own directors could not do - restore a struggling company to solvency - and he is going to have to take difficult and unpopular decisions.
Nor will he necessary enjoy unqualified support from within the company.
In many instances, the current board of directors may have skeletons in the cupboard, in the form of guilty knowledge about their past reckless (and possibly dishonest) conduct that brought the company to its knees. Now, they will be hoping that the attempt at business rescue will succeed or, if it does not, that the company's ultimate failure will be blamed on the business rescue practitioner, and not on them. In short, their major objective in the business rescue process may be to see their past transgressions get lost in the wash. They are obliged, in terms of the new Companies Act, to carry out the instructions of the business rescue practitioner, but their co-operation may be less than whole-hearted.
There is also an important aspect in which the business rescue practitioner will be hamstrung in his attempts to turn the company's financial fortunes around and restore it to viability, namely, that he is not permitted to dismiss the company's employees or reduce their remuneration. Consequently, a major cost-cutting strategy is not available to him. Moreover, if the employees lack confidence in the business rescue process, they may be more focussed on their own future than on the company's welfare, and may spend much of their working day on the telephone to employment agencies, or searching the internet, covertly trying to find another, more secure job, instead of giving their full attention to their duties.
A further problem facing the business rescue practitioner is the risk of animosity between the company's employees and its creditors.
When creditors are deciding whether to vote in favour of an attempt at business rescue, they will have a simple equation in mind - is a bird in the hand (the reasonable predictability of a liquidation dividend if the company were to go straight into liquidation) worth more than two in the bush (the uncertain prospect of getting their claims paid in full if business rescue is successful). Many creditors may see business rescue as a high-risk, high-cost gamble which will further deplete the company's already diminished financial resources and which will reduce the ultimate liquidation dividend. In addition to the company's ordinary costs of doing business will be the undoubtedly high fee of the business rescue practitioner.
For creditors of the company, a further significant downside of an attempt at business rescue is that the claims of creditors which arise after the commencement of business rescue will enjoy a preference. This will be an inevitable element of business rescue. The only terms on which anyone would lend money or extend credit to a company which is undergoing an attempt at business rescue is on the basis that the claim for payment will enjoy a preference over the claims of creditors which arose before business rescue commenced.
Employees of the company, on the other hand, will invariably be in favour of business rescue, for even if it fails, they will have been paid their wages in the meantime and will have had time to look around for another job.