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Unfounded optimism is not a basis for commencing business rescue proceedings

The business rescue provisions of the Companies Act of 2008 cannot be implemented unless there is a reasonable prospect of success

The business rescue provisions were one of the most eagerly awaited innovations of the new Companies Act of 2008. These provisions replaced the judicial management provisions of the now-repealed Companies Act of 1973 which, it is generally agreed, had seldom yielded positive results.

In theory, judicial management under the Companies Act of 1973 offered the prospect that a company whose financial woes had been occasioned by mismanagement could return to viability if put under the control of an expert judicial manager. In practice, however, placing a company under judicial management almost always proved to be the kiss of death. The company's reputation in the market place was thereby irreparably damaged, it was considered a lost cause, and few were prepared to do business with it.

The team that drafted the new Companies Act of 2008 was able to learn from the shortcomings of the judicial management regime and drew on international best practice in crafting the business rescue provisions of the new Act.

The business and legal community has been impatiently awaiting the first High Court judgments that will set the tone as to how the judiciary will respond to applications to place a financially distressed company into the business rescue regime.

The first High Court judgments on business rescue are now being reported

It has already become clear from the first High Court judgments in this regard that the South African judiciary is adopting a hard-headed approach, and is not open to being persuaded by vague and unfounded optimism as to the prospects of restoring a struggling company to solvency.

The latest judgment to be reported in this regard is that of the Cape High Court in Koen v Wedgewood Village Golf & Country Estate (Pty) Ltd 2012 (2) SA 378 where judgment was handed down on 9 December 2011.

This case concerned a company whose sole business was the establishment of a golf course development in Port Elizabeth. However, the expenditure that the company had incurred in developing the golfing estate had outpaced the funds that the company was receiving from the sale of plots in the estate. The bank that was the principal financier of the project had now refused to advance any further funds. Work on the development of the estate had ground to a halt, with only 14 holes of the planned 18 hole golf course completed. By the time the business rescue application came to court, the golf course had reverted to scrub and the access roads were strewn with rubble. Electrical reticulation that had been installed had been plundered or vandalised. No more plots were being purchased.

The company was at this juncture indebted to its banker for some R60 million and to its holding company for some R118 million. The land that was the company's major asset had been valued at between R42 million and R65 million and there were conflicting opinions by people in the know as to the feasibility of completing a golf course development in Port Elizabeth in the prevailing economic climate.

This dismal scenario had not deterred a person who had purchased a plot in the planned golf estate from applying to court to postpone the winding up of the company so that application could be made to place the company under supervision in terms of the business rescue provisions of the new Companies Act.

The judgment in question is the decision of the court in respect of that application.

The response of the High Court to the application

The only significant new development since the application to wind up the company was that a Port Elizabeth estate agent had filed an affidavit, in support of the application to commence business rescue proceedings, which claimed that there was a prospect of raising further finance from an undisclosed third party to enable the company to complete the golf course development.

The court was extremely sceptical in this regard and was also critical of the time it had taken to bring the business rescue application before court. Binns-Ward J commented that -

"It is axiomatic that business rescue proceedings, by their very nature, must be conducted with the maximum possible expedition. In most cases a failure to expeditiously implement rescue measures when a company is in financial distress will lessen or entirely negate the prospect of effective rescue. Legislative recognition of this axiom is reflected in the tight timelines given in terms of the Act for the implementation of business rescue procedures if an order placing a company under supervision for that purpose is granted. There is also the consideration that the mere institution of business rescue proceedings - however dubious might be their prospects of success in a given case - materially affects the rights of third parties to enforce their rights against the subject company."

The court also pointed out that -

"Business rescue is intended to serve that public interest by providing a remedy directed at avoiding the deleterious consequences of liquidations in cases in which there is a reasonable prospect of salvaging the business of a company in financial distress, or of securing a better return to creditors than would probably be achieved in an immediate liquidation."

However, said the court, a person who applies for a company to be put under supervision in order that business rescue proceedings can commence -

"must satisfy the court that there is a reasonable prospect that the subject company can be rescued in the relevant sense by being placed under supervision".

In order to establish such a "reasonable prospect", said the court -

"the applicant must be able to place before the court a cogent evidential foundation to support the existence of a reasonable prospect that the desired object can be achieved".

This, as the High Court had earlier held in the unreported judgment in Southern Palace Investments 265 (Pty) Ltd v Midnight Storm Investments 386 Ltd (Registrar of Banks), required the applicant to lay before the court -

"some concrete and objectively ascertainable details going beyond mere speculation of (i) the likely costs of rendering the company able to commence with its intended business or to resume the conduct of its core business; (ii) the likely availability of the necessary cash resources "

In the present case, Binns-Ward J said that "vague and speculative averments" in this regard would not suffice. The affidavit that had been filed by the estate agent had failed to identify either the unnamed potential investor, who might come to the rescue of the project or the terms of the investment that might be made. No explanation had been given to the court as to why these particulars had not been provided. The court commented that without such particularity, the court was being "invited to buy into [an] optimistic assessment on a manifestly uninformed basis".

In the result, said the court, the applicants in the present matter who sought an order that business rescue proceedings should commence -

"have fallen woefully short of furnishing the court with the material required to make the assessment of whether a reasonable prospect of business rescue succeeding exists. Their case is manifestly dependent on the provision by the mystery potential investor of the means to enable a business rescue practitioner to draw up a feasible rescue plan. What those means might be, or on what terms and conditions they might become available, are as much a mystery as the identity of the party which might provide them."

The court dismissed the application to place the company under supervision as the first step in business rescue proceedings.

The result was that the pending application for the winding up of the company would go ahead.

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