Business Rescue vs. Liquidation
Updated: Apr 22
Two mechanisms with very different outcomes! What process should a distressed entity follow in an attempt to save a business? To answer this question, let us have a quick look at what the South African legislation stipulates. Financially distressed, as defined in the companies act 71 of 2008, is when it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediate ensuing six months; or it appears to be reasonably likely that the company will become insolvent within the immediate ensuing six months; The insolvency act 24 of 1936 section 8 stipulates that a debtor has committed an act of insolvency when; a) He leaves the republic with the intent to evade or delay the payment of his debts. b) If a court has given a judgement against him and he fails to satisfy the officer of demand of sufficient disposable assets to pay for such judgement/claim. c) When he makes disposition of any of his property which would have a effect of prejudicing his creditors or preferring one creditor above another. d) If he removes or attempts to remove any of his property with the intent to prejudice his creditor or prefer one creditor above another. e) If he makes or offers any arrangement with any of his creditors for releasing him wholly or partially from his debts f) If he gives notice in writing to anyone of his creditors that he is unable to pay any of his debts. I often find that business owners in distress forget what their obligation as a responsible director of a company is. As per the companies act 71 of 2008 section 76(3), a director of a company, when acting in that capacity, must exercise the powers and perform the functions of director- (a) in good faith and for a proper purpose; (b) in the best interests of the company; and (c) with the degree of care, skill and diligence that may reasonably be expected of a person- (i) carrying out the same functions in relation to the company as those carried out by that director; and (ii) having a general knowledge, skill and experience of that director. As per the companies act 71 of 2008 section 22, a company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. If the commission has reasonable grounds to believe that a company is engaging in fraudulent conduct or is unable to pay its debts as they become due and payable in the normal course of business, the commission has the rights to cease trade of an entity. The solvency and liquidity test as defined in the companies act 71 of 2008 can be defined when the assets of the company, as fairly valued, equal or exceed the liabilities of the company, as fairly valued; and it appears that the company will be able to pay its debts as they become due in the ordinary course of business. When in deep distress, business owners tend to enter a stage of panic and initiate asset shifting. Business owners can be accused of reckless trading, collusive dealings and undue preference to creditors should property of an insolvent company be transferred for the benefit of certain affected parties. The accused can be held personally liable for losses as a result of criminal activity. Such illegal transfer of assets can be reversed by a court order should an affected person provide proof and witnesses. Given the above, the question remains, which instrument is best for a distressed business? This question can be answered by a straightforward concept "Reasonable Prospect". A reasonable prospect can be defined as the motivation for continuing trade if restructuring practices can force the business into a profitable trade position. Restructuring practices include the restructuring of the business management and staffing policies, operational strategies & practices, sales offering & financial policies. The aim is to restructure to improve the financial statement profits and balance sheet position. Business rescue ensures the protection of business property against any creditors. It provides the business with the opportunity to restructure the business operations to ensure business continuation rather than cutting the lifeline of the company. It is a mechanism that ensures the business continuation and fair treatment of all affected persons. It provides creditors with better returns than in liquidation. Liquidation, on the other hand, is a mechanism when a business should not be allowed to continue trade as there is no economic benefit or reasonable prospect in doing so. Liquidation halts business trade and sells remaining assets to pay for outstanding debts of the business. After selling all assets, the liquidator is forced to de-register the entity, and continuing trade will not be possible.