Cancelling entire agreements

Turnaround professionals and a company’s business rescue professionals (BRPs) have learned a lot over the past two years. One of the main lessons is that, like horse racing, there are no certainties or sure bets. A company that is seemingly healthy will be placed into financial distress through external factors and challenges that the company battles to address. This same company may put together a seemingly perfect business rescue/turnaround plan only to be placed into provisional liquidation as the challenges that they are n the process of addressing become to great.

In an effort to address financial challenges, companies typically enter into agreements which they hope will address their financial distress. Often, BRPs find this detrimental. But can a BRP cancel entire agreements? An opinion piece by Webber Wentzel clarifies this.

Subheadings were inserted by Turnaround Talk.

Section 136(2)(b)

Under Section 136(2)(b) of the Companies Act, BRPs can only cancel obligations under agreements that meet certain criteria, and not agreements in their entirety

Section 136(2)(b) of the Companies Act, 71 of 2008 (the Companies Act) is a key tool for a business rescue practitioner (BRP) when engaging with creditors and onerous agreements that the company has concluded before the commencement of business rescue.

It has become apparent that, in practice, the full extent of the powers afforded to a BRP in this section are often misunderstood.

Section 136(2)(b) of the Companies Act provides that:

despite any provision of an agreement to the contrary, during business rescue proceedings, the practitioner may apply urgently to a court to entirely, partially or conditionally cancel, on any terms that are just and reasonable in the circumstances, any obligation of the company contemplated in paragraph (a) (our emphasis added)

Key aspects for BRPs

We address below certain key aspects of this section.

In our experience, BRPs are often quick to suggest that, if an amicable cancellation cannot be agreed, the courts will be approached to terminate the agreement. This veiled threat is often based on the assumption that a court will always come to the aid of a BRP seeking to implement a restructuring for the benefit of all stakeholders, leaving the disgruntled party with nothing more than a damages claim (which is, in turn, often compromised). While it is true that our courts generally lean towards supporting business rescue rather than liquidation, it is not a given that a BRP can exit an agreement in toto.  The right to approach a court is only in respect of the cancellation of obligations which meet certain criteria, not in respect of entire agreements.

As a starting point, for urgent relief under this section, the BRP must show:

• the application is indeed urgent;
• the contract giving rise to the obligation that is sought to be cancelled was in existence at the commencement of the business rescue proceedings;
• the obligations sought to be cancelled fall due during the business rescue proceedings; and
• it is just and reasonable in the circumstances that the obligation be cancelled, whether entirely, partially or conditionally.

These requirements could potentially be problematic for a BRP who is seeking to implement a plan to ensure that the current legal entity in rescue continues to exist.

Certain contractual obligations may only fall due after business rescue has ended. Examples can include obligations relating to warranties, indemnities or defects. In these events, a court is not empowered to provide the relief sought by a BRP under this section in relation to these obligations. This creates a fundamental issue, in that the BRP may well successfully terminate most of the obligations of a company under an onerous agreement, but will be unable to terminate other obligations which will survive business rescue. These types of obligations often arise at some unknown future point, and could prompt substantial claims after completion of the business rescue process.

Du Toit and Others v Azari Wind Proprietary Limited and Others

In the recent unreported case of Du Toit and Others v Azari Wind Proprietary Limited and Others (8825/2021) [2021] ZAWCHC 168 (4 August 2021), Francis J was asked to consider several issues relating to section 136(2)(b) of the Companies Act.

The court took the view that, to succeed, a BRP who approaches a court in terms of section 136(2)(b) of the Companies Act has to provide a legal and/or factual basis that the elements set out above have been met.

The court held that since the cancellation of an obligation in terms of section 136(2)(b) of the Companies Act is a court-sanctioned cancellation and the obligation cannot be revived in the ordinary course, if the business rescue process does not succeed, it is incumbent on an applicant to identify precisely which obligation ought to be cancelled and provide a proper explanation why such a drastic measure is necessary. In this case, it was held that apart from identifying in general terms the obligations to be cancelled, the applicants failed to demonstrate that the obligations they sought to be cancelled would become due during the business rescue proceedings.

The findings in this matter highlight an important aspect of the limitation of the BRP’s powers under section 136(2)(b). A BRP cannot simply approach a court, refer to obligations that it wishes to cancel and expect relief, even if the relief would assist the business rescue process.  The obligations, apart from having to meet certain other requirements, have to be obligations which would otherwise become due during the business rescue process. If not, they cannot be cancelled and the company will remain liable.

The second issue of importance the court decided was the statutory right to approach the court urgently. While it is often assumed that business rescue matters are inherently urgent due to the nature of the process, the court in this matter found that, despite the reference in the section to approaching court urgently, the BRP was still required to make out a proper case for urgency. A BRP is therefore not exempted from following the normal procedure for getting urgent applications into court.

Although Francis J ultimately found that, in the context of business rescue proceedings, there was no merit in the contention that the matter was not urgent, his judgment serves as a warning to BRPs not to assume that their statutory right to approach the court urgently is assured. Furthermore, a BRP’s right to cancel agreements in toto is potentially limited and these limitations must be properly taken into account when preparing a business rescue plan.

When it comes to cancelling agreements, BRPs need to follow a specific procedure in order to stay in the right side of the law!