Is business rescue facing an identity crisis?

On 6 April, the business rescue and business turnaround profession descended on Waterfall in Midrand, Johannesburg, to attend the release of the 2023 Deloitte Restructuring Survey.

The importance of this document within the profession is undeniable. Deloitte conducts an intensive round of information gathering from professionals, members of C suite within companies, and industry lenders who provide a snapshot on the trends that are prevalent within the industry.

Before we go into the specifics from this years Restructuring Survey, it is important to frame the information with the news from Deloitte that this was one of their best surveys yet in terms of participation where there was a 35% increase in the response rate to the survey.

There is always a key takeaway from the Restructuring Survey. In 2022, Deloitte pointed out that there was a crisis of trust. According to that survey, lenders and other industry shareholders (creditors) were becoming increasingly disillusioned with the business rescue process. Additionally, they (lenders and creditors) felt that only a handful of business rescue professionals were suitably qualified to do their job.

It seems as if there is a slight turning of the tide in this years Survey. Little mention was made of the low success rate of business rescue and the suitability of business rescue professionals. The predominant theme in this years Survey is that the business rescue profession is currently going through an identity crisis.

What is Deloitte’s evidence that qualifies this statement?

Is business rescue working?

To get to the bottom of the identity crisis, we need to ask whether business rescue is still working.

The 2022 Deloitte Restructuring Survey was concluded just before Russia invaded Ukraine. Even without the knowledge of these events and their effects, 60% of the survey’s respondents expected increased business rescue activity in 2022.

Deloitte adds that one year later, statistics published by Statistics South Africa highlight a marked increase in liquidation activity, particularly in December 2022 compared to December 2021. Unfortunately, the statistics on business rescue from the Companies and Intellectual Property Commission (CIPC) for the same period are unavailable, which remains a continued frustration for restructuring professionals in South Africa.

“Given the current energy crisis, many of the 2023 Survey respondents feel that there will be increased activity in the business rescue sector,” says Jo Mitchell-Marais, Africa Turnaround & Restructuring Leader at Deloitte.

The 2023 Restructuring Survey points out that there is a strong alignment among survey participants that the primary purpose of business rescue remains the rescue of a company. Business rescue is clearly defined in Chapter 6 of the Companies Act No 71 of 2008 (Companies Act) as the development and implementation of a plan to rescue the company through restructuring its affairs, business, property, debt, and other liabilities, and equity in a manner that maximises the likelihood of the company continuing in existence on a solvent basis (referred to as a Part A outcome).

A total of 71% of our lender participants and 85% of our practitioner participants (insolvency practitioners, lawyers, and advisors) support this. Notably, the Companies Act also views an outcome that results in a better return than liquidation to creditors as a successful business rescue (referred to as a Part B outcome).

However, the true test of success for business rescue is ultimately captured in Section 7(k) of the Companies Act. Business rescue should provide a restructuring mechanism for the efficient rescue and recovery of financially distressed companies, balancing the rights and interests of all relevant stakeholders.

The Survey adds that, therefore, success in business rescue should be measured through an additional lens and on a case-by-case basis. This is especially true when a Part B outcome results from an intentional distressed mergers and acquisitions (M&A) process where, together with further corporate restructuring and the support of lenders and new equity providers, jobs are preserved, suppliers continue supplying, and SARS continues to collect. This clearly meets the success requirements Section 7(k) intended.

Business rescue’s identity crisis

The Restructuring Survey points out that, with 80% of respondents defining the primary purpose of business rescue as a Part A outcome, the success rate achieved for Part A compared to Part B outcomes are disappointing.

Survey participants still believe that the success rate of business rescue, whether through restructuring the companies’ affairs or giving creditors a better outcome than in liquidation, is less than 50%. Analysed differently, only 3% of lender respondents experienced Part A success in more than 50% of their portfolios. Compare this with 39% of lender respondents experiencing success in more than 50% of their portfolios using a Part B outcome.

Therefore, if the purpose of business rescue is defined as a Part A outcome, but more success is being achieved with Part B, is business rescue suffering an identity crisis?

The 2023 Restructuring Survey points out that CIPC data collected between 2011 and June 2022 indicates that nearly 19% of the 4 370 companies that entered business rescue proceedings filed substantial implementation notices. If termination notices were included (filed where a business rescue practitioner determines that the company is no longer distressed), the success rate would likely increase.

So where does this leave the role of business rescue?

2023 Restructuring Survey participants clearly support advisor-led and management-led restructuring. This does not mean business rescue is an ineffective restructuring mechanism. Instead, it merely supports Deloitte’s view that business rescue has a matter-specific place, which can be accessed by management, a board, financial stakeholders, and advisors, to facilitate a rescue or restructuring, that balances the rights and interests of all stakeholders with success measured on a case-by-case basis.

Critical factors

The Restructuring Survey continues to unpack and understand what is required to support a successful business rescue. Understanding and addressing these requirements are critical to support the long-term adoption of business rescue as an acceptable restructuring mechanism under the appropriate circumstances.

However, the timing of a business rescue remains one of the most important success factors. Business rescue is unlikely to be a successful restructuring and rescue mechanism if the distress is so deep that there is no chance of reasonable prospect of rescue, despite all stakeholders’ best will and intentions.

The 2023 Restructuring Survey points out that it is the collective responsibility of management and the board, financial stakeholders, and legal and financial advisers to collaborate to ensure that business rescue is used as a restructuring mechanism at the appropriate time, and under the appropriate circumstances.

Our survey once again delved into the qualitative success factors. Like last year’s survey, the importance of a competent business rescue practitioner (BRP) remains a vital contributing factor to a successful business rescue.

The Restructuring Survey points out that the foundation of a competent business rescue practitioner, however, remains anchored in trust and integrity. Trust is earned through robust, transparent, and frequent stakeholder engagement. Founded on transparency and integrity, a collaborative business rescue plan can be developed and implemented, with the business rescue practitioner trusted to balance the rights and interests of all stakeholders.

Pre-assessment remains another critical success factor for business rescue. The engagement of a business rescue practitioner with sufficient time to conduct a pre-assessment is essential. The pre-assessment lets the prospective business rescue practitioner weigh up the reasonable prospect of rescue with the level of independence and professional scepticism required.

Industry and legislature also need to facilitate and encourage pre-assessment by allowing pre-assessment costs to be accommodated as costs of the business rescue process, as in a few overseas jurisdictions.

The Restructuring Survey points out that the availability of post-commencement finance (PCF) remains a challenge in a developing market. Financial stakeholders, already exposed to a company that intends to enter business rescue proceedings, usually have limited risk appetite to increase their exposure. They also have security rights prohibiting new funders from coming to the table.

Fortunately, global special situation funds are showing interest in the South African market.

However, we cannot rely on these finance providers alone. A deliberate effort from our industry is required to urgently fill this gap, in collaboration with development finance institutions, as well as lenders.

The Restructuring Survey points out that the most trusted and competent business rescue practitioner, having performed a thorough preassessment, which supports a reasonable prospect of success, is unlikely to achieve this outcome without PCF.

Is there an identity crisis?

The identity crisis exists because there is a conflict between a Part A outcome, the continuation of a solvent company, and a Part B outcome, a better outcome for creditors than in liquidation.

Unlike last years view that there was an overall crisis of trust in the profession, I am sure that business rescue professionals will be more amenable to this years view that there is somewhat of an identity crisis in the profession.

This can be put down to the disruptive nature of the root cause of distress that many companies are experiencing. BRPs are taking the Bear Grylls quote of improvise, adapt, overcome very seriously. Again, Deloitte’s advise of assessing each distress on a case-by-case basis will continue until the energy crisis is resolved. Therefore, provided Government is not delayed on the implementation of its measures to address loadshedding, this approach will be prevalent for at least another 12 to 18 months.

Another interesting announcement to come out of the 2023 Restructuring Survey is that Deloitte will now be taking business rescue appointments. Now whether this is the reason for the disappearance of the 2022 crisis of faith is up for debate. However, it does frame the identity crisis in a more positive light.

Many view an identity crisis as a negative thing, and it can be if the person/organisation/profession is stuck in this state of flux without any progression towards a resolution of the crisis.  The crisis that Deloitte is referring to can be seen as an effective way to manage the expectations of creditors and lenders when dealing with a specific business rescue. Not all companies can have a Part A outcome, that doesn’t mean that a Part B outcome should be frowned upon.

Perhaps its not an identity crisis, rather an effective way to manage expectation in a highly disruptive environment?