Ranking of creditors in business rescue: the buck stops here

The ranking of creditors’ claims during business rescue is, to a creditor, one of the most important aspects of business rescue. This is dealt with by the Companies’ Act, No. 71 of 2008 (“the Companies Act”) and has been considered by our courts in several judgments.

There are various factors which must be taken into account to determine where a creditor ranks and what dividend it will receive during business rescue.

Creditor’s claims

From the outset, it is important that a creditor distinguishes between its pre-commencement and post-commencement claims (if any). The former relates to amounts payable for goods and services provided prior to the commencement of business rescue and the latter to those provided after. Further, if a creditor holds security for its claim, it’s claim will enjoy preference.

Goods and services provided after the commencement of rescue can constitute post-commencement financing (“PCF”) and will also enjoy a preference in ranking. However, this is not automatically the case. Of particular importance is the judgment handed down in the matter of The South African Property Owners Association v Minister of Trade and Industry and Others 2018 (2) SA 523 (GP) (29 November 2016) (“SAPOA case”).

This matter dealt with the ranking of claims of creditors who continues to provide goods or services to the distressed entity under an agreement which came into being prior to business rescue. The court determined that the provision of such goods or services does not fall within the definition of PCF and will therefore not enjoy a preference in ranking.

In the SAPOA case, a landlord had requested an order stating that amount payable for rental and ancillary services qualified as PCF or costs arising from the business rescue. The court held that post-commencement financing as intended in section 135(2) of the Companies Act “relates to obtaining of financing in order to assist in managing the company out of its financial distress It does not lean to an interpretation that encompasses existing obligations of the company that are utilized to assist in managing the company during the business rescue proceedings.”

Creditors must consider whether a basis exists upon which their claims will enjoy a preference during business rescue to ensure that claims are ranked correctly.

Ranking of claims in business rescue

The courts have confirmed the ranking of creditors as follows in business rescue proceedings:

• first, the fees and expenses of the BRP and associated with the business rescue:

• second, remuneration due to employees which became due and payable after commencement of business rescue;

• third, secured claims by creditors for the provision of PCF;

• fourth, unsecured claims by creditors for the provision of PCF;

• fifth, secured pre-commencement claims by creditors;

• sixth, remuneration due to employees which became due and payable prior to commencement of business rescue; and

• seventh, all other claims including creditors’ unsecured pre-commencement claims and claims for goods or services provided during business rescue under a pre-existing agreement.

Can a business rescue practitioner alter the ranking of claim?

Practitioners have tried to alter this ranking in business rescue plans. Whether this can be done has not yet been canvassed by our courts but was considered by Retired Justice Harms when presiding over dispute resolution proceedings between the South African Pilot’s Association (“SAAPA”) and South African Airways SOC Ltd (“SAA”) during the course of the SAA’s business rescue proceedings.

SAA’s business rescue practitioners had classified employees’ pre-commencement claims for meal allowances as concurrent claims in the plan. The plan was adopted. SAAPA, on behalf of the employees, argued that these are unsecured preferent claims under section 144(2) of the Companies Act and should be treated as such. SAA argued that the adopted plan overrides the statutory preference and that the employees would have to set aside the plan to enforce the claim.

Retired Justice Harms found that the plan (as adopted) could not override the statutory preference and that the employees’ claims should be dealt with as prescribed by the Companies Act. If the order or preference were to be decided by the practitioners or majority of creditors, the provisions dealing with ranking in the Companies Act would have been unnecessary. Retired Justice Harms considered the structure of the Chapter 6 of the Companies Act (which deals with employees’ rights before that of other creditors) and the wording of section 144(2) when making his ruling. He found that to the extent that the plan altered the ranking, the specific provisions are ultra vires and it is not necessary to set aside the plan to enforce the employees’ claims.

When a reasonable prospect of rescue no longer exists

When there is no longer a reasonable prospect of rescuing a company, business rescue proceedings will be converted into liquidation. Thereafter, creditors’ claims will be dealt with by a liquidator according to the principles applicable in that scenario.

The Companies Act expressly provides that the order of preference confirmed in section 135(4) will remain in force in liquidation proceedings preceded by business rescue, except for the ranking of claims for the costs of liquidation. The order of application of proceeds realised in liquidation proceedings preceded by business rescue, as set out in the Insolvency Act No. 24 of 1936 and considered in various case law, is as follows:

• first, secured creditors in respect of the proceeds realised from their securities and after the costs of realisation of such securities. In Diener N.O. v Minister of Justice and others 2018 (2) SA 399 (SCA) and National Union of Metalworkers of South Africa and others v VR Laser Services (Pty) Limited and others [2020] 2 All SA 536 (GJ) the courts reiterated that a secured creditor’s security could not be diluted or undermined in favour of other claims such as the BRPS remuneration or that of employees post commencement claims,

• second, the costs of liquidation;

• third the BRP’s remuneration and expenses, together with the costs of the business rescue proceedings (as considered in the Diener case);

• fourth, employees’ post-commencement claims (as considered in the VR Laser case);

• fifth, post-commencement creditors’ secured claims;

• sixth, post-commencement finance creditors’ unsecured claims;

• seventh, costs of execution as prescribed in section 98 of the Insolvency Act;

• eighth, salaries and wages of former employees as prescribed in section 98A of the Insolvency;

• ninth, preferent claims afforded the statutory obligations as prescribed in section 99 of the Insolvency Act;

• tenth, preferent claims for taxes obligations as prescribed in section 101 of the Insolvency Act;

• eleventh, the claim of a general bondholder under a general mortgage bond; and

• finally, the claims of non-preferent concurrent creditors.

Conclusion

Creditors should consider their claims and surrounding circumstances carefully to ensure that their claims are ranked and afforded the requisite preference (if any) during both business rescue and subsequent liquidation proceedings.

The ranking of creditors will be a contentious issue going forward.

Gareth Cremen is a Partner at Cox Yeats Attorneys