Serving two masters requires conflict management

Roxanne Webster
Senior Associate: Werksmans Attorneys

In many respects, the South African Airways business rescue was a landmark case in South Africa as it was the first State-Owned Entity (SOE) that was placed into business rescue. However, what was supposed to be a solid test case for future business rescues of similar companies turned into a convoluted drawn-out process which highlighted why it is extremely challenging to apply existing rules of engagement on these companies.

In one of the first articles that was published by Turnaround Talk, Eric Levenstein (Director and Head of Insolvency, Business Rescue, & Restructuring Practice at Werksmans Attorneys), pointed out that one of the challenges with the SAA rescue was that the rescue had to be implemented while adhering to the Companies Act (71 of 2008) as well as the Public finance Management Act (1 of 1999) [PFMA]. The problem with this is that, in many instances, both acts contradict each other.

Siyabonga Galela
Candidate Attorney: Werksmans Attorneys

Major differences
The SAA business rescue has certainly presented a novel test case for South Africa with everyone closely watching whether the mechanism of business rescue available to financially distressed companies in terms of the Companies Act can be successfully implemented for SOEs.

Although it appears that SAA will take to the skies again soon, the process has certainly provided new legal considerations that must be considered for business rescue in general (such as the Labour Court’s recent decisions) and for business rescue of SOE’s (such as the balance and interplay between the Companies Act and the PFMA). BRPs of SOEs will need to comply with the provisions of both the Companies Act and the PFMA.

The PFMA, as amended by Public Finance Management Amendment Act 29 of 1999, is premised on the need to inspire good financial management in the public sector to maximise service delivery. In a Guide for Accounting Officers published by the National Treasury in October 2000, the objective of the PFMA is described as:

…to modernise financial management in the public sector and, in the process, to reduce fraud, corruption and waste. More efficient and effective use of public resources will maximise the capacity of Government to deliver services. The PFMA enables accounting officers to manage but, at the same time, holds them accountable for the resources they use. It establishes clear lines of accountability and broad frameworks of best practices that managers can adopt or, where necessary, adapt.

On the other hand, as the Companies Act states, its objectives are to (inter alia):

•             provide for the incorporation, registration, organisation, and management of companies;

•             the capitalisation of profit companies;

•             the registration of offices of foreign companies carrying on business within South Africa;

•             define the relationships between companies and their respective shareholders or members and directors;

•             provide for equitable and efficient amalgamations, mergers, and takeovers of companies;

•             provide for efficient rescue of financially distressed companies; and

•             provide appropriate legal redress for investors and third parties with respect to companies.

With the aforesaid objectives in mind, the major difference between the two Acts are the sectors which they aim to regulate and the purpose of such regulation. The PFMA’s primary focus is geared towards regulation of financial management and accountability in the public-sector while the Companies Act’s primary focus is regulating every aspect of the private-sector. It does not focus on financial management and accountability only.

This however does not mean that the Companies Act does not apply to SOEs. Section 9 of the Companies Act makes specific mention of the application of the Companies Act to SOEs and states that, inter alia, subject to section 5(4) and (5), any provision of the Companies Act that applies to a public company also applies to a SOEs except to the extent that the Minister of Public Enterprises has granted an exemption thereto.

In summary, the Companies Act is concerned solely with the governance and regulation of companies, including SOEs, while the PMFA is concerned with management of the public purse in general.

Other differences between the two Acts lie in their relationship with the Constitution of the Republic of South Africa as well as the kinds of bodies the two Acts establish. For example, the PFMA was specifically enacted to give force to, inter alia, Section 216(1) of the Constitution, and accordingly establishes the Department of National Treasury to administer the requirements of the Act. Conversely, the enactment of the Companies Act does not directly flow from any constitutional provision specifically targeting companies or the private sector. The body established to administer the requirements of the Companies Act is the Companies and Intellectual Property Commission (CIPC).

The PFMA and Companies Act are always at odds
Photo By: Canva

Working against each other
Levenstein stated, inter alia, that the provisions of the Companies Act and the PFMA are sometimes at cross-purposes and gave the following example: the PFMA provides for certain procedures that must be adhered to and authorisations that must be obtained by SOEs when alienating or encumbering state assets, or concluding agreements involving future financial commitments. These provisions of the PFMA may, in certain circumstances, be incongruent with the extensive management powers afforded to BRPs under the Companies Act, which are aimed at effectively rescuing a company.

As stated above, the key objectives of the PFMA are, inter alia, to eliminate wasteful expenditure and corruption in the use of public resources and/or assets, and to enable public sector managers to fulfil their duties while remaining accountable for their actions. The key objectives of the Companies Act include, inter alia, the promotion of compliance with the Bill of Rights in the application of company law, balancing the rights and obligations of directors and shareholders in companies and creating optimum conditions for the aggregation of capital for productive purposes, and the investment of same in enterprises.

Indeed, both Acts seek to encourage and/or develop efficient and responsible management or regulatory frameworks. However, each Act’s focus in encouraging and/or developing this is intrinsically different. As a result, statements that the two Acts may operate in cross-purposes refers to clashes between the two Acts stemming generally from the fundamentally different objectives the two Acts seek to achieve.

As another example of how provisions of the PFMA and the Companies Act may clash, one can consider the question of who or what institution a BRP is accountable to when carrying out his/her responsibilities in the business rescue of a SOE. In terms of section 140(1)(a) of the Companies Act, a BRP – once appointed – has full management control of a company in substitution of the company’s board. Furthermore, Section 140(3)(a) of the Companies Act provides that a BRP is an officer of the court. Accordingly, a BRP is accountable to the judiciary.

However, in the case of a SOE, section 49(2)(a) of the PFMA provides that a public entity’s board is the accounting authority for that entity. Furthermore, a concurrent reading of sections 1(c) and 50(c) of the PFMA implies that whoever takes on the role of accounting authority of a public entity should be accountable to government.

In other words, a BRP of a SOE will be considered an accounting officer accountable to government (and not the judiciary). Questions pertaining to the constitutional acceptability of this purported difference in treatment of BRPs tasked with rescuing SOEs as opposed to those tasked with rescuing private companies highlights the possibly irreconcilable clash between provisions of the Companies Act and the PFMA and problematizes the non-negotiable prevalence of the PFMA over the Companies Act as set out in section 5(4)(b) of the latter.

Financial statement problems
Another fundamental clash between the two Acts, can be found when considering certain events leading up to the commencement of business rescue by SAA on 6 December 2019. The Annual Financial Statements (AFS) for SAA for the periods 2017/18 and 2018/19 had not been tabled before Parliament and its various committees within one month of the Audit Report as required by section 65(1)(a) the PFMA. However, the Minister of Public Enterprises claims that in terms of section 65(2), he was entitled to delay the tabling of the AFS.

Section 65(2) of the PFMA provides that, if the AFS are not tabled in accordance with section 65(1), the relevant Minister must table a written explanation setting out the reasons why the AFS were not tabled. According to minutes of a meeting held between the Standing Committee on Public Accounts and the Portfolio Committee on Public Enterprise, if the AFS were tabled, they would effectively place SAA in liquidation. The effect of not tabling the AFS timeously in terms of section 65(1) and using the loophole in section 65(2) resulted in SAA continuing to operate despite its precarious, probably insolvent, financial position since 2017 (and possibly earlier) and circumventing Government’s oversight and intervention.

The Companies Act on the other hand prescribes that a company should commence business rescue proceedings at the first signs of it being financially distressed either when it is reasonably unlikely that a company will be able to pay its debts when they fall due for payment in the immediately ensuing six months or when it is likely that the company will become insolvent in the immediately ensuing six months. In terms of section 129(7), if the board of directors of a financially distressed business fails to adopt a resolution to commence business rescue, and such proceedings are regarded as being necessary, there is an obligation to deliver a written notice to all affected persons with explanation why the board has elected not to pass a resolution initiating business rescue proceeding. Regardless of the damaging consequences of a section 129(7) notice, the directors may be held liable for inter alia reckless trading if they do not act appropriately and within a reasonable time.

This is a fundamental clash between the PFMA and Companies Act as the rationale behind business rescue proceedings is to assist ailing companies at the first signs of financial distress; yet, the PFMA (if used in the manner that it was used in SAA), can effectively stave off intervention in SOEs.

Concurrent application problems
Generally speaking, if conflict exists between the Companies Act and any other national legislation, then both acts should be applied concurrently to the extent that such an interpretation is possible.

However, Section 3(3) of the PFMA provides that in the event of any inconsistency between the PMFA and any other legislation, the PFMA must prevail. Furthermore, Section 5(4)(b)(i) of the Companies Act provides a closed list of legislation that should prevail in situations of conflict between the Companies Act and legislation included in the aforementioned list. The PFMA forms part of this list and the only exception to its prevalence lies in those cases in which the Companies Act provides a more onerous requirement than that provided for in the PFMA.

Lessons learned from all sides
To say that no lessons were learned during the SAA business rescue would be disingenuous. While painstakingly frustrating, the rescue did provide some key lessons that can be applied in the future.

BRPs are now aware of what it involves implementing a business rescue of an SOE through the lens of applying both the Companies Act and the PFMA. We also know that it is a long process and that serving two masters is not without its challenges and adherence to political red tape.

If delays are going be associated with this process, they need to be minimised. Taxpayers bankroll this process, and they deserve better than unwelcome delays. In future, lets get our ducks in a row as soon as possible knowing the challenges that we will likely face.

Roxanne Webster is a Senior Associate at Werksmans Attorneys

Siyabonga Galela is a Candidate Attorney at Werksmans Attorneys