Partner: GCS
While business rescue has been in existence (under Chapter 6 of the Companies Act of 2008) for more than ten years, there is still some room for improvement when it comes to the legislative framework that governs business rescue proceedings.
While this development is taking place, there are areas within the profession that the Act will never address. As such, there will always be gaps in the legislation. For example, the Act will never prescribe how lenders should assess risk or manage their business model.
Post Commencement Financing (PCF) is a sensitive subject with some BRPs describing it as a thorn on the side of the business rescue process due to lack of risk appetite by lenders. There are some significant difficulties associated with PCF. Werksmans Attorneys shared their thoughts regarding this in 2013 citing the Kgomo J judgement as significant. Further, a Toolkit for Corporate Workout (published by the World Bank in January 2022) lists the challenges for PCF (Interim Finance) across different jurisdictions. This is an indication that PCF challenges are not unique to South Africa’s jurisdiction.
The Kgomo J judgement was handed down in the South Gauteng High Court on 10 May 2013, in the case of Merchant West Working Capital Solutions (Proprietary) Limited v Advanced Technologies; Engineering Company (Proprietary) Limited; Gainsford (Unreported, Case no 2013/12406). In this case, Merchant West Working Capital Solutions (Proprietary) Limited (“Merchant West case”) launched an application to perfect its security, while the business rescue proceedings of Advanced Technologies and Engineering Company (Proprietary) Limited were ongoing.
The case dealt specifically with the ranking of creditor claims during business rescue.
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Ranking of claims
Werksmans points out that Section 135 of the Companies Act 2008 sets out the order in which the claims of creditors rank during business rescue. In terms of this section, post-commencement financiers are preferred in the order of payment waterfall created by the Act over unsecured creditors that have exposure pre-commencement of the business rescue proceedings.
However, it is important to note that Section 135(3)(b) does not stipulate whether or not the claims of secured post-commencement financiers will rank ahead of the claims of unsecured post-commencement financiers. It merely states that post-commencement financiers will have preference in the order in which they were incurred over all unsecured claims of the company accumulated before the commencement of business rescue.
Further, one of the major issues that is not clear from the Act relates to where creditors who are secured (as understood in insolvency law) prior to the commencement of business rescue rank in the order of preference delineated by Section 135 of the Act. Section 135(3)(a)(ii) of the Act states that the claims of post-commencement financiers (whether secured or unsecured) will rank ahead of the claims of all unsecured creditors.
This has led academics, attorneys and practitioners alike to conclude that the claims of secured creditors, prior to the commencement of business rescue, will rank ahead of the claims of post-commencement financiers.
Going back to the Kgomo J Judgement, Werksmans adds that Kgomo J, in the Merchant West case, stated in unequivocal terms that creditors rank in the following order of preference during business rescue proceedings:
- fees and expenses (including legal and the other professional fees) of the business rescue practitioner incurred during business rescue proceedings (section 135(3));
- fees of employees which become due and payable after the commencement of business rescue (section 135(3)(a));
- secured lenders or creditors for any loan or supply made after the commencement of business rescue (i.e. secured post-commencement financiers) (section 135(3) (a)(i) and section 135(3)(b));
- unsecured lenders or creditors for any loan or supply made after the commencement of business rescue (i.e. unsecured post-commencement financiers) (section 135(3) (a)(ii));
- secured lenders or creditors for any loan or supply made before the commencement of business rescue;
- claims of employees (for instance for remuneration) which became due and owing prior to the commencement of business rescue; and
- unsecured lenders or creditors for any loan or supply made before the commencement of business rescue (i.e. concurrent creditors).
The above makes it clear that the claims of secured lenders prior to the commencement of business rescue rank after the claims of both secured and unsecured post-commencement financiers.
Werksmans points out that, practically, this makes sense. If a lender or creditor wants to provide post-commencement finance to a company in business rescue, it should be clear to such financier that it will rank before secured pre-commencement creditors who may in a liquidation be paid in full from their security.
Post-commencement financiers can thus seek comfort in that the court has, at least for now, settled the much-debated position of the ranking of creditors who hold security for their claims prior to the commencement of business rescue. However, lenders are still not particularly excited about providing PCF given that PCF ranks behind of business rescue fees and cost. The reputation of the Business Rescue Practitioners comes into play when lenders consider whether or not to provide PCF because lenders fear that business rescue practitioners may use PCF to pay their fees and that business rescue practitioner may not have understanding of the business.
Other considerations
The provision of PCF in the business rescue proceedings challenges go beyond its ranking in the payment waterfall as prescribed in Chapter 6 of the Companies Act. Once the company experiences cash flow pressures, and a decision is taken to put the company into business rescue, the likely hood is that the company does not have sufficient capacity to take additional debt because of specific circumstances. These include deteriorated credit rating, single obligor limit constraints, pricing of the debt, and low key relationship with current lenders .
During business rescue, time is of the essence. Yet, prospective lenders do not have sufficient time to conclude due diligence. The 10 days time period required by the Act to provide an opinion on whether the company can be rescued or not, and the 25 business day period to publish the business rescue plan, does not give comfort to the lenders who have a fiduciary duty to look after the interest of shareholders that the business rescue practitioner has a full understanding of the business.
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The World Bank Toolkit for Corporate Workout (Jan 2002) lists some of the considerations in granting funding for companies going through restructuring. One of the serious challenges is the granting of security which could be prohibited by contractual terms of the company’s existing debts, (i.e. negative pledges). It is highly likely that lenders who have exposure to the company that is going through business rescue may be unwilling to waive certain conditions, especially if their security may be compromised.
Section 136(2)(a) of the Act, as amended, provides that during business rescue proceedings (and for the duration of such proceedings), a business rescue practitioner may, despite any provision of an agreement to the contrary, entirely, partially or conditionally suspend any obligation of the Company that arises under an agreement to which the Company was a party at the commencement of the business rescue proceedings and would otherwise become due during those proceedings. Could this be the way to deal with limitations that may be imposed by the lenders facilities that are in place pre commencement of business rescue proceedings? It is my view that Business Rescue Practitioners should be reasonable when conducting business rescue proceedings, and any action taken by the business rescue practitioners be always in the interest of affected persons.
It is obvious that challenges that Business Rescue Practitioners face in raising PCF are enormous, mostly because the Act does not and cannot prescribe what approach and consideration lenders should look at in making lending decisions on financially distressed companies.
Moses Singo is a Partner at Genesis Corporate Services and is a Junior Business Rescue Practitioner.
