Category Archives: Insolvency

BETWEEN A ROCK AND A HARD PLACE

by Dirk Kotze

It is trite that the ultimate fate of a financially distressed company, unable to pay it creditors, are liquidation. Once in liquidation and should creditors elect to proceed with an insolvency enquiry, the directors of the company might, in appropriate circumstances, be faced with the uncomfortable question, “why did the board not timeously inform the stakeholders and creditors of the fact that the company was financially distressed and why did you not resolve to place the company under business rescue”.

Why would this be a relevant question? The relevance of this question is found  in the duty imposed on the board of directors in section 129 (7) of the Companies Act 71/2008 (“the Act”), which states that, “if the board of directors of a company has reasonable grounds to believe that the company is financially distressed, but the board has not adopted a resolution contemplated in this section (referring to a resolution to place the company in business rescue proceedings), the board must deliver a written notice to each affected person, setting out the criteria referred to in section 128 (1)(f) that are applicable [i.e. choose and explain the financially distressed scenarios as per the definition provided in section 128 (1)(f)] to the company, and its reasons for not adopting a resolution. Simply stated, if a company is in financial distress and it has not filed for business rescue, their is a positive duty on its board of directors (“the board”) to advise the affected persons being the creditors, shareholders and employees of the company that it is financially distressed, and also advance reasons why they have elected not to file for business rescue.

The language used in this section is not directory, but peremptory and it suggest that once the definition of financial distress in section 128 (de facto and commercial insolvency foreseen in the ensueing 6 months) of the Act are met, the board has a positive duty to act. Not only must they inform stakeholders of the fact that the company is in financial distress, but they must also advance reasons why they have not adopted a resolution and filed for business rescue.

A  further question that arises automatically is whether a failure of the board of directors to comply with this duty in terms of  section 129 (7) (hereinafter referred to as “this duty”) will have adverse consequences for the board, especially in circumstances where the company is eventually liquidated and creditors suffer huge losses as a result of unpaid claims, which losses could have been lessened if this duty had been complied with

The answer to this question is by no means staightforward. At the outset, section 129(7) does not contain any sanction if the board fails to comply with this  duty, nor does the Act provide any specified time limits within which such compliance must occur.  The main and obvious reason for the absence of a sanction, is the fact that such notice to creditors will in all likelihood be tantamount to commercial suicide by a company, as its creditors may no longer be willing to supply goods and services on favourable credit terms, if any at all. Banks and financial institutions will, in all likelihood, withdraw all credit facilities or at least substantially reduce such facilities.

Does this mean that the board could simply ignore this duty if they have reason to believe that the company is financially distressed? The answer should be a clear NO.

Although I do not propose that that a failure to comply with this duty will automatically lead to the directors being liable for the losses suffered by creditors in a liquidation, the following should be kept in mind.

Firstly, the Act, via section 218(2), makes it clear that, “any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention”. Thus for instance, an aggrieved shareholder (who continued to invest his money into a financially distressed company whilst not having been informed of its financially distressed status), and a creditor (who continues to supply goods and/or services to a financially distressed company whilst being blissfully unaware of its financially distressed status) might well choose to claim their losses from the directors of the company should the company end up in liquidation.

Secondly, a failure to comply with this duty, in conjuction with other relevant evidence, may lead to a conclusion that the directors of the company acted recklessly and with gross negligence. Section 424 of the old Companies Act (which still applies under our new company law regime) and the judicial pronouncements thereon [see Philotex (Pty)Ltd and Others v Snyman and Others 1998 (2) SA 138 (SCA)] makes it clear that directors will be held personally liable for the debts of a company if they traded recklessly.  When the Philotex judgement was handed down, this duty did not exist and under our new company laws it could well be argued that a failure to comply with this duty is an important factor from which an inference of “recklessness” can be made in event of a company continueing to trade and incurring huge debts in a financially distressed scenario. Filing for busines rescue could certainly and in appropriate circumstances be regarded as a reasonable step that a board of directors could and should have taken to prevent the losses being uncurred by creditors and shareholders.

Thirdly, the failure to act in terms of section 129(7) of the Act could also impact on an inference that a director acquiesced in the carrying on of the company’s business despite knowing that it was being conducted in a manner prohibited by section 22(1) of the Act (i.e. recklessly, with gross negligence, with intent to defraud or for any fraudulent purpose). This may lead to personal liability for any loss, damage or costs sustained by the company [see section 77(3)(b) of the Act].

Taking into account the risks involved, directors of companies should at least take note that a failure to comply with section 129(7) may in appropriate circumstances lead to personal liability for the debts of the company. The real conundrum is however that you are, in no way, “damned if you do and damned if you don’t.

It will be interesting how the Courts will interpret this provision, which, due to its possible adverse commmercial consequences, will not in isolation lead to personal liability, but will most certainly in appropriate circumstances be an important factor when considering reckless trading.

Dirk Kotze LLB (Stell) LLM (Unisa) is an attorney who practices for his own account in Stellenbosch.  www.dirkkotze.co.za

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.

SECTION 345 Demands: FIGHTING FOR YOUR COMMERCIAL LIFE

by DIRK KOTZE

The use of a statutory letter of demand in terms of section 345 (1)(a) of the old Companies Act 61 of 1973 (“the Act”) to collect outstanding debts of R100.00 (one hundred rand) or more payable by Companies is an established commercial recovery procedure which has survived the new Companies Act 71/2008[1]. Its effectiveness lies in the threat of a liquidation application based on the deeming provisions of section 345 relating to commercial insolvency.

It is trite law that commercial insolvency, being the inability of a company to pay its debts as it becomes due and payable, justifies the liquidation of a company. Factual solvency in itself is not a bar to an application to wind-up a company on the ground that it is commercially insolvent.[2] When faced with a section 345 demand based on an amount that is allegedly due and payable, the options of a company are limited. Either pay, secure or settle the amount claimed to the satisfaction of the creditor[3] or alternatively, show on a balance of probability that the alleged indebtedness is disputed on bona fide and reasonable grounds. If the company neglects to adequately respond to a secton 345 demand it will run the risk of being deemed to be unable to pay its debts and ultimately face a liquidation application based on its deemed commercial insolvency.

If a company elects to dispute the alleged indebtedness it must send a detailed response within the three weeks allowed for under section 345 (1) (a) of the Act recording the basis upon which the alleged liability to pay is disputed, mindful also of the legal principles that will apply, if a liquidation application is to follow. What are these legal principles?

First and foremost is the Badenhorst rule[4], which rule finds its application in a scenario where a claim is disputed. Under this rule, liquidation proceedings are not intended to be used as a means of deciding claims which are bona fide and reasonably disputed. Its foundation lies in the fact that court will not entertain factual disputes in application proceedings because of the need to hear oral evidence to properly adjudicate the factual disputes. An application for liquidation will thus fail if the alleged liability to pay is disputed on bona fide and reasonable grounds.

What constitutes a bona fide and reasonable defence will be determined by the relevant facts presented to Court. Insofar as presenting facts in support of its defence, it is important for the debtor company to “allege facts which, if approved at a trial, would constitute a defence to the claims against the company.. subject of course to the qualifications.. and in particular, to the Court being satisfied of their bona fides..”.[5]

Insofar as assesment of bona fides by a Court is concerned, it is important to bear in mind that, “..if the defence is averred in a manner which appears in all the circumstances to be needlessly bald, vague or sketchy, that will constitute material for the Court to consider in relation to the requirement of bona fides.”[6]

It is important to distinguish between two of the defences which a debtor may raise in opposition to a creditor’s claim. The one being an attack upon the substance of the creditor’s claim which is disputed on bona fide and reasonable grounds and the other, to raise a genuine and serious counterclaim in excess of the creditor’s claim which will extinguish the claim[7]. A factual foundation must of course exist for a debtor company to even consider using such a defence or counterclaim.

In the event of an alleged counterclaim, the creditor’s claim is not in issue and the purpose of such a defence will be to extinguish the debt by virtue of set-off. If the counterclaim is a bone fide and reasonable liquid claim then the use of it to oppose a liquidation application will succeed.

The question however is what happens when the debtor company raises a un-liquidated counterclaim for damages to oppose a liquidation application? An un-liquidated claim for damages will only become due and payable once judgement has been pronounced on it pursuant to a trial. Does this preclude the use of this defence to oppose a liquidation application? The answer is NO. It is however important to bear in mind that if such a defence is raised, it should be set-out with sufficient particularity for a Court to find that there exists a reasonable possibility that it will extinguish the creditors’s claim. In such circumstances it would be prudent to provide a breakdown or quantification of the un-liquidated counterclaim together with supporting vouchers. As Davis J pointed out in the recent case of Tiador CC and Other vs Rock Construction CC[8], the key point to consider is how genuine is the counterclaim.

Directors of debtor companies who neglect to give section 345 letters of demand the respect and attention it deserves, do so at their own peril and may ultimately end up having to fight for the commercial life of the Company by having to prepare and file court papers to oppose a liquidation application based upon the deeming provision in section 345.

Dirk Kotze (BA LLB, LLM) is an attorney at Dirk Kotze Attorneys in Stellenbosch  www.dirkkotze.co.za

[1]See Scania Finance Southern Africa (Pty)Ltd v Thomi-Gee Road Carriers CC & Another 2013(2) SA 439

[2]See Firstrand Bank Limited vs Vecto Trade 68 (Pty) Ltd

[3]See wording of section 345

[4]Badenhorst v Northern Construction Enterprises (Pty) Ltd 1956 (2) SA 346 (T) at 347H-348C

[5]See Hulse Reutter & Another vs HEG Consulting Enterprises (Pty)Ltd 1998 (2) SA 208 (C) at 219F-220C

[6]The often quoted words of Colman J in Breitenbach v Fiat SA (Edms) Bpk 1976(2) SA 226 (T) at 228

[7]See ABSA Bank Ltd vs Erf 1252 Marine Drive (Pty)Ltd 2012 ZAWCHC 43

[8]2014 ZAWCHC case no 21088/2013

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.

THE SOUTH AFRICAN INSOLVENCY PRACTITIONER: QUO VADIS?

“A paid occupation, especially one that involves prolonged training and a formal qualification”

(Definition of Profession –Oxford Dictionaries)

The significance of a modern insolvency system as a key foundation of sustainable economic development has widely been acknowledged and documented by international institutions such as the World Bank and the United Nations Commission on International Trade Law (UNCITRAL). In the context of global economic developments, insolvency laws and systems are increasingly being recognised as a fundamental institution, essential for the development of credit markets and entrepreneurship in developing countries, and, in turn, those insolvency systems depend on the existence of sound and effective institutional and regulatory frameworks.

It should be acknowledged that creditors today are more likely to vote in favour of some kind of reorganisation which enables the insolvent company to continue to exist rather than pick over the bones of a dead carcass. The liquidation v business rescue debate is continuously being played out in our courts and in two recent SCA judgements it was affirmed that while business rescue may often seem an obvious choice, the option of liquidation should not be ignored. The court also held that mere savings on the costs of the winding-up process in accordance with the existing liquidation provisions can hardly justify the separate institution of business rescue. Therefore although there is a discernible international trend to move towards corporate rescue mechanism, it isn’t always to the advantage of creditors and as such in the public interest to create an artificial alternative to the liquidation of a company.

The insolvency profession has evolved considerably in recent years. These days, IPs are no longer the ‘Undertakers’ of old but are increasingly running businesses, constructing and negotiating deals or investigating the affairs of the company. Practitioners accordingly have to possess certain specialist skills if they are to convince creditors of the feasibility and benefits of the painful process of bankruptcy as oppose to other alternative proceedings available. Insolvency work is also as much about people as it is about financial figures and boardroom tactics. On the battlefields populated by dying companies, rogue directors, anxious creditors and destitute employees, practitioners could become enemies or allies. From an economic viewpoint, and especially in the current global financial situation, confidence in skills of the insolvency practitioner and the regulation of insolvency practitioners is essential.

In conclusion it is submitted a number of factors exists which policy – and lawmakers should consider in order to holistically develop an effective and efficient regulatory framework for South African insolvency law. In the South African context the transformation theme will remain a complex and emotive process, and as such it is imperative that law reform takes place on the basis of a rational, structured policy approach and policy documents and objectives not be plucked out of the stratosphere. Any attempt to regulate the profession should be done against the background of generally accepted social and economic goals, but nonetheless also produce a system where practitioners would be required to have the skills, knowledge and experience so as to maintain the integrity of the insolvency system, and profession.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.