Tag Archives: Finance

A VIEW ON SOURCES OF POST COMMENCEMENT FINANCE IN SOUTH AFRICA

I recently concluded that banks or other financial institutions are not sources for post commencement finance (“PCF”) in business rescues as is envisaged in terms of Chapter 6 of the Companies Act 71 of 2008. It also became clear that none of the South African commercial banks have thus far developed any “products” that can be described as ideal for “distressed funding”.

I suspect that commercial banks might feel that it is simply not an area where they will find a return or where there will be sufficient volumes to justify the development of such banking products. It is also understandable that conventional governance of depositors’ and shareholders’ funds will not permit distress lending.

It is must however also be understood that where a bank is exposed as a creditor in a business rescue matter that they will evaluate the matter on its own merits been made clear that the availability of and the providing of PCF is not entirely “embargoed” by banks.

We have found that the bank, as a PCF lender, would consider granting PCF when, under circumstances where the bank can be described as a “defensive pre- commencement lender” seeking to maximize the value of its pre-commencement claim. The bank may then agree to provide PCF in an amount designed to ensure a successful reorganization and which may be conditional upon them being involved in the business rescue decision making process.

At a minimum, such PCF would be expected to cover anticipated working-capital and the expenses in the business rescue process needed for the period necessary to effect operational changes or restructure the debtor’s business. In some instances, however, the nominal amount of the PCF may significantly exceed the debtor’s working-capital needs, even with the additional costs that will be incurred because of the debtor’s filing for business rescue. The effect of such a higher nominal amount of PCF may be that that the company under BR will have the benefit of increased creditor confidence and as consequence of which suppliers may be more willing to provide products on terms more advantageous to the company than what they would have been prepared to do under regular uncertain business rescue circumstances.

Furthermore, customers may continue to utilise the company’s service with the confidence that the company will ultimately emerge from Business Rescue. It is therefore so that a relatively large PCF facility can decrease the negative operational impact of a BR filing. I suspect that South African banks have thus far provided the most PCF to date but also believe and will not be surprised if all this is “defensive” PCF financing.

It has been alleged that there is an unwritten rule or understanding amongst banks in South Africa that the one bank will not bail out a company with PCF to enable a company to repay its debts with another bank. We have practically experienced in recent dealings with a parastatal lender that the borrowers had to certify the lender that the finance being obtained by shareholders (two levels up) were not to be utilised for purposes of settling the debts of a company under business rescue.

We have also found in practice that a further major stumbling block for potential PCF financiers arises when there is a pre-commencement cession of book debts in favour of a bank as security for its overdraft of whatever is owing to the bank. There is a view that banks are in terms of its cession of book debts entitled to rely on book debts created post the commencement of business rescue proceedings as additional security. This is despite them not having provided the finance that enabled the BRP on behalf of the company to render the service or manufactured the product that enabled to BRP on behalf of the company to create the invoice. All of this post the commencement of business rescue proceedings.

Its seems untenable that the PCF financier may not, as first charge, rely on the proceeds of the post BR book debts. The law in this regard needs to unfold We are of the view that in order for PCF to succeed under such circumstances the BRP needs to enter into an agreement with the bank in order to have future debts released from the cession.

It is clear to us that distressed funding or, PCF, remains one of the most topical issues in restructuring businesses and for the business rescue process to work. There is no doubt that the ability of a company under business rescue to continue trading or carrying on with its business activities depends entirely on its ability to procure PCF in some form or another.

Internationally the motivation of distressed investment funds to get involved in PCF of debtor in possession finance under Chapter 11 in the USA (“DIP finance”) is often very different from that of commercial banks. While a commercial bank may seek to profit through fees and interest earned over the course of a long-term relationship with a borrower, the business model of distressed investment funds is entirely different.

We need to look at the various forms of PCF that are available. First, there is conventional post commencement trade credit and in terms of the Companies Act the BRP may incur credit in the ordinary course of its business. This will be treated as PCF and suppliers and trade creditors typically extend this credit on similar terms as existed before the commencement of BR proceeding if they are comfortable that the debtor has sufficient cash flow to pay them on a timely basis. Such PCF enjoys the protection of section 135 of the Act and must be repaid in the order that such debts were incurred.

Second, Secured PCF which is permitted in terms of the Companies Act and under which circumstances the BRP obtains post commencement credit secured by either a lien or pledge or any other agreed form of security over assets that are otherwise unencumbered. This may appear to be preferable and safe in theory but distressed businesses under business rescue usually do not have unencumbered assets, any equity in assets that are already encumbered, or all their assets are fully encumbered by other lenders. Security for the PCF lender is therefore a logical option to have, but usually of little practical assistance.

However. an alternative, in rare cases, is a second or reversionary form of pledge or lien over assets already encumbered. This is done in the USA under Chapter 11 procedure in terms of what is called Super Priority Secured Financing. How it is works is that, under circumstances where a debtor under Chapter 11 is unable to obtain credit in any of the traditional DIP finance ways, the Bankruptcy Court can allow the debtor to obtain financing secured by a first lien on already encumbered assets of the estate. This means that secured creditors that already have liens on the assets will be pushed down or “primed”. This must be done with Bankruptcy Court approval, and creditors whose liens are being “primed” must have the opportunity to object.

The only way the Bankruptcy Court will allow such financing is if  the debtor makes an appropriate case that it is unable to obtain credit in any other way and it must be demonstrated that the creditor whose security is eroded is “adequately protected.” This essentially means that the creditor whose lien is being primed needs to be shown that even though its lien is being pushed down, it will not be unduly harmed by this event.

Author:

Hans Klopper of Independent Advisory

References:

  • Perlman F.G, Baer H.P, Kevane H, Bagby I, Corbi R.J, Farnsworth S, Krause S, Kriegel M, Lucas J.W and Maman M : “Debtor-in-Possession Financing: Funding a Chapter 11 Case” American Bankruptcy Institute
  • Salerno TJ, Kroop J.A and Hansen C : “The Executive Guide to Corporate Bankruptcy” – Second Edition (BeardBooks 2010)

REVIEWING SOUTH AFRICA’S POST COMMENCEMENT LENDING CULTURE

Background to Debtor in Possession (“DIP”) Finance in USA

The Common Law Origins of Debtor Financing

In the USA the modern Bankruptcy Code’s DIP financing provisions are codifications of practices developed in the common law era prior to the enactment of a national bankruptcy law.

Modern DIP financing grew out of practices developed in nineteenth-century railroad receiverships, which were governed by a special body of common law.

When a large rail company became insolvent back then the bondholders would approach the courts appoint a receiver. The receiver took control of the rail company’s property as the “hand of the court.”

Akin to a moratorium under the modern Bankruptcy Code this stayed the process while a recapitalization of the railroad was being formulated.

The receiver was authorised to issue new debt in the form of “receivers’ certificates” which were made attractive to new and existing investors by securing a first lien on the bankrupt rail company’s assets.

This was the background that led to the introduction of debtor financing into the Bankruptcy Act in the 1930s.

Pre 2011 – in South Africa

In cases of financial distress prior to the enactment of the Companies Act of 2008 and a restructuring of its affairs was possible, a moratorium was achieved by the granting of a provisional order of liquidation.

When a provisional liquidator was appointed to the company and found that there was merit in continuing with a company’s trading operations, leave to borrow money was obtained by applying to court.

Such loans became a cost of administration and were repayable as a first charge and protected by the Order of Court.

Ensuring access to finance is available for businesses in business rescue

Where does a Business Rescue Practitioner (“BRP”) look to obtain Post Commencement Finance? Shareholders, creditors or the companies’ customers?

In South Africa, BRP’s came to the conclusion that they must look elsewhere than to commercial banks for PCF funding.

Much has been said about the formation of funds here in SA such as distressed hedge funds in other jurisdictions but not much of it has been seen.

The challenges for BRP’s in obtaining PCF are:

  • The majority of funders that are prepared to provide funding, mostly proved too slow in making decisions.
  • The harsh reality is that PCF is mostly required at a time when a company is almost at the end of its ability to provide security.
  • Where the PCF funder cannot secure his PCF and have only the relative cold comfort of ranking ahead of all pre commencement creditors the appetite to provide PCF seems to be waning.
  • There is also uncertainty as to whether a PCF funder will rank ahead of a secured creditor under circumstances where they provided funding to maintain or preserve a secured creditor’s security. This position should surely be akin to section 89 of the Insolvency Act where the costs of maintaining and preserving security rank ahead of the claim of the secured creditor?
  • The reality is therefore that PCF will only be attracted where the business model is sound, where there is a prospect that the business will be a going concern going forward.

Understanding current decisions from Financial Institutions and Courts on Funding

In our Law reports until 31 December 2016 the mention of PCF is limited to three cases and also not really relevant to funding as such.

These cases are:

Copper Sunset Trading 220 (Pty) Limited v Spar Group Limited and another 2014 (6) SA 214 (LP)

In this case the BRP contended that the procuring of PCF was conditional upon a business rescue plan being adopted.

The respondents voted against the plan and upon application the court set that vote aside as inappropriate and adopted the BR Plan. It would be interesting to hear as to whether PCF was ever procured.

Prior to the above mentioned case, there were the cases of Commissioner South African Revenue Services v Beginsel NO and another 2013(1) SA 307 (WCC) and the Cape Point Vineyards case. In both cases the references to PCF was obiter.

Suffice to say that our law has not as yet developed much and we are therefore bound to look at what happened in other jurisdictions.

What transpired under Chapter 11 in the USA is no different from what happens here and the Americans refer to “defensive DIP Financing” as the typical DIP financing situation.

This happens when a pre-commencement lender (pre-petition in the USA) secured by a form of security over the assets of the company under Chapter 11 is faced with two primary choices:

  • extend additional financing post-business rescue to permit the company to either reorganize, or sell its assets in an orderly fashion under Chapter 11, or, alternatively,
  • risk the uncertainty of a piecemeal liquidation of the debtor’s assets.

Therefore, rather than taking a chance with a fire sale, many lenders conclude that financing a case is more likely to protect the going-concern value of the borrower.

American studies have shown that commercial banks have provided the majority of DIP financing in the USA by way of such “defensive DIP Finance”.

The experience in SA to date, would also appear to indicate that the banks and financial institutions involved in matters where business rescue was filed, have reluctantly agreed to provide post commencement finance and mostly only because they had to protect their pre-business rescue debt and/or maintain their security.

By HANS KLOPPER
Independent Advisory

HOW TO RESCUE YOUR BUSINESS

Is your company experiencing financial strain? Are creditors breathing down your neck? Business Rescue proceedings may be a solution to your problems.

Business Rescue is an approach that is governed by the Companies Act 71 of 2008 (“the new Companies Act”) with the aim of assisting companies which are experiencing financial strain and are unable to pay their creditors in the ordinary course of business.

What is business rescue?

Section 128(1) (b) of the Companies Act defines Business Rescue proceedings as proceedings to facilitate the rehabilitation of a company that is financially distressed by providing, inter alia, temporary supervision of a company under a Business Rescue practitioner.

The role of the Business Rescue practitioner (who must be appointed within 5 days after the company has been placed under Business Rescue) is to ensure that the company complies fully with the steps to be taken once Business Rescue proceedings have commenced. They must also ensure that everything reasonably possible is being done (including the drafting of a Business Rescue plan) to assist the company in getting out of its current state of financial strain and into a position where it will be able to pay its creditors in the ordinary course of business.

The new Companies Act stipulates that, in order to place a company under Business Rescue, a resolution must be taken by the Board of Directors and an application thereto must be made to the CIPC (Companies and Intellectual Property Commission). The Commissioner must then consider the application and approve or reject it. Alternatively, any interested or affected party may apply to the Court for a court order placing the company under Business Rescue.

A company that is under Business Rescue is protected from creditors in that no legal action or proceedings may be taken against a company that has commenced with Business Rescue proceedings.

It is imperative to note that a lack of full compliance with the requirements in respect of Business Rescue proceedings may render the Business Rescue proceedings null and void. This position was reiterated in the High Court case of Advanced Technologies & Engineering Company (Pty) Ltd v Aeronautique et Technologies Embarquees SAS (unreported CASE NO 72522/20110), and the Court further held that the new Companies Act does not provide for condonation of non-compliance with the requirements.

References:

Companies Act 71 of 2008

D Davis, W Geach, T Mongalo, D Butler, A Loubser, L Coetzee, D Burdette, 3rd Edition (2013) Commercial law: Companies and other Business Structures in South Africa.

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. Errors and omissions excepted (E&OE)