CRS Business Rescue
Overview of business rescue in South Africa - the context, process, and stakeholders

Business rescue versus workout

A turnaround refers to recovery from an existence-threatening decline. Turnaround takes place in two settings,  namely informal creditor workout, and Chapter 6 business rescue.

Informal creditor workout - turnaround outside of the legislative framework

Workout has been with us in South Africa for decades. 

It is a negotiated agreement, effectively an out-of-court settlement between management of a distressed or defaulting company, and creditors, on a plan to reduce indebtedness.

Note that informal creditor workout has two connotations. We refer to workout in the sense of a turnaround of an economically viable company i.e. that the company survives, as opposed to the other connotation where debts of an economically unviable company are worked out prior to a liquidation.

Advantages of workout over business rescue

  • The company is not affected by adverse publicity since the turnaround is silent.
  • It is cheaper than business rescue since no legal fees are involved.
  • It has a higher success rate than business rescue, since turnaround starts earlier and it is normally applied to the more economically viable companies that are in less financial distress.
    • UK: 75% (Franks and Sussman, 2000).
    • USA: 67% (Gilson, 1997).

Disadvantages of workout relative to business rescue

  • Company is harassed by creditors not in the fold - typically unsecured trade creditors.
  • Information, negotiation and control asymmetries between debtor and creditors, and within different classes of creditors.
  • Holdout by creditors (for concessions by others).
  • Smaller dissenting creditors may threaten to applying for liquidation (or business rescue) to get a better deal, thereby blackmailing larger creditors, typically the bank, to pay them off.
  • Turnaround practitioners have little power as consultants, but more so if appointed as interim managers right at the top e.g. CEO or MD. 

Informal creditor workout works well with less creditors and a supportive bank as the dominant creditor.

Chapter 6 business rescue - turnaround within a legislative framework

In the past, SA had Judicial Management, which was a complete and utter failure, and compromises with creditors.  

On 1 May 2011 these were replaced by the business rescue provisions in Chapter 6 of the Companies Act No. 71 of 2009, the Companies Amendment Act No. 3 of 2011, and the Companies Regulations, 2011. 

Advantages of business rescue over workout

  • The moratorium on claims against the company (section 133: General moratorium on legal proceedings against company) overcomes harassment by creditors. The moratorium was not available in judicial management, hence its failure, and it is not enforceable in workout other than by informal agreement amongst creditors.
  • The business rescue plan (section 150: Proposal of business rescue plan) is available to all stakeholders, which mitigates information asymmetries characterised by workout.
  • The voting rules in section 152: Consideration of business rescue plan mitigates creditor coordination problems of holdout and dissent encountered in workout.
  • Contracts other than employment contracts can be cancelled or suspended (Section 136: Effect of business rescue on employees and contracts).  Parties affected can claim for damages only.
  • An empowered business rescue practitioner, that is not liable for any act or omission in good faith, manages the process.  This overcomes weak management if that is the cause of financial distress, and provides better protection than what a turnaround practitioner may face in workout.  Note that whereas the business rescue practitioner has more power than a judicial manager, it has less power than a liquidator in some cases.

Disadvantages of business rescue relative to workout

  • Business rescue is relatively expensive.
    • Firstly, there are additional direct costs e.g. legal fees.  This is why business rescue may turn out to be too expensive for small companies.  Other professional fees are the same as for workout.
    • Secondly, the biggest disadvantage is indirect costs, which come in the form of adverse publicity; disruption; loss of reputation, sales, customers, employees, suppliers, and credit; and difficulty to enter into new contracts due to uncertainty
  • Business rescue needs sufficient financial resources to survive until business rescue plan is adopted (40 days?).
  • It has a lower success rate than workout, essentially because it is a measure of last resort attracting the less economically viable companies (see business rescue resolution).

Which is best - business rescue or workout?

When to use informal creditor workout

Workouts will still flourish despite the introduction of new business rescue legislation on 1 May 2011. 

The overseas experience is that larger companies, and their banks, prefer to have a silent turnaround conducted informally to avoid the reputational risk (the stigma of bankruptcy) of entering Chapter 6 business rescue. 

This is especially true if economic viability is more apparent and financial distress has not reached crisis levels.

How to interpret section 129 (7)

Section 129 (7) stipulates that "If the board 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, 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 to the company, and its reasons for not adopting a resolution contemplated in this section".

  • A company is only financially distressed if all avenues to overcome financial distress have been exhausted.
  • If a company believes it's bank will support it in an informal creditor workout, it is by definition not in financial distress.

When to use business rescue

Companies and close corporations, believing that the legal protection offered by business rescue - the breathing space provided by the moratorium on claims against the company - outweighs the reputational risk of business rescue, will follow this route. 

It can be expected that Chapter 6 business rescues will be mostly smaller companies and close corporations, larger companies whose financial problems are already well known by suppliers, customers and staff i.e. the reputational damage is already done, and companies and close corporations in serious financial distress with economic viability that is not that apparent up front.

In this sense, business rescue becomes the measure of last resort if all other options failed, hence its low success rate.

The legal fraternity, which doesn't really have a market in workouts, stand to gain from business rescue with its high court and attorney interaction,  Accordingly, it can be expected that the legal fraternity will use its influence to make business rescue rather than workout happen.

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