Business rescue is a term that has become synonymous with the economic lockdown of 2020. Barely a day goes by without another headline proclaiming a well-known company to have entered business rescue.
The most high-profile examples of companies in business rescue include Edcon, SAA and more recently Comair. The first two were broken long before COVID-19 arrived.
People make the mistake of thinking that business rescue and bankruptcy (or liquidation) are the same thing. In practice, business rescue is often the precursor to liquidation, but it doesn’t have to be that way.
For those interested in reading further on international laws, Chapter 11 protection in the U.S. is a comparable legislative framework.
What is business rescue?
Imagine you are in financial trouble, but you have assets you could sell that could help get you out of trouble. If you are forced to sell your house in the next few weeks to pay your creditors, you’ll have to sell it for a desperate price. You might not even be able to pay your creditors in full, so everyone loses out.
Now imagine that your creditors agree to be patient, giving you a chance to maximise value. If you take 3 months to sell the house, you’ll likely achieve a far better price. Your creditors get more and there might even be some left over for you. Everyone is theoretically better off.
Business rescue is a legal construct that allows companies to force creditors to be patient, assuming the legal requirements for the process are met.
First prize is to genuinely rescue the business, helping it escape liquidation and avoid or at least minimise job losses. Second prize is an orderly wind-down of the company, allowing employees, creditors and even shareholders to get as much as possible from the process.
Almost 3,300 business rescue processes has taken place since 2011. Alarmingly, 1,275 are still in process, a significant backlog. Of the resolved cases, around 570 ended in implementation of a business rescue plan and 400 ended in liquidation.
Media outlets and researchers often suggest a success rate for business rescue of 10%, which doesn’t tie up with the CIPC statistics.
Regardless of which numbers are correct, the reality is that entering business rescue gives no guarantee at all of being rescued.
How does a company enter business rescue?
The directors need to come to two conclusions:
- The company is financially distressed; and
- There is a reasonable prospect of rescuing the company
This assessment is currently playing out in many boardrooms across the country as the economic horrors of lockdown play out.
“Financially distressed” means the company is either unlikely to pay all its debts in the next six months or is reasonably likely to become insolvent (liabilities exceed assets). Simply put, the company must be at risk of entering liquidation in the next six months.
That’s the easier of the two conclusions to reach. It is far trickier to determine whether there is a reasonable prospect of rescuing the company. One of the critical success factors is early detection. It’s no use entering business rescue when a company is about to take its final breath.
If formal liquidation proceedings have already started, a company cannot enter business rescue.
What happens in a business rescue process?
Firstly, a business rescue practitioner (BRP) is appointed. The BRP takes over the role of management of the company. The directors step aside for this process.
For the duration of the business rescue process, creditor claims are put on hold by law. This gives the company the breathing space required to achieve the best possible outcome.
The BRP thoroughly investigates the company’s affairs, forming a view on the true financial position and the reasons for the current troubles. Where fraud is uncovered, this is reported to the relevant authorities.
To keep the lights on, post-commencement finance can be obtained from any source. Assets of the company can be given as security, provided not already held as security by other creditors. For example, SAA received R4bn in post-commencement finance, of which R2bn was provided by government.
Within 3 months, the BRP needs to formulate a rescue plan that is presented to creditors, trade unions and shareholders. Whilst only creditors vote to approve or reject the plan, trade unions and shareholders may review the plan and make representations.
The plan is often a proposal of an extensive restructure of the company, closing poorly performing divisions or undertaking a company-wide retrenchment programme.
In practice, the plan is often delayed. Where this is the case, the BRP prepares a monthly report to creditors explaining why.
The first and most obvious challenge is operational: creditors need to keep supplying the company in order for it to trade, even though there is significant risk that they will not be paid. This is the harsh reality now facing Edcon suppliers, many of whom are going to lose their businesses as a result of Edcon’s misfortune.
Only companies operating a business can enter business rescue. This means that investment holding companies typically wouldn’t be suitable for the process, as they don’t control operating divisions with employees and the like.
The skill set of the practitioner is also a challenge. The management team are sector experts and couldn’t save the company, but the hopes of creditors and staff are now pinned on a BRP (often a lawyer or accountant) who may not have any experience in that sector. This can result in costly strategy consultant fees, like the SAA BRPs spending around R35m on American aviation consultants.
Court challenges from unions and creditors aren’t unusual in a business rescue process. The law extensively provides for a system of checks and balances. This is important to avoid directors abusing the power of business rescue and is also critical to protect the rights of employees and creditors in general.
Where fraud has taken place, court battles can play out for years.
Are employees protected?
Yes – the company must respect the terms of employment agreements and has to operate within the rules of the Labour Relations Act.
Importantly, employees are treated as preferred creditors i.e. salaries and wages are paid by the company before creditors are paid.
Retrenchments are a common outcome of business rescue but must be executed legally.
The SAA BRPs have serious egg on their faces as the courts decided last week that the planned retrenchments are procedurally unfair. People love to hate unions and the criticism is often valid (like when above-inflation increases are demanded), but unions do play a critical role in protecting employees at times like these.
Do BRPs get rich?
The practitioner has a complicated job with serious legal consequences if he or she gets it wrong. Fees need to reflect the risk being taken.
Hourly rates are regulated by the Companies Act (up to R2,000 per hour for a senior practitioner), which sounds appealing until you see what senior legal advisors charge on other corporate matters (sometimes up to R10,000 per hour).
The real money is in the side arrangements with creditors, for example a bonus if the business plan is delivered and accepted within 3 months. The Companies Act regulates the way these agreements are entered into but doesn’t regulate the amount.
This is where top-rated BRPs make proper money.
It’s also worth noting that the practitioner always gets paid, even before the employees. Nobody would do the job otherwise.
It’s a complex legal topic and we’ve barely scratched the surface, but the most important thing to remember is that business rescue tries to avoid the company going into liquidation. It rarely works, as the company is in business rescue because it was already very ill.
In practice, there’s usually a bun fight over a stale bun. It gets ugly quickly.
For those who wish to read further, law firms like Werksmans prepare detailed business rescue guides that deal with more of the legal complexities.