19 November 2011

Business Rescue - creditors beware

Chapter 6 of the New Companies Act allows the board of a company to pass a resolution placing the company under "business rescue" and appointing a business rescue practitioner, as an alternative to liquidation.

The threshold for passing the resolution is extremely low. The board merely needs reasonable grounds to believe the company is financially distressed and there is a reasonable prospect of rescuing it. No legal action can be instituted against a company once it is under business rescue proceedings.

The provisions can be abused. Even when there is no prospect of saving the company, the board can proceed to pass the resolution in an attempt to buy more time from creditors who are threatening liquidation.

The Act provides relief to affected parties (creditors, shareholders and employees) to set aside the resolution by instituting legal proceedings on the grounds that the company is not financially distressed, or that there is no reasonable prospect of rescuing the company.

But creditors could find it difficult to make use of the remedy the Act provides. The information needed to set aside the resolution such as management accounts, updated financial information and cash flows, will not be freely available to affected parties. The business rescue practitioner may not have the requisite information or may be unwilling to release it. Even if the information is made available, the books may not be up to date, may be incorrect, or plainly non-existent. Creditors may face an uphill battle in seeking to set aside a resolution.

By the same token, the business practitioner's powers of investigation are limited. Unlike a liquidator, the practitioner does not have the powers of a subpoena and interrogation, as prescribed in Sections 417 and 418 of the old Companies Act. So it may not be possible to establish whether certain activities or transactions of the former board could potentially be set aside since these activities may not be properly investigated.

The high cost of litigation associated with approaching a court to set aside the resolution and the delays brought about by this process, is another impediment. Another difficulty is that creditors' rights in relation to proving claims have not been stipulated. Most practitioners have resorted to using the requirements and the forms contained in the old Companies Act. There does not seem to be any mechanism by which independent third parties can object to other creditors' claims. The only basis may be either to vote against the business rescue plan or to set aside the practitioner's decision to admit a claim.

While the philosophy behind business rescue is sound, it is open to abuse by a board of directors who wish to frustrate the rights of creditors and conceal their activities from those creditors. For that reason creditors should be vigilant in business rescue proceedings. They should be involved and ask the hard questions.

Julian Jones

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