The COVID-19 effect: Its impact on industries and how to reduce insolvency risks
The COVID-19 effect: Its impact on industries and how to reduce insolvency risks
Society is adjusting to a ‘new normal’. Amid efforts by government and the medical sector to mitigate the health impact of the COVID-19 (Coronavirus) pandemic, many commercial enterprises are having to fundamentally alter how they do business, as the economic effects of the Coronavirus continue to manifest. It is therefore pertinent to have an understanding of the current economic landscape in South Africa, and what might be done to minimise financial damage and reduce insolvency risks during this uncertain time.
This article will provide an overview of some of the industries in South Africa that are most affected by the COVID-19 pandemic, as well as a discussion on a number of mechanisms available to directors and stakeholders to minimise harm to their businesses and reduce insolvency risks. This will include a brief consideration of commercial legal procedures, policy responses as well as steps that may be taken to be proactive in protecting your business and to practice financial prudence. Many of these processes outlined below have been canvassed in greater detail in previous editions of our Business Rescue, Restructuring & Insolvency newsletter.
Industries in South Africa hardest hit by the COVID-19 pandemic
Responses to the COVID-19 pandemic, including lockdowns and travel restrictions, have brought much of the global aviation industry to a standstill. Aviation is the only form of rapid domestic and international transport, which makes it vital for several other industries, including logistics, trade and tourism. As international airlines (such as Virgin Atlantic) consider bailout negotiations, economic models have predicted that the global aviation industry is to suffer an approximate loss of USD 150 – 230 billion in gross operating revenues. This is partly because airlines, unlike other businesses, essentially hit a revenue stream of zero overnight due to policy decisions such as lockdowns, while still having to maintain a number of fixed costs including aircraft maintenance and leases.
In South Africa, aside from strictly regulated flights designated for repatriation or essential cargo, flights have been halted and the domestic industry is expected to suffer losses in excess of R40 billion during the nationwide lockdown. A number of airlines are considering mechanisms such as business rescue, restructuring and/or liquidation, in order to facilitate either the possibility of conducting business in the future or winding-down operations (for example, South African Airways is currently in business rescue and South African Express Airways SOC Limited has just been placed into provisional liquidation).
A contracting economy and decreased government spending were factors already affecting the local construction industry prior to the pandemic. Now, the nationwide lockdown has forced many businesses to temporarily shut down. The South African Forum of Civil Engineering Contractors has estimated that the construction sector will, in terms of the rand value of fixed investment, decline by 8.7% this year, from an initial forecast decline of only 1.5%.
The sector employs close to one million people and it is predicted that due to the COVID-19 pandemic, job losses could amount to 100,000 over the next 18 months. As a labour-intensive sector, the construction industry is among those hit hardest by the Coronavirus. The sector has formed a COVID-19 Construction Rapid Response Task Team to look at the recovery of the industry post-lockdown. The Task Team has been formed at a critical time for the industry, against the backdrop of its aforementioned challenges, and has called for major interventions by stakeholders.
Transport, logistics and manufacturing
For the transportation and logistics industry, the economic outlook is slightly more layered than others. The nature of the COVID-19 lockdown is to minimise movement. For manufacturers, this has meant that all factories, warehouses and modes of transport have been forced to shut down. Vehicle manufacturing has also been put under immense pressure, with new vehicle sales statistics for March 2020 reflecting a substantial decline of 29,7% compared to March 2019 while export sales demonstrated a decrease of 21,5% compared to March 2019.
The South African automotive industry is export-oriented. China was South Africa’s seventh largest automotive trading partner in 2019, with imports of R18,6 billion. Managing tasks on the ground has become more difficult than ever, in an unprecedented time for the sector. The contraction of other industries during the pandemic has had a knock-on effect on this sector, as capacity will surely exceed demand at the current rate of activity. The movement of goods has continued in relation to the support of essential services, as well as the associated supply chains therein, however high-earning sectors such as mining and the automotive industry, as mentioned, are of course excluded from this.
Hospitality and tourism
The hospitality industry has also been hard hit by the COVID-19 pandemic, forcing many hotels, guest houses and tourism sites to operate with a skeleton staff and minimal-to-no guest and customer income. The industry is historically a major job creation hub for South Africa, employing over 700,000 in 2019.
Tourism was also on the rise in January and February, with 1.7% more travellers (3,091,233 individuals) passing through SA’s ports of entry and exit compared to the same period last year. To suddenly shift from this growth to complete inactivity has resulted in many companies in the industry considering and implementing measures such as restructuring, pay-cuts, retrenchments and the possibility of winding-up.
The COVID-19 pandemic has had a wide-ranging impact on the entertainment industry. Social distancing and travel restrictions mean that events, concerts, weddings, world tours and film sets are no longer viable activities for the foreseeable future. The Events Industry Council values the size of the global sector as large as USD 1 trillion, and estimates that, due to the pandemic, about 23% of the market has evaporated.
In South Africa, artists and organisers are prioritising a move to online events and performances in order to mitigate the impacts and reignite revenue streams. The Department of Sports, Arts and Culture as well as the National Film and Video Foundation is providing financial relief to entertainment companies or individuals who have had to cancel productions due to the pandemic.
The textile industry has had to shut down almost all operations during the five-week lockdown period. A number of retail outlets that were struggling prior to the onset of the pandemic might now be forced to wind-down operations or restructure and sell-off certain departments. In order to save costs, several major clothing retailers have also reached an agreement with landlords to pay 20% of their rental during this lockdown period. A few companies will see a spike in activity due to the need to produce Personal Protective Equipment, particularly cloth masks at an estimated demand of 100 million per month.
The industry was one of the first in South Africa to receive pay-outs from the COVID-19 relief fund run by the Unemployment Insurance Fund (the UIF). The agreement between industry stakeholders and government allows for the sector’s employees to be paid their full wages for a six-week period. The easing of lockdown restrictions from level 5 to level 4, nationally, as of 1 May 2020 should also see the resumption of a number of commercial activities in the sector.
How to minimise damage and reduce insolvency risks during the COVID-19 pandemic
It is important to be aware of how and when a company is at risk in order to effectively address the consequences of COVID-19. A company will be financially distressed in terms of section 128(1)(f) of the Companies Act 71 of 2008 (the New Companies Act) if it appears to be reasonably unlikely that the company will be able to pay all of its debts as and when they become due and payable within the immediately ensuing six months or if its liabilities will exceed its assets within the ensuing six months.
A company is said to be insolvent if its liabilities exceed its assets (this is known as factual insolvency), or if it cannot pay its debts as and when they fall due (this is known as commercial insolvency). The latter is the more appropriate test for insolvency as companies are often factually solvent whilst unable to pay their debts due to cash-flow issues.
Directors’ liability and duties in financially distressed times
There is an onerous obligation placed on a board of directors of a company in terms of section 129(7) of the Companies Act wherein, if the board determines that a business is in fact in financial distress, they are to either adopt a resolution to commence with business rescue proceedings, alternatively, deliver a written notice to each of its creditors, employees, trade unions and shareholders, setting out, inter alia, reasons for not voluntarily commencing business rescue proceedings.
Failure to adhere to provisions as set out in the New Companies Act could result in a director being held personally liable for all the debts of a company. Section 77 of the Act speaks to this personal liability and explains that where a director knowingly carried on the business of the company recklessly or with the intent to defraud creditors or other stakeholders, he/she shall be held personally liable for any loss incurred by the company. Section 214 goes even further to provide for criminal liability for those directors at the steer of a company which is being traded recklessly.
In considering the above, should your company run into financial difficulties during this time, while it is understandable to not readily concede that there may be problems, it would be unwise not to seek guidance in navigating through these uncertain and challenging times. All directors should be asking themselves the following two important questions: Is it reasonably unlikely that the company will be able to settle all its debts as they become due and payable in the ensuing six months? Or, is it reasonably likely that the company will become insolvent within the immediately ensuing six months? If the answer is yes to either of the above questions, then the company is financially distressed and we suggest you make contact with us as soon as possible.
Business rescue and liquidation
In light of the above, it is important to take note of legal mechanisms available to financially distressed and insolvent enterprises.
Business rescue is defined in section 128(1)(b) of the new Companies Act as “proceedings to facilitate the rehabilitation of a company that is financially distressed”. The proceedings are aimed at aiding a company which is in financial distress, by allowing it to reorganise and restructure its affairs, assets, equity, debts, property and liabilities. We have comprehensively dealt with the mechanism of business rescue in edition 3 and 4 of our Business Rescue, Restructuring & Insolvency newsletter and we encourage readers to take note of its contents.
It may be that the situation is so dire that the only option left is to liquidate the company in order to prevent any further damage. The purpose of liquidation is to wind up the company’s affairs by selling the company’s assets either by way of private treaty or public auction in order to pay the costs of its winding up as well as its creditors. In South Africa, insolvent companies are liquidated in terms of Chapter 14 of the Companies Act 61 of 1973 (Old Companies Act), while solvent companies are liquidated in terms of the new Companies Act. We have ventilated the mechanism of liquidation in edition 5 of our Business Rescue, Restructuring & Insolvency newsletter and we encourage readers to take note of its contents.
Policy responses to reduce insolvency risks
A notable policy response is the provision of R30 billion made available by the UIF for COVID-19 income support to retrenched workers. It aims to assist workers who have been affected by the shutdown across several sectors of the economy to contain the spread of COVID-19. Industry-specific responses include commercial banks being exempted from the Competition Act 89 of 1998 to coordinate on measures which can be used to support business and citizens. In particular, the exemptions will enable banks to coordinate in respect of payment holidays, debt relief, limitations on asset repossession and the extension of credit lines.
The Industrial Development Corporation of South Africa has put a package together with the Department of Trade, Industry and Competition of more than R3 billion for industrial funding to address the needs of vulnerable firms and to fast-track financing for companies vital to efforts to address the coronavirus and its economic impact.
For April and May 2020 retails landlords, as previously discussed will offer relief in the form of rental discounts and interest-free rental deferments which includes rent, operating costs and parking rental but excludes all rates, taxes, utilities and insurance, which tenants will still be required to pay in full during the relief period.
On 7 April 2020, the Minister of Tourism announced that the Tourism Relief Fund is open for applications with effect from 7 April until 30 May 2020. On 24 April 2020, Finance Minister Tito Mboweni announced in his economic recovery address that the banking industry has announced measures to postpone clients’ debt repayments. Additionally, he stated that National Credit Guarantee Scheme will be available for businesses who make R300 million or less in annual revenue and that R1 billion has already been spent on medical necessities using money from the Solidarity Fund. The Minister also made mention of possible incoming loans from the World Bank, International Monetary Fund and the New Development Bank.
The importance of being proactive
Directors and stakeholders must take ardent steps to protect their businesses and commercial interests. Now, more than ever, it is vital to ensure lines of communication are open and being efficiently used to liaise with landlords, banks, suppliers and debtors. It is hoped, and assumed, that contracting parties will be reasonable in the circumstances when it comes to performance and concessions such as payment holidays. Additionally, in line with the insolvency tests and commercial legal mechanisms outlined above, it is paramount that companies ensure all financial statements, books and records are up to date to determine a company’s financial position and assess cash flow.
While the above discussion may arguably paint a picture of distress and uncertainty, it is important to remain hopeful and optimistic. A reimagining of society is required, and it will be vital to capitalise on the new commercial opportunities that arise from this. Navigating this new normal can at times be a daunting process, especially in light of the current international economic strain and uncertainty surrounding the COVID-19 pandemic.
The Business Rescue, Restructuring and Insolvency team at Cliffe Dekker Hofmeyr possesses the specialist knowledge, skill and experience to guide you through the process of deciding the next step for your business. Directors and stakeholders should take note of the procedures outlined above when trying to mitigate the fallout of the current economic climate and when deciding which course of action is most appropriate in the circumstances. We are willing and able to assist in these unprecedented times.
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