19 January 2021 by , and Dispute Resolution Alert

When does a surety’s right of recourse arise and what effect does section 154(2) of the Companies Act 71 of 2008 have on this right?

These are two of the questions that the Supreme Court of Appeal (SCA) had to consider in the recent case of Zungu-Elgin Engineering (Pty) Ltd v Jeany Industrial Holdings (Pty) Ltd and Others (1138/2019) [2020] ZASCA 160 (3 December 2020) (Zungu-Elgin Case).

Case discussion

In the Zungu-Elgin Case, three sureties paid to a creditor the indebtedness owing by the principal debtor, after the creditor had exercised its rights in terms of the suretyship agreements and obtained judgment against the sureties (jointly and severally) for the indebtedness owing. The sureties thereafter attempted to exercise their right of recourse against the principal debtor, by suing the principal debtor for the total amount that the sureties paid to the principal debtor’s creditor. The principal debtor defended the action proceedings. The sureties consequently applied for summary judgment against the principal debtor, which proceedings the principal debtor opposed on the following basis:

  1. It argued that it was placed under business rescue and that the debt to its creditor arose (and accordingly the sureties’ right of recourse arose) prior to the commencement date of its business rescue. The principal debtor argued that, since the approved and implemented business rescue plan did not provide for this debt, the sureties were not entitled to enforce it; and
  2. It contended that to permit claims against a company that were not provided for in the approved and implemented business rescue plan, might jeopardise the business rescue process.

It is important to mention at this juncture that the sureties only paid the principal debtor’s creditor after the commencement of the business rescue proceedings. Despite this, the principal debtor argued that the sureties’ right to recourse arose on an earlier date, when the principal debtor’s debt arose.

The court a quo granted summary judgment against the principal debtor and granted the principal debtor leave to appeal its judgment.

In its judgment, the SCA first considered what is stated in section 154(2) of the Companies Act 71 of 2008 (Companies Act), which deals with the discharge of debts and claims against a company in business rescue. Section 154(2) states:

If a business rescue plan has been approved and implemented in accordance with this Chapter, a creditor is not entitled to enforce any debt owed by the company immediately before the beginning of the business rescue process, except to the extent provided for in the business rescue plan.

The SCA thereafter highlighted the following well-known common law principles relating to a surety’s right of recourse:

  1. A surety who has paid the debt owed by the principal debtor to the creditor, has a right of recourse against the principal debtor. The surety is entitled to reimbursement by the principal debtor of what he/she has paid to the principal debtor’s creditor; and
  2. A surety can only be regarded as a creditor of the principal debtor, when the surety has paid the principal debtor’s creditor.

The SCA thereafter held that the principal debtor’s arguments were bad in law for the following reasons:

  1. Section 154(2) of the Companies Act does not expressly or by necessary implication vary the common law principle that a debt based on the surety’s right of recourse arises upon payment to the creditor.
  2. On the contrary, in terms of section 154(2), the question whether any debt was owed by the company at the specified point in time, is to be determined in terms of existing law, including the common law.

The SCA accordingly dismissed the principal debtor’s appeal.

Conclusion

The judgment makes it clear that a surety’s right of recourse arises against the principal debtor when the surety has paid the debt owed by the principal debtor to the creditor, and that section 154(2) of the Companies Act does not alter this common law position.

The judgment is, however, not clear on what effect business rescue has on a surety’s contingent claim against a principal debtor in business rescue and in particular in circumstances where the surety has not as yet paid the creditor of the principal debtor and accordingly the debt is not as yet due and owing by the principal debtor to the surety (but may however become owing at a later stage once the surety pays the principal debtor’s debt).

Should a surety have a contingent claim against a company in rescue, it is important that the surety seeks legal advice in the business rescue proceedings of the principal debtor, since the effect of the business rescue may be that the surety’s pre-commencement contingent claim is compromised in terms of the adopted business rescue plan and accordingly unenforceable once the debt becomes due and owing (which is when the surety pays the creditor). A surety wishing to later enforce a pre-commencement contingent claim, therefore needs to ensure that the contingent claim is not compromised in the business rescue plan and it is crucial that the surety informs the business rescue practitioner of the surety’s claim so that it can be included in the plan. Even if the business rescue plan does not compromise the surety’s claim, but the business is subsequently sold to a third-party purchaser, the surety may sit with a judgment against an empty shell without any assets.

Considering the complicated nature of a surety’s right to recourse during business rescue, it is important that, if you have signed a suretyship agreement and the principal debtor goes into business rescue, or if you are a creditor of a company in business rescue and you hold suretyships as security for the debts of the principal debtor, you consult with us for purposes of understanding your rights in the business rescue and the effect which section 154(2) of the Companies Act may have on these rights.

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