The test for insolvency revisited: Setting aside liquidation proceedings
The test for insolvency revisited: Setting aside liquidation proceedings
In the case of The Commissioner for the South African Revenue Service v Nyhonyha and Others (1150/2021)  ZASCA 69 (18 May 2023) the Supreme Court of Appeal (SCA) was confronted with the question of whether the High Court erred in setting aside an order for the liquidation of Regiments Capital (Pty) Ltd (Regiments) in circumstances where the conditions that led to the order for liquidation had since changed.
At a glance
- In The Commissioner for the South African Revenue Service v Nyhonyha and Others (1150/2021)  ZASCA 69 (18 May 2023) the Supreme Court of Appeal (SCA) had to determine whether the High Court erred in setting aside an order for the liquidation of Regiments Capital in circumstances where the conditions that led to the order for liquidation had since changed.
- The SCA had to determine whether the setting aside of the High Court’s winding-up order constituted the exercise of a true discretion by the High Court and whether, based on the available facts, Regiments was commercially solvent at the time of the hearing in the High Court.
- The SCA found that Regiments would be unable to settle the claims of all its current creditors, which included unrelated creditors and the South African Revenue Service (which was still to issue a tax assessment for R279,343,833), and as result, Regiments was commercially insolvent.
The purpose of liquidation is to wind up an insolvent company’s affairs by selling its assets and allocating the proceeds and surplus among its creditors and shareholders. Hence, the object of a liquidation is to ensure that a company is wound up equitably and fairly.
In this case, the National Department of Public Prosecutions (NDPP) obtained a provisional restraint order under the Prevention of Organised Crime Act 121 of 1998 (POCA) which related to Regiments’ assets. Section 26(1) of POCA provides that the NDPP may by way of an ex parte application apply to a competent High Court for an order prohibiting any person, subject to such conditions and exceptions as may be specified in the order, from dealing in any manner with any property to which the order relates. In terms of the restraint order, Regiments was interdicted from participating in an unbundling transaction in respect of the shares it held in Capitec Bank Holdings Limited. The restraint order was eventually discharged. However, prior to the discharge, Regiments was placed in final liquidation at the instance of an unpaid creditor.
Pursuant to the discharge, Regiments and others brought an urgent application to the court a quo for an order to set aside the final liquidation order, on the basis that the circumstances leading to the final winding-up had since changed. The application was brought in two parts, the first for an order staying the winding-up of Regiments and authorising the execution of the unbundling transaction, and the second to set aside the liquidation. The aim of the first part of the urgent application was to realise funds for the benefit of Regiments. The rule nisi was granted authorising the implementation of the unbundling transaction under the supervision of an independent attorney, together with an order granting the South African Revenue Service (SARS) leave to intervene in the proceedings.
In his report, the supervising attorney stated that he received an amount of R36,348,950 as proceeds of the unbundling transaction, which he held in trust for the benefit of Regiments. However, SARS filed an application to oppose Regiments’ application to set aside the winding-up order. The basis of SARS’ opposition was that it was in the process of conducting an audit in respect of the liability of Regiments for income tax for the 2014 to 2019 income tax periods, as well as its liability for value-added tax (VAT) in respect of the 2013/03 to 2016/02 VAT periods. The SARS audit, which it contended was due to be finally approved, indicated an income tax liability for the 2014 to 2016 income tax periods of R217,578,411.92 and liability for VAT in the amount of R61,765,421.56. This total amount of R279,343,833.48 did not include understatement penalties, statutory penalties or interest. In its opposing papers, SARS further stated that the audit in respect of the 2017 to 2019 income tax periods had not been completed in relation to Regiments. All of this meant that assessments in the amount of circa R279,343,833 were imminent and that this amount was a conservative estimation of Regiments’ liability towards SARS.
SARS contended that Regiments’ cash on hand in the amount of R36,348,950 from the unbundling transaction, and the value of the shares it held in Capitec worth R350 million, being the liquid and realisable assets, would not be sufficient to pay the income tax and VAT liability due to SARS as well as the unrelated creditors of Regiments, whose combined debt amounted to R278,011,795. The related creditors whose combined debt amounted to R113,920,106 had given the undertaking that they would not seek payment of the debts owed to them until the unrelated creditors were paid in full.
The court a quo accepted from various valuation reports, which were not confirmed under oath nor qualified by an expert, that Regiments had various interests in two other entities, Kgoro Consortium (Pty) Ltd and Little River Trading 191 (Pty) Ltd to the value of R513 million and R32 million respectively. Consequently, the court a quo found that Regiments’ total assets, although not all liquid, would exceed its total liabilities. The court a quo therefore found that Regiments was commercially insolvent – “asset rich but cash poor” – and that the winding-up order fell to be set aside. The court directed SARS to issue its tax assessment, which was to be paid by Regiments before payment to the unrelated creditors. Essentially, the court ordered a court-designed winding-up.
The SCA, pursuant to an appeal against the order of the court a quo by SARS, disagreed with the findings of the High Court. The SCA had to determine whether the setting aside of the winding-up order under section 354 of the Companies Act constitutes the exercise of a true discretion by the court a quo and whether, based on the available facts, Regiments was commercially solvent at the time of the hearing in the court a quo.
The SCA reiterated that a true discretion is one which provides a court with a range of permissible options. If the impugned decision lies within a range of permissible decisions, an appeal court may not interfere “unless it is clear that the option applied by the lower court is at odds with the law”. The court found that where, as was the case here, the setting aside of a winding-up order is sought based on subsequent events, the test is whether the facts show that the continuance of the winding-up would be unnecessary or undesirable. As this does not involve a choice between permissible and impermissible alternatives, the test is either satisfied or it is not. It therefore follows that the decision of the court a quo did not constitute the exercise of a true discretion.
In respect of the order setting aside the winding-up order, the SCA found that the court a quo had failed to apply this test, i.e., whether the facts demonstrated that the continuance of the winding-up would be unnecessary or undesirable. The court had in any event erred in factually including the valuation of the interest of Regiments in Kgoro and Little River, which was not valued by an expert or confirmed under oath. On the facts before the court a quo, Regiments was unable to pay its debts, which was the basis for the liquidation in the first place. Consequently, Regiments was factually insolvent at the time of the hearing in the court a quo.
The court reiterated that the nature of commercial insolvency is not something to be measured at a single point in time by asking whether all debts that are due up to that day have been or are going to be paid. The test is whether the company “is able to meet its current liabilities, including contingent and prospective liabilities as they come due”. Determining commercial insolvency requires an examination of the financial position of the company at present and in the immediate future to determine whether it will be able in the ordinary course to pay its debts, existing as well as contingent and prospective, and continue trading. In any event, section 345(2) provides that: “In determining for the purposes of section (1) whether a company is unable to pay its debts, the court shall also take into account the contingent and prospective liabilities of the company.”
The SCA held that the court a quo misdirected itself in finding that because SARS had yet to issue tax assessments for R279,343,833, this amount was not yet due and payable and thus could not be considered in computing the liabilities of Regiments. The court expounded that a tax liability arises at the end of a tax year at the very latest and that this liability is not conditional upon the issuance of an assessment.
Consequently, the debt owed to SARS had to be included in calculating Regiments’ assets and liabilities. In the event, Regiments would be unable to settle the claims of all its current creditors, that is the unrelated creditors and SARS, and the result is that Regiments was commercially insolvent.
On this basis alone, given that Regiments was both factually and commercially insolvent, there was no basis for the finding that the continuation of its winding-up was unnecessary or undesirable. Therefore, where there is a change in the circumstances of an insolvent company, which led to the winding-up of the entity, a court will only grant an order to set aside the winding-up order if there is evidence to the satisfaction of the court that the order is unnecessary or undesirable. This will be the case where, on the facts before the court, the company is able to meet its current liabilities, including contingent and prospective liabilities as they fall due.
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