Recommend: Winding-up of insolvent companies

When the Companies Act 71 of 2008 (the Companies Act) was brought into operation in 2011, a number of transitional arrangements were enacted, including the retention of chapter 14 of the repealed Companies Act 61 of 1973 (the previous Act) which provides for the winding up and liquidation of insolvent companies. This, according to schedule 5 of the Companies Act, is to remain until alternative legislation for the winding up and liquidation of companies has been enacted. It is now almost ten years, and it does not appear that the Department of Trade and Industry is even thinking about developing such alternative legislation. The result is that, among other things, courts continue to retrofit certain ambiguous aspects of the Companies Act into the insolvency regime that in certain cases appears to contradict the Companies Act. A case in point is the recently decided case in the matter of Montic Dairy (Pty) Ltd (in liquidation) and Others v Mazars Recovery & Restructuring and Others.

This case concerns certain payments to Mazars Recovery & Restructuring made after the erstwhile business rescue practitioners of Montic Dairy (Pty) Ltd had made an application for the final winding up of Montic. The liquidators of Montic applied to the Western Cape High Court for those payments to be declared void in terms of section 341(2) of the previous Act. The court found in favour of the liquidators.

The decision of the court in this matter is difficult to understand, not only in relation to the payment of business rescue fees and costs by a company in business rescue whose proceedings are subsequently converted to liquidation but also in relation to the practitioner’s obligation to continue managing the affairs of the company until the liquidators are appointed. Although section 132(2)(a)(ii) of the Companies Act is very clear and unambiguous with regard to when the business rescue proceedings end, namely ‘when the court has converted the proceedings to liquidation proceedings’, the court somehow arrived at a conclusion that invalidates section 132(2)(a)(ii) and creates a continuing conflict between the Companies Act and the previous Act.

This is particularly so because a company cannot be both in business rescue and in liquidation at the same time. Although counsel for the business rescue practitioners brought section 132(a) to the attention of the court, the judgment seems to completely ignore this section wholly.

In analysing this judgment, we also need to bring section 131(6) of the Companies Act into sharp focus, which concerns an application for business rescue by a company that is in liquidation, which suspends the liquidation proceedings until, if that application is granted, the business rescue proceedings are ended. Suspension must mean only one thing, namely that the application of the provisions of the Insolvency Act 24 of 1936 is suspended for the duration of that company’s business rescue proceedings. To illustrate this point, let’s assume that a company’s final liquidation proceedings were suspended for six months whilst its business rescue was in progress, but thereafter its business rescue practitioner decides to convert the business rescue back into liquidation. If we apply the Montic judgment in this instance, all payments made during this company’s business rescue proceedings stand to be declared voidable dispositions, and similarly all contracts entered into during business rescue could also be declared void and unlawful. In other words, all the trading that occurred during the tenure of the company’s business rescue could be declared unlawful, as the trading offends the concept of the concursus creditorium that would have arisen when the liquidation application was made. Simply put, on the basis of the Montic judgment, everything done by a practitioner during the tenure of business rescue could be considered unlawful, in circumstances where liquidation proceedings precede business rescue proceedings that are subsequently converted back to liquidation proceedings.

Let us consider another scenario, where a creditor applies to the court to terminate business rescue proceedings and where the practitioner concerned legitimately believes the company is rescuable and thus validly opposes that application. Let’s assume further that this application is not heard in the urgent court roll and that while this litigation is in progress, a large customer of the company decides not to extend a large off-take agreement it had previously promised to extend, on the basis that the litigation poses a significant risk for this customer. The termination of the customer relationship forces the practitioner to withdraw his/her opposition to the liquidation application, which is finally decided after five months from the date of application.

In this case, the litigation itself becomes the poisoned chalice that inevitably results in the business rescue plan suddenly becoming unimplementable.

Once again, in this scenario the practitioner would have acted illegally for at least five months, as the commencement of the company’s liquidation proceedings is backdated to the date the application was made, in terms of section 348 of the previous Act. Section 132(2)(a)(ii), on the other hand, avoids this conundrum as liquidation will only commence after business rescue has ended, and not before.

It appears to me that the court in the Montic case decided to favour the provisions of the previous Act that clearly contradict sections 131 and 132 of the Companies Act out of a desire to preserve the concept of the concursus creditorium at all costs. This decision will have far-reaching consequences for business rescue as a whole, as practitioners will be discouraged from continuing the rescue of a company as soon as a liquidation application is lodged even in circumstances where the application is made frivolously, as there is no guarantee that such an application may not be granted. This would mean practitioners must not pay for security, insurance, and any other preservation costs, as doing so could be considered voidable dispositions. In addition, no attorney would agree to act for a practitioner to oppose a liquidation application to wind up a company that is in business rescue, as the practitioner will not be able to pay for the services rendered by the attorney in the event such an application succeeds. In my humble opinion, the decision in the Montic case needs to be appealed as there is a realistic possibility the court may have misapplied itself.

Without revisiting the decision in the Diener case (Ludwig Diener NO v Cloete Murray NO and Others), which was upheld by the Supreme Court, I am of the view that the decision to relegate the practitioner’s fees and costs below pre-commencement secured claims is similarly informed by this desire to favour the Insolvency Act principles over those created by the Companies Act, as in my view there is no reason why the lawmakers may not have wanted business rescue costs to be afforded the ‘super preference’ that is implicit in sections 135 and 143 of the Companies Act. The only reason liquidation costs are afforded the ‘super preference’ they have in liquidation is simply that the Insolvency Act says so, to ensure that liquidators are not placed at risk for doing the necessary work of winding up insolvent companies. There is no reason why the legislators may not have wanted to create the same certainty for those who undertake the risky occupation of business rescue. In the current environment where the Master of the High Court delays appointment of liquidators, sometimes by several months, why would business rescue practitioners continue to safeguard the insolvent estate if they stand a high risk of not being paid?

These decisions, the effect of which is to create uncertainty of payment of business rescue practitioners’ fees, are likely to have unintended consequences where a practitioner will always prioritise payment of his/her fees ahead of the continuation of trade. For example, if a practitioner is faced with a choice between paying for raw materials to ensure the continuation of production and paying his/her fees, the practitioner will be inclined to pay his/her fees even if paying for raw materials could conceivably result in a successful rescue of the company, as there is always a risk that a creditor could launch liquidation proceedings at any point during the rescue proceedings. Another example is where a creditor that has an unperfected general notarial bond considers providing post-commencement finance (PCF) to a company that is in business rescue, but on condition that the practitioner consents to the perfection of the general notarial bond that covers the creditor’s pre-commencement claim. In that scenario, the practitioner may well not pursue such PCF arrangement out of concern that the perfection will effectively secure a pre-commencement claim that will rank ahead of the practitioner’s fees and costs in the event the company is subsequently liquidated. His/her decision in this case will result in the practitioner prioritising his/her own interests against those of the company and other stakeholders. To avoid such scenarios, the practitioner’s fees need to be protected, the same way the liquidator’s fees are protected in liquidation.

Perhaps it is high time that the Department of Trade and Industry aligns the Insolvency Act with the Companies Act, as the courts will continue to favour the principles of the Insolvency Act whenever there is a conflict between these two pieces of legislation.

Author
Sipho Sono, Director, OPIS Advisory, is a turnaround and senior business rescue practitioner