The legal framework for business rescue was introduced to South African law with the promulgation of the Companies Act 71 of 2008 (the Companies Act) to ‘provide for the efficient rescue and recovery of financially distressed companies’ (s 7(k) of the Companies Act). This legislation borrowed aspects particularly from American (Chapter 11 of the United States Bankruptcy Code Bankruptcy Reform Act 11 USC 1978) and British (Enterprise Act 2002) legislation on the restructuring of distressed corporations with the result that South Africa (SA) now has a modern corporate restructuring regime that compares favourably to any of its kind in the world.
Considering the novel nature of the business rescue process in South African law, it is unsurprising that some aspects thereof are yet to be properly explained or tested in our courts. The precise role of an appointed business rescue practitioner is one such aspect, which remains relatively unexplained by our courts and relatively misunderstood by the lay businessperson. Often commentators, courts and people watching from the side-lines tend to forget or even completely overlook certain practical realities and legal provisions surrounding a business rescue with the result that they are unable to properly assess the performance and effectiveness of the business rescue practitioner. Accordingly, this article will attempt to shed light on the unique role that a business rescue practitioner is required to play in successfully guiding a company through the business rescue process, while also considering examples from recent case law, which illustrates how seemingly proficient observers can, and do, get it wrong.
Section 140(3)(b) of the Companies Act provides that the business rescue practitioner has the responsibilities, duties and liabilities of a director of the company during its business rescue proceedings. The Companies Act also provides that the business rescue practitioner has full management control of the company during business rescue proceedings in substitution for its board and pre-existing management (s 140(1)(a) of the Companies Act). Based on this, many conclude that the business rescue practitioner is essentially a temporary new managing director, and therefore, that a business rescue practitioner’s duties are substantially the same as that of a director. What is, however, often overlooked is that, in practice, managing a company under normal circumstances and managing a financially distressed company are entirely different beasts, so to speak. Furthermore, and perhaps more importantly, the business rescue practitioner owes their duties to a broader group of stakeholders, while a director owes their duties predominantly to the company and its shareholders.
Fiduciary duties are based on principles, such as trust, confidence, loyalty, good faith, and avoidance of conflicts of interest. Both a director and business rescue practitioner can be viewed as fiduciaries, but while it is clear that a director of a company is a fiduciary in respect of that company, it is not as clear to whom the business rescue practitioner is a fiduciary. The Companies Act aims to provide for the ‘efficient rescue and recovery of financially distressed companies, in a manner that balances the rights and interests of all relevant stakeholders’ (s 7(k) of the Companies Act) (my italics).
Therefore, the business rescue practitioner has the difficult task of acting in the interest of all stakeholders, for as far as possible. In practice, ‘as far as possible’ is the operative phrase. Various parties such as creditors, shareholders, employees and the broader community surrounding a company all have an interest in its business rescue proceedings and their interests do not always align. In fact, where a company is financially distressed, the interests of the creditors and shareholders will usually conflict and the nature of business rescue proceedings is that, invariably, certain stakeholders will be dissatisfied with the outcome.
A recent judgment handed down in the Gauteng Division of the High Court, Pretoria illustrates the precarious tightrope that a business rescue practitioner has to walk in having to remain independent, while simultaneously trying to serve the competing interests of the various stakeholders in a business. In Gupta v Knoop NO and Others (GP) (unreported case no 84095/2018, 13-12-2019) (Ledwaba DJP) the business rescue practitioners of certain companies owned and controlled by the Gupta family were removed from their posts. In the view of the court, the business rescue practitioners had failed to execute their duties with the highest level of good faith, objectivity and impartiality. This was so, according to the court, because the business rescue practitioners had failed to conclude the business rescue proceedings timeously and had continued to earn fees and commissions while selling off the assets of the companies without having a plan regarding how the business would operate once the creditors of the companies had been paid. The court also took issue with the fact that one of the business rescue practitioners had been the appointed business rescue practitioner of two related, but different, companies. Furthermore, the court criticised the business rescue practitioners for raising allegations of criminal unlawfulness against the companies’ directors despite not having reported their suspicions of such criminal activity to the relevant authorities at an earlier stage despite being required to do so by law.
I submit that the above judgment has not taken cognisance of the practicalities surrounding a business rescue, which make it very rare, if not impossible, for business rescue proceedings to be concluded within the three-month period prescribed by the Companies Act.
Further, the court raised the issue of conflict that a business rescue practitioner of two related companies may potentially find adversely impacts one’s ability to remain impartial and independent. There may certainly be circumstances in which being a business rescue practitioner of two related companies simultaneously may negatively affect the business rescue practitioner’s independence, but that is not so per se. In fact, it often makes commercial and practical sense to have the same business rescue practitioner appointed in related matters in order to ensure that interests are aligned. The notion of a ‘conflict of interest’ is often expressed by academics and the judiciary alike without considering the enormous cost duplication and impracticalities that multiple appointments bring about.
Most notably, however, the court appears to have been unaware that the successful rescue of a company – as provided for in s 128(1)(b)(iii) of the Companies Act – does not necessarily mean that the company is brought to a position where it is able to continue on a solvent basis, but that a successful rescue may also occur where creditors are provided with a better outcome than would have been the case with a liquidation. The court’s non-recognition of this second possible outcome of a successful business rescue appears to have resulted in it over-emphasising the business rescue practitioner’s duties towards the shareholders and board of a company at the expense of its creditors. The court’s presumption at para 32 that business rescue is ‘for the ultimate benefit of the … board and shareholders’ is telling in this regard.
Although the shareholders of the companies in this case may have been dissatisfied by the selling off of their companies’ assets, it is possible that such an approach was the only possible way for the companies’ creditors to be placed in a better position than would have been the case under a liquidation and that the continued trading of the companies on a solvent basis was never an attainable outcome.
One aspect where the court was correct was in questioning why the business rescue practitioners brought up allegations of criminal unlawfulness against the directors of the companies in their answering affidavits, but had failed to earlier report such suspicions to the relative authorities. This does constitute a failure by the business rescue practitioners to uphold their duties as provided in the Companies Act at s 141(2)(c)(ii) and probably constitutes a ground to have the business rescue practitioners removed.
It may be that the business rescue practitioners had not upheld their duties as officers of the court due to their failure to report their suspicions of criminal activity by the directors, but this case nonetheless illustrates how courts and laypersons alike have tended to forget that the business rescue process requires a delicate balancing of interests of all stakeholders. While it seems easy to cast judgment on the handling of a certain business rescue, particularly when called on by a partial stakeholder to do so, one may fail to recognise that the dissatisfaction of a particular stakeholder, who may even be acting in good faith, does not necessarily mean that the business rescue practitioner has failed at their task.
LM Jacobs (‘Die Vertrouensverpligtinge van Ondernemingsreddingspraktisyns: ’n Regsvergelykende Studie’ (LLD thesis, University of the Free State 2015) at 260) suggests that the business rescue practitioner’s fiduciary duties are owed to the following parties, with the following order of preference –
- shareholders; and
- the broader community.
Although the above list may be a good starting point, in practice it is not always that simple. In different cases, these different groups may need more or less protection depending on the circumstances. Accordingly, a business rescue practitioner’s fiduciary duties may oscillate depending on which stakeholders in the business require protection in a particular case.
An analogous example may be found in the UK’s Companies Act 2006 in s 172, where the primary duty of the directors of a solvent company is to act in the interest of its members. However, if a company is clearly insolvent, its directors are duty bound to act primarily in the creditors’ interests (West Mercia Safetywear Ltd (In Liquidation) v Dodd (1988) 4 BCC 30, CA). In between the extremes of a clearly solvent company and a clearly insolvent company, there remains a large grey area and it is difficult to know precisely at which point a director’s duty shifts towards creditors as a whole.
The fact that a director has to look after the interests of creditors ‘as a whole’ is important, as depending on the circumstances, a company may be factually solvent, but still unable to meet its short-term liabilities. In such a case, where a company faces immediate concerns over liquidity and cash flow, it will be necessary for the director to act immediately and offer a restructuring proposal to short-term creditors in terms of which those creditors may have to compromise some of their debts. The directors’ duty to creditors ‘as a whole’ may thus force them to require that some creditors suffer larger losses than others so that the business remains a going concern that can service its debts to some extent. Similarly, circumstances may force a business rescue plan to require that some stakeholders suffer greater losses than others to advance the interests of stakeholders in the company ‘as a whole’.
What is certain, is that the most successful business rescues have occurred in cases where the business rescue practitioner has managed to get the four groups of stakeholders mentioned above to work for one common purpose in everyone’s shared interest, to save the business, even if some groups may suffer greater losses than others. Where creditors are not interested in saving a business and cannot be convinced otherwise, the business rescue process is doomed and the task of the business rescue practitioner becomes almost impossible. However, if the business rescue practitioner and the management of a business develop a strong professional working relationship and develop a level of trust between themselves and creditors, it becomes more likely that a successful outcome may be reached.
Ricky Klopper LLB (UCT) BCom (Actuarial Science) (Stell) is a candidate legal practitioner at Hans Klopper Inc in Stellenbosch.
This article was first published in De Rebus in 2020 (July) DR 10.