What is business rescue and when should you use it?

A company that cannot pay its creditors has essentially two statutory routes. One tries to save it. The other winds it up and distributes what is left.

Business rescue is the first of those, and it is misunderstood in both directions: treated as a magic pause button by companies that are already beyond saving, and dismissed as hopeless by companies that could have used it if they had acted six months earlier.

What it is

Business rescue is governed by Chapter 6 of the Companies Act 71 of 2008. It provides for proceedings to facilitate the rehabilitation of a company that is financially distressed, by placing it under temporary supervision, imposing a temporary moratorium on the rights of claimants against it, and developing and implementing a plan to restructure its affairs.

"Financially distressed" has a defined meaning. Broadly, it means that it appears reasonably unlikely that the company will be able to pay all of its debts as they fall due within the next six months, or that it appears reasonably likely that the company will become insolvent within the next six months.

Note that this is a forward-looking test. A company does not have to be insolvent already. It has to be heading there, and the whole design of the chapter assumes it is entered before the position becomes hopeless.

The reasonable prospect test

The gateway requirement is that there must be a reasonable prospect of rescuing the company, and the Act defines rescue in two alternative ways:

• returning the company to solvency, or
• if that is not possible, resulting in a better return for creditors or shareholders than would result from immediate liquidation

That second limb is often forgotten and it matters. A company that cannot be saved as a going concern may still be a proper candidate if an orderly, supervised wind-down under a rescue plan will produce more for creditors than a forced liquidation sale.

What the test does not permit is rescue as delay. A reasonable prospect must be founded on facts and a plan, not on hope that something will turn up, and courts set aside resolutions and refuse applications where the prospect is speculative.

The moratorium

The immediate practical effect, and the reason most companies enter the process when they do, is the moratorium.

During business rescue, no legal proceeding, including enforcement action, may be commenced or continued against the company or in relation to its property, except with the written consent of the practitioner or the leave of the court. Attachments stop. Summonses cannot be issued. A creditor halfway through execution is halted.

That breathing space is what makes restructuring possible. It is also what attracts companies with no prospect of rescue at all, which is why the courts scrutinise resolutions that appear to have been passed on the eve of a sale in execution.

Getting into it

By resolution. The board may resolve that the company voluntarily begin business rescue, if it has reasonable grounds to believe the company is financially distressed and there appears to be a reasonable prospect of rescuing it. The resolution must be filed, and a practitioner appointed. This is the faster and cheaper route.

By court order. An affected person, meaning a shareholder, creditor, registered trade union or employee, may apply to court for an order placing the company under supervision. This route is used where the board will not act, and it can be brought even while a liquidation application is pending, in which case the liquidation proceedings are suspended.

The practitioner

A business rescue practitioner takes over the management of the company, with full management control in substitution for the board. Directors remain in office and must cooperate, but they no longer run the business.

The practitioner investigates, consults creditors and employees, and prepares a business rescue plan setting out the proposed restructuring: what will be done with the assets, how creditors will be treated, what happens to contracts and to employees, and what the expected outcome is compared to liquidation.

The plan is voted on by creditors. If it is adopted, it binds the company and all creditors, including those who voted against it. If it is rejected, the practitioner may take steps to have it revised or the company moves toward liquidation.

What it means for employees

This is one of the sharpest differences from liquidation and it is worth stating plainly.

Employment contracts continue on the same terms, unless changed by agreement in the ordinary course or as part of the plan. Employees are not automatically dismissed as they would be on liquidation.

Wages become preferent. Remuneration and benefits that become due after the start of business rescue rank ahead of most other claims.

Retrenchment is still possible, but only in accordance with the ordinary process, which means a fair reason and a section 189 consultation. The rescue does not suspend labour law. Our guide on rights during a retrenchment consultation sets out that process, and our retrenchment package calculator works out what a lawful retrenchment costs.

Employees are affected persons, so they and their union are entitled to participate, to be consulted, and to vote on the plan.

When it is the wrong answer

Business rescue is not free and it is not quick. There is a practitioner to pay, professional advisers, and a process that occupies management attention at exactly the moment the business needs it elsewhere.

It is the wrong answer where:

• the company has no reasonable prospect on either limb, in which case liquidation is the honest route
• the problem is one large disputed claim rather than general distress, where defending the claim is cheaper
• the business has no viable core once the distressed element is removed
• it is being used purely to defeat a single creditor, which courts see through

It is the right answer where there is a genuine business underneath the debt: profitable operations dragged down by a bad contract, a failed expansion, a single customer's insolvency, or a funding gap that a restructuring can bridge.

Directors cannot simply wait

The most common failure in this area is delay, and delay is not a neutral choice for a director.

The Companies Act imposes duties on directors, and trading a company recklessly or while insolvent carries personal exposure. A board that watches a company slide into deeper insolvency, incurring debt it knows cannot be paid, is accumulating risk for itself as well as for creditors, and that exposure does not disappear when the company is eventually wound up.

The Act also requires that where a company is financially distressed and the board decides not to begin business rescue, it must deliver a notice to affected persons setting out the criteria that are met and the reasons for not adopting the process. That notice requirement exists precisely because silent deterioration is the thing the chapter was written to interrupt.

What it means for creditors

If you are owed money by a company that enters business rescue, three things change at once.

You cannot enforce. Whatever stage your claim had reached, it stops. Judgments cannot be executed and new proceedings cannot be issued without consent or leave.

You have a vote. Creditors vote on the business rescue plan, weighted by the value of their claims, and an adopted plan binds creditors who voted against it. That makes the vote the moment at which your position is actually decided, and it is worth reading the plan properly rather than treating it as a formality.

Post-commencement finance ranks ahead of you. Money lent to the company after rescue begins, to keep it trading, has preference over pre-existing unsecured claims. That is deliberate, because without it nobody would fund a company in rescue, but it means an ordinary trade creditor can find itself further back than it expected.

Secured creditors retain their security, and the plan has to deal with them on a basis they will accept or it will not be adopted.

The practical advice for a creditor is to engage rather than disengage. Creditors who ignore the process are bound by a plan they did not read, and by then the alternative, liquidation, is usually worse for them too.

Worked example

This example is illustrative. A manufacturing company loses its largest customer, which accounted for 40% of turnover. It has R6 million in creditors, R2 million in stock and equipment, a workforce of 34, and two smaller customers whose orders are profitable but not sufficient to cover the current cost base.

If the board does nothing, creditors begin issuing summons within months, an attachment follows, and the business is liquidated in a forced sale where the equipment realises a fraction of its value and the 34 employees are dismissed with claims against an insolvent estate.

If the board acts while the smaller customers are still there, business rescue is a genuine candidate. There is a viable core: two profitable customers and the capacity to serve them. A plan might restructure the debt, reduce the cost base through a properly conducted retrenchment, and return the company to solvency on a smaller footing. Even if it cannot, an orderly disposal under a plan is likely to realise more than a liquidation auction, which satisfies the second limb of the test.

The difference between those two outcomes is months. By the time the sheriff arrives, the reasonable prospect the Act requires has usually evaporated, and the resolution passed that week is the one a court is most likely to set aside.