Navigating Financial Distress: Alternatives to Liquidation for Struggling Businesses

The coronavirus (COVID-19) pandemic has contributed to the current dire financial consequences experienced by many businesses in South Africa and the globe. 

For example, the COVID-19 restrictions meant that most small businesses could not fully operate; hence, this affected the cash flow and income of these businesses.  

As a result, due to these challenging economic periods, many companies have opted for liquidation

Nevertheless, it must be noted there are different rehabilitation mechanisms that financially distressed companies can consider instead of liquidation.

Below are some of the different rescue options available under South African law for financially distressed companies:

1. Business rescue: 

This business rehabilitation process was introduced in South African through the enactment of the new Companies Act, 71 of 2008 (the Companies Act). 

Financially distressed companies in South Africa can use this support structure to revive their financial outlook and avoid liquidation. 

Business rescue gives the distressed company leverage by using a court order imposing a moratorium on the company from its contractual obligations for a specific period. Usually, this is done to allow the financially distressed company to turn around its debt affairs and be able to get back to business. 

To strengthen and fast-track this process, a business rescue practitioner is appointed to turn around the business, working closely with the company’s directors and the management team. 

 2. Compromise

Compromise is another option that a financially distressed company can pursue for rehabilitation purposes. The provisions made in Section 155 of the Companies Act relate to formal and procedural requirements. 

For instance, Section 155  sets out the procedure and requirements a business has to follow to qualify for a compromise, and how to get access to creditors of a debtor company.

Therefore,  once the requisite majority vote, which is 75%, has been obtained at a meeting convened for this purpose, there is little left for a disgruntled creditor to do. 

Generally, compromise can be a quick fix and an easy way to acquire immediate financial relief for a portion of its debt.  Conversely, if the creditors vote for the compromise process, they would negatively affect their claims against the financially distressed company. 

According to Rhoodie and Bester (2017), a compromise is more beneficial than a business rescue because it creates provisions for a creditor to retain its rights to go against the surety of the distressed company.  

So, the outcome of a compromise is not far from that of a business rescue. For example, during these two proceedings, creditors are given powers to vote for the turnaround plans.

One of the major shortcomings of a compromise is that when the turnaround plan is not yielding the expected results, directors can be held liable.

3. Out-of-court restructuring

Another alternative mechanism that a financially struggling company can opt for is a process called “out-of-court restructuring” or “work-out” process. 

This is a non-judicial process through which a financially distressed business and its significant creditors reach an agreement for adjusting the obligations of the business. 

Out-of-court debt restructuring compromises the restructuring of a financially distressed company’s assets and liabilities. These could include flattening the company’s structure or selling some of the company’s assets and subsidiaries. 

Although rarely used; out-of-court restructuring plays a vital part in the insolvency system. For example, out-of-court restructuring is similar to formal business rescue but without the involvement of the courts and a business rescue practitioner. 

Out-of-court restructuring aims to protect the interests of all the respective stakeholders in the company (Antonoff, 2013).

What makes an informal restructuring more attractive is the fact that the financially distressed company works closely with its creditors through negotiations to restore the company’s financial status. 

Therefore, the process of informal restructuring seems to be more successful than the legislated business rescue. 

Unlike business rescue, the out-of-court restructuring is confidential; hence, the integrity of the company will not likely be compromised.

Although out-of-court restructuring is cheap and quicker than the legislated business rescue, it is still a rarely considered business rehabilitation process. 

The reason affected financially distressed companies choose the business rescue plan is because it is legislated; hence,  gives the stakeholders comfort and trust in the qualified business rescue practitioner.

4. Standstill agreements

Furthermore, financially distressed companies may also enter into standstill agreements with their creditors to fulfill their obligations for a short period. The purpose of this process is for the company not to breach its agreements.

Normally, a debt standstill agreement  includes the following provisions: 

  1. The period of the standstill;
  2. Whether the standstill was for the payment of the capital owed amount or the interest;
  3. Appointment of a practitioner to turn around the affairs of the company on the verge of business rescue;
  4. The clauses that allow the lender to cancel the agreement and call on their debt. 

In essence, standstill agreements are only between the parties that entered into it. Subsequently, other third parties could still apply to place the company under business rescue or liquidation.

Conclusion

In conclusion, it is not all doom and gloom if a juristic person finds themselves in financial distress. With that said, there are many options that one should consider before closing the doors.