Corporate Renewal Solutions Blog

View of and news about the topics and industries of corporate renewal, business transformation, turnaround and business rescue in South Africa.

Thursday, August 31, 2006

New debtor-friendly business rescue legislation for South Africa

South Africa's business rescue legislation is relatively antiquated compared to progressive overseas countries. 

Government has decided to take action, and after a number of past initiatives (see history of business rescue legislation reform in South Africa), new business rescue legislation will now be contained in Chapter 6 of the new Companies Act.

It is understood that in October 2005 a creditor-friendly proposal was made by Professor David Burdette based on the UNCITRAL Legislative Guide and aligned with SA insolvency legislation.

In June 2006 draft new business rescue legislation was distributed for comment to selected parties.

This latest version by new authors is reportedly a debtor-friendly "mix of judicial management, Chapter 11 and other".

Questions have been raised about its compatibility with SA insolvency legislation and Uncitral guidelines.

Nevertheless, the main features are understood to be:

  • Debtor-friendly (similar to Chapter 11) with regard to:
    • Who appoints the supervisor in charge of business rescue.
    • The board and directors continue to perform and exercise their functions and powers.
    • Committee of employees, or of creditors may consult with the supervisor in charge of business rescue about any matter relating to the business rescue proceedings, but may not direct or instruct the supervisor.
  • Requiring a majority vote of both shareholders and independent creditors.
  • A moratorium on the rights of claimants and legal proceedings against the company.
  • Post-commencement finance ranking highest.
  • No time limit on the duration of business rescue as long as it is working.
  • Opening the door for pre-packaged business rescue.

Proposed new business rescue legislation will be published and analysed here as soon as it has been officially released.  For initial comments on new business rescue legislation, read Werksmans' "Turnaround".

Is debtor-friendly business rescue legislation flawed?

The switch from previous creditor-friendly approaches to a debtor-friendly business rescue approach represents a significant reversal with more positive implications for distressed companies at the expense of creditors.

Gary Moore, an attorney practising in the commercial department of a large Johannesburg law firm, warns against slavishly following the debtor-friendly approach of Chapter 11 in the USA, in an 16 May 2006 article in the Free Market Foundation.

The government is seriously considering a revision of company-insolvency law that will take account of the USA’s Chapter 11 procedure and allow a company to seek protection from its creditors, avoid paying all its debts, and resume business.  This could introduce a flawed system, with perverse effects of coddling sick companies, encouraging inefficient managers to avoid restructuring, allowing unproductive firms to undermine their healthy competitors, thereby promoting unfair competition, and weakening entire sectors. 

The trade-and-industry department (DTI) has issued a policy document which deals with the reform of company law (South African Company Law for the 21st Century: Guidelines for Corporate Law Reform), which says that the department has decided to revise company law to bring it into line with international trends and to accommodate the changing business environment.  The paper sets out the approach that the government intends taking.

On the one hand, the document recognises that corporate businesses are central to the country’s prosperity.  The document says that a key role for government is to ensure that its regulatory framework promotes growth, employment, stability, good governance, confidence and competitiveness.  Regulation should not create unnecessary artificial preferences and distortions.  Company law should promote investment in markets and companies, and the efficiency of companies and managers.  Over a century ago, case law ruled that directors must act in the long term interests of the shareholders: Shareholders invested their capital in the company so are entitled to its profits after claims are satisfied; as residual claimants are best positioned to police the efficiency of the company. 

But on the other hand, the policy document also says that regulatory policy should promote equity, in light of the government’s view that there is a second, marginalised, economy, populated by those unemployed in the formal economy, which risks falling further behind if there is no decisive government intervention. There will be a review of company law that will have regard to the interests, not only of shareholders, but also of creditors, employees and other participants and interests such as the state, consumers and suppliers, and incorporating the view that there is a growing need for more social responsiveness by enterprises.

Since at least the 1932 US law-professor’s article about whom corporate managers are trustees for, says the document, the approach of running companies mainly to benefit its shareholders has been questioned.  In the late 1980s when the debate about corporate governance commenced, concerns about other stakeholders revived, and there is now much opinion that corporate governance is about balancing economic with social goals, so that companies should be controlled to benefit shareholders, employees, suppliers, lenders, customers and society at large, and be run in partnership with them.

The document proposes that shareholders’ interests should be balanced with others’ because a company is a social institution whose economic pursuits should be constrained by social imperatives.

Regarding a company’s insolvency, the document says that the winding-up of companies concerns not only creditors, but a multiplicity of interests, including shareholders’ and employees’, as well as the public’s in their proper administration.   The DTI envisages the introduction of a proposed new Insolvency and Business Rescue Bill, and notes that in practice the current system of judicial management is rarely used, even more rarely leads to a successful conclusion, and allows a protective moratorium only where there is a reasonable opportunity that, if the debtor company is placed under judicial management, it will be able to pay all its debts.

In contrast, new business-rescue systems have been introduced in the past decade in Canada, Australia and other countries which, say commentators, recognise a well-nigh-universal reality of creditors being prepared for their own benefit to forgive part of the debt, and that it is frequently the case that a creditor will benefit far more from having the debtor back in the market place than from suing it to extinction.  Furthermore, the agreed plan by which the future relations between the debtor company and its creditors will be governed may well include the reduction of the company’s overall indebtedness.  These commentators recommend that new rescue provisions should allow a specified majority of creditors to approve a plan under which the debtor may emerge from protection and resume normal commercial dealings.  The DTI says that this recommendation and the USA’s Chapter 11 provisions will be taken into account in the law review process.

In carrying out the review, the government would be well advised to consider the extent to which the US Chapter 11 bankruptcy-protection measure is a flawed system.  It has the perverse effects of coddling indebted companies, encouraging incumbent managers to avoid restructuring, indirectly allows bankrupt firms to undermine their healthy competitors, and in effect promotes unfair competition, thus depressing entire industries, as in the case of the US airline industry.?

Useful links for business rescue in South Africa

This turnaround news flash was brought to you by Turnaround Solutions - turnaround management consulting firm rescuing distressed companies and improving results of underperforming companies in South Africa.