College of Law and Management Studies

The COVID-19 virus has ruthlessly battered the world’s economy and its citizens’ health. The timing of the virus infection and the subsequent lockdown could not have been worse for South Africa. Our economy, already grappling with low GDP growth and high levels of unemployment, suffered the simultaneous downgrading of credit ratings by Fitch and Moody’s. The combined impact of the COVID-19 lockdown and the rating agencies’ downgrades will cause many businesses in our economy to spiral into financial distress and shed thousands of jobs. Companies experience financial distress when they are unable to meet creditor payments thereby increasing the possibility of insolvency.

Financial distress

When a company experiences financial distress, it can either be liquidated, undertake an informal turnaround or file for a legislated business rescue. The preferred route for a financially distressed company is to prevent a forced liquidation due to the detrimental impact that business closures and job losses have on our communities. Many companies that experience financial distress will consider the feasibility of business rescue as a means for a financial rehabilitation.

Business rescue

South African business rescue legislation was introduced in 2011. Business rescue is a mechanism which allows financially distressed companies a moratorium on payment of claims by its creditors. The provision of this moratorium provides temporary relief to the distressed company. Distressed companies make changes to their ownership, management or operations during the moratorium, thereby facilitating the company’s rehabilitation and continued survival. In this manner, a company that successfully implements the business rescue will be able to avoid the negative impacts of closure, save some or all of its jobs and continue in operation.

Concerns around business rescue

Since the adoption of business rescue legislation, there have been many questions around the success rate and effectiveness of business rescue. Due to the low success rate of business rescue in South Africa, there are doubts as to whether business rescue provides a remedy for a distressed company. There are concerns that business rescue is another costly addition to the inevitable liquidation of financially distressed businesses. In fact, some researchers have interpreted business rescue legislation as a lengthy and expensive liquidation.
However, it is worth nothing that there are several examples of successful business rescues in South Africa. These cases have demonstrated that if the legislation is properly implemented and managed, the potential for an improved success rate does exist.

Improving the chances of a successful business rescue

How can the chances of success be improved? Firstly, business stakeholders should gain an understanding of our business rescue legislation and circumstances when it should be implemented. Not all companies that experience financial distress are suitable for the business rescue mechanism. Business rescue is not a substitute for the liquidation procedure. Companies that cannot be financially rehabilitated should apply to be liquidated rather than file for a business rescue.

Secondly, management of financially distressed companies should consult extensively about utilising the business rescue legislation to rehabilitate financially distressed companies. Consultations should include shareholders, employees, trade unions, bankers, creditors and possible funders. Many stakeholders prefer an active and supportive role during the business rescue application process rather than being informed at a late stage about management’s decision to enter into business rescue.
Research indicates that the earlier a financially distressed business enters into business rescue, the better the chances of the rescue being successful. Management should therefore pay close attention to detecting financial distress in the business as early as possible. This can be achieved by considering early warnings of financial distress such as such as liquidity problems, carefully analysing financial ratios that may indicate financial distress and undertaking scenario planning for the business. The early detection of financial distress will facilitate an earlier application for business rescue, thereby improving the chances of a successful rescue.

In the event that management decides to apply for business rescue, an effort must be made to communicate details of the filing to all stakeholders as soon as possible. Due to tight deadlines that exist when a company is in business rescue, important decisions and planning must be undertaken prior to the application for the business rescue. For example, the chances of success will be immensely improved if the company being rescued arranges for post commencement funding as early as possible. One of the major reasons for failed business rescues is the lack of funding for the business rescue.
Finally, the skills of the person appointed as a business rescue practitioner is vital to the success of a business rescue. Business rescue legislation specifies that the practitioner should possess a legal, business or accounting qualification. Research indicates that it is also important for the practitioner to possess mediation, conflict resolution, restructuring and decision making skills.

Conclusion

In summary, business rescue legislation can most certainly be utilised to minimise the negative impact of COVID-19. The financial rehabilitation or economic rebirth of distressed companies in our current recessionary environment will result in the saving of jobs, a more resilient business sector and, ultimately, a stronger democracy. However, a thorough understanding of the legislation and careful planning and implementation of a business rescue is vital for the legislation to serve as an economic remedy.

Credit: Article was originally published in the Mercury Newspaper on 08 April 2020

Professor Raj Rajaram

Professor Raj Rajaram

Professor Raj Rajaram is an academic at the University of KwaZulu-Natal’s School of Accounting, Economics and Finance. He is a Chartered Accountant with a PhD focusing on Business Rescue.

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