Financial distress: your obligation to inform the public

In the last few years, many business owners have had to make difficult decisions to restructure their business in order to survive the economic recession. Family businesses were sold, assets made to money and unfortunate events even led to liquidation of businesses. Owners, understandably, often don’t keep perspective of their financial struggles and will do anything to salvage the business without taking formal steps or letting anyone know of its dire financial position. The following questions thus arise: At what point must you take formal steps to notify persons about your financial situation? Who needs to know? How much do they need to know?

The Companies Act has provided companies (and closed corporations) the opportunity to save their business and avoid liquidation by implementing business rescue proceedings. These are proceedings aimed at facilitating the rehabilitation of a company that is in financial distress. In other words, where a company appears to be in a position that it is reasonably unlikely that it will be able to repay its debts as they become due and payable within the next six months or it is reasonably likely that the company will become insolvent within the next six months, the company is a likely candidate for undertaking business rescue proceedings.

Although the business rescue procedure is a positive procedure aimed at resolving disputes between businesses, the negative connotation attached to a company being under business rescue, has the effect that many companies would do anything to avoid it. Sometimes a company’s refusal to consider business rescue proceedings, however leads to a situation where the company is in too much financial trouble for it to be rescued, and a sometimes preventable situation of liquidation then becomes reality.

The Companies Act accordingly makes provision for exactly such situations. The Act determines that if the company has reasonable grounds to believe that it is financially distressed and there appears to be a reasonable prospect of rescuing the company, it must consider business rescue proceedings, and if it for any reason whatsoever it decides not to commence with business rescue proceedings, it must inform all affected parties (shareholders, employees and creditors) that the company is financially distressed and provide reasons for its decision. If the directors of a company do not consider business rescue proceedings or do not inform all necessary parties of the company’s decision not to commence such proceedings, it may be determined that the directors operated the company in a reckless and negligent manner and the directors could be held personally liable.

It is therefore important that the directors of a company take the required steps in order to ensure that their actions are not deemed to be reckless and negligent. The following steps can be used as a guideline:

Step 1 – Keep track of your financial obligations and cash flow

A company is financially distressed if it is likely that it will not be able to pay its creditors on its due date within the following 6 months or it is likely that the company will become insolvent within the next six months. Although a company may believe that it is currently not under financial pressure, if there are reasonable grounds to believe that the company won’t be able to pay all its debts within the following 6 months or the company will become insolvent within the next six months, the company must consider business rescue. A company must therefore at all times keep track of its financial position in order to be in the best possible position to make a prediction as to the payment of its debts in order to prevent directors’ liability.

Step 2 – Consider business rescue

Business rescue is a positive procedure aimed at assisting parties to reach an agreement on the repayment of a company’s debts, which could benefit all affected parties. Business rescue should therefore be considered with an open mind and should the company wish not to commence business rescue, it must be able to provide a reasonable explanation for its decision. It is suggested that a company discuss the procedure with an expert in the area, to make an informed decision on whether or not to commence with business rescue and support its decision with reasons.

Step 3 – Inform affected persons

Should a financially distressed company not commence business rescue proceedings, the board of the company must notify all affected persons within five days of considering the matter. The company must complete the official form provided by the CIPC and attach a statement confirming the relevant criteria of the company’s financial distress, as well as reasonable reasons for not commencing business rescue. The reasons for its decision should confirm that its decision is to the benefit of all affected persons. These documents must be sent to all affected persons, which include the shareholders, employees and creditors of the company.

The intent of business rescue proceedings is not merely to afford a company respite from action by creditors, but to provide a beneficial solution for all parties that have an interest in the future success of the business. Following the above steps might just be the way to rescue your business and protect your interests in that which you have built up.

November 22, 2013
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