By Innocentia Moele, Senior Associate, Business Restructuring & Insolvency and Charlene Ferns, Associate, Dispute Resolution at CMS South Africa.
Business rescue, introduced through the Companies Act 71 of 2008 and implemented on 1 May 2011, has become a critical mechanism for struggling businesses in South Africa. As an alternative to liquidation, it provides financially distressed companies with a systematic opportunity to recover, restructure operations, and settle debts while staying in business.
This process not only enhances their chances of business survival but also protects jobs and sustains key business relationships, making it an essential tool in an economy facing ongoing financial challenges.
The role of the creditor
Once a company enters business rescue, a legal moratorium is placed on legal proceedings so creditors cannot immediately enforce claims or take legal action, while balancing the rights of “affected persons” – employees, shareholders, creditors, and registered trade unions.
This relief gives the company time to appoint a business rescue practitioner (BRP) to reorganise and develop a workable recovery plan.
Business rescue is intended to offer creditors better returns than liquidation. Instead of assets being sold on a “fire sale”, the company has the opportunity to stabilise and strengthen over time.
The two main role players in business rescue are creditors and the BRP. Creditors, based on their voting interests, have the right to vote for, or against, a business rescue plan. The BRP must act in the best interest of all stakeholders, including creditors and the company in business rescue.
There are two types of creditors in this process: pre-commencement creditors, whose claims arose before the commencement of the business rescue proceedings, and post-commencement creditors/financiers (PCFs) whose claims arise afterwards. These creditors provide goods, services, or financing to the company during the rescue process, playing a crucial role in helping distressed businesses stay afloat.
The law
Chapter 6 of the Companies Act provides for the efficient rescue and recovery of distressed companies, in a manner that balances the rights and interests of the relevant stakeholders.
A recent Supreme Court of Appeal (SCA) judgment, handed down on 29 January, has now brought certainty to the debate on the interpretation of section 152(2) of the Companies Act, which outlines that a majority vote is required to pass a business rescue plan.
Background
On 23 August 2023, Wescoal Mining (now Salungano) initiated business rescue proceedings against Arnot Opco, a joint venture between Wescoal and Arnot. Additional creditors involved included Mashwayi Projects, a construction materials wholesaler, and Ndalamo Coal, a mid-tier coal producer.
The business rescue process included several options for the company’s future, such as selling the business or investing more capital. The creditors were asked to vote on the plan, and a vote was taken electronically.
Initially, the votes seemed to support the plan, but a forensic accountant found several issues with how the votes were counted, including double counting, missed votes, and late proxies, deciding that the 75% threshold needed to approve the plan had not been met. This led to a dispute over whether the plan was validly adopted.
Mashwayi Projects, a post-commencement financier, argued they should be allowed to vote and that excluding them violated the Companies Act and the Constitution.
The High Court sided with Wescoal, Salungano, and Ndalamo, ruling that the plan was validly adopted. The court found voting rights were only due to pre-commencement creditors. Since Mashwayi Projects was a PCF, its vote should not have counted. If its vote had been excluded, the required 75% threshold would have been met.
The ruling would have a significant impact on how business rescue proceedings will be handled in the future.
SCA decides
Mashwayi Projects, Arnot Opco, and the BRP appealed to the SCA, arguing that PCFs should also be allowed to vote on business rescue plans and that preventing these creditors from voting would discourage companies from providing such financing, which is often crucial for the success of business rescue.
Wescoal, Salungano, and Ndalamo maintained creditors who join after proceedings have started do not qualify for a vote and allowing them to would unfairly limit the claims of pre-commencement creditors, amounting to a violation of property rights.
The SCA disagreed with the High Court’s ruling and found that PCFs are entitled to vote. The court stressed that the Companies Act does not define “creditor” in a way that excludes post-commencement creditors and that the law does not impose different rights on them.
The court also rejected the argument that business rescue should be treated like liquidation, where different categories of creditors have different rights. Business rescue, unlike liquidation, aims to help a company recover while balancing the interests of all stakeholders. Excluding post-commencement creditors from voting would contradict this purpose.
Final outcome
The SCA ultimately ruled that post-commencement creditors have the same voting rights as pre-commencement creditors. This decision means that the business rescue plan for Arnot was not validly adopted, as the 75% threshold was not met.
The ruling has broader implications for business rescue in South Africa, ensuring that all creditors who play a role in keeping a distressed company afloat have a say in its future.
Innocentia Moele is a Senior Associate, at CMS South Africa
Charlene Ferns is an Associate, Dispute Resolution, CMS South Africa
