To be or not to be December 2017

By ZOLANI BUBA, Published in Company Law

"To be or not to be": the Pretoria High Court issued a declarator on the phrases "post-commencement financing" and the "costs of the business rescue proceedings" in s135 of the Companies Act, 2008.


This article briefly explores the practical implications of the declarator recently granted by the Pretoria High Court.

Post-commencement finance is critical for any business hoping to achieve a semblance of what may be considered a successful outcome in business rescue. Whether the rescue intervention envisages a return to solvency, sale of business or a window, post-commencement finance often determines the extent to which expected outcomes are capable of being achieved (Companies Act, 2008, s128(1)(b)). Much has been written on post-commencement financing and its impact achieving the purposes set out in business rescue.

In terms of the post-commencement finance provision found in s135 of the Companies Act, the ranking in which claims against the company are to be paid are as follows:

"135. Post-commencement finance
(1) To the extent that any remuneration, reimbursement for expenses or other amount of money relating to employment becomes due and payable by a company to an employee during the company's business rescue proceedings, but is not paid to the employee –

(a) the money is regarded to be post-commencement financing; and

(b) will be paid in the order of preference set out in subsection (3) (a).

(2) During its business rescue proceedings, the company may obtain financing other than as contemplated in subsection (1), and any such financing –

  1. (a) may be secured to the lender by utilising any asset of the company to the extent that it is not otherwise encumbered; and
  2. (b) will be paid in the order of preference set out in subsection (3) (b).

(3) After payment of the practitioner's remuneration and expenses referred to in section 143, and other claims arising out of the costs of the business rescue proceedings, all claims contemplated –

(a) in subsection (1) will be treated equally, but will have preference over –

(i) all claims contemplated in subsection (2), irrespective of whether or not they are secured; and

(ii) all unsecured claims against the company; or
(b) in subsection (2) will have preference in the order in which they were incurred over all unsecured claims against the company.

(4) If business rescue proceedings are superseded by a liquidation order, the preference conferred in terms of this section will remain in force, except to the extent of any claims arising out of the costs of liquidation" (own emphasis).

In both Merchant West Working Capital Solutions (Pty) Ltd v Advanced Technologies and Engineering Company (Pty) Ltd and others, Case no. 18486/2013 of 10 May 2013 and Redpath Mining South Africa (Pty) Ltd v Piers Marsden NO and others (North Gauteng High Court), Case No. 18486/2013 of 14 June 2014, the courts expounded on s135, and the judgments have sub-sequently been considered elsewhere. In South African Property Owners Association v Minister of Trade and Industry and Others (66068/2016) [2016] ZAGPPHC 1148 (29 November 2016), a declaratory order was issued on the content of certain phrases in s135. The South African Property Owners Association sought a declaratory order that rental and services used by a company under business rescue fell within the ambit of the phrase "post-commencement financing", alternatively that the liabilities fell within the phrase "claims arising out of the costs of the business rescue proceedings".

The court opined that the reference to "financing" in ss2 refers specifically to finance obtained from an institution, and the court seemed to narrow the scope of the term to a cash injection. Apart from the exception of employees, this excludes general contractual obligations not of a financial nature, which exist during proceedings. Having given content to "financing", the court held that costs relating to a lease agreement are incidental to such an agreement and, therefore, cannot not be accepted as falling within the ambit of the phrase "claims arising out of the costs of the business rescue proceedings".In the view of the court, a contrary view would have the effect of granting a lessor a preference over other creditors and negate the intended purpose of business rescue. The court stated:

"Furthermore, the liability of such costs arises out of the relevant lease agreement, despite being continually incurred, even after commencement of the business proceedings. To hold that such costs constitute post-commencement financing would elevate an obligation prior to commencement of business rescue proceedings to a preference over other creditors not provided for or contemplated by the provisions of section 135 of the Act."

The practitioner's power to suspend and cancel certain obligations was viewed by the court as further support for its conclusion. No strong emphasis seems to have been placed on the distinction between liabilities preceding business rescue and those which become due and payable after commencement; the court observed that the contract of lease resulted in a liability being "continually incurred". It seems that the court's attention was squarely on the existence of a contractual agreement whose existence had preceded commencement of business rescue, rather than on an analysis of the liability itself (that is whether or not a liability which became due and payable after commencement resulted in a change in the latter's categorisation). It is my view that the latter enquiry is particularly pertinent within the context of a procedure underpinned by an objective which seeks to resolve financial distress by inter alia permitting a "haircut" in relation to one category of claim while leaving another completely intact. This objective is clearly articulated in s7(k) and in the definition of "business rescue" in s128(1)(b).

Due to the succinct manner in which the judgement is written, it is not clear whether the legal consequences would have been different where a practitioner, upon appointment, sought leave from the court to cancel the lease agreement and thereafter re-entered into the agreement afresh. Whether or not the liability arising out of a lease agreement re-entered into would, in such an instance, have fallen into the phrase "claims arising out of the costs of the business rescue proceedings" remains unclear.

The practical implications of the declarator warrant further analysis. It is essential that any company wanting to commence business rescue proceedings must satisfy the test of "financial distress" in terms of s128(1)(i) and (ii). This is a forward-looking test, which does not make it a precondition that an entity be factually insolvent. In fact, in some instances such as Welman v Marcelle Props 193 CC and Another (33958/2011) [2012] ZAGPJHC 32 (24 February 2012), the courts have remarked that business rescue is not for "terminally ill" entities.

Notwithstanding the relatively low thresholds finding application within the context of entering business rescue proceedings, taking account of the various provisions in s128(1)(b)(iii), the procedure provides an opportunity for an indebted entity potentially to restructure its pre-business rescue debt. This may seem a fairly obvious proposition, however, in practise some practitioners attempt to use the procedure to compromise debt not yet due and payable at commencement of the procedure. In other words, a liability which at best may have been contingent at the date of commencement. It is within the context of liabilities accruing after commencement, and their categorisation, where the declarator assumes particular relevance.

If the dictum of the court is applied to categories of creditors who may not have security for their claims and are not specifically highlighted in s135, it is not entirely clear whether the innovation extrapolated from the United States in the form of prioritising "critical vendors" has much scope. This approach of finding application in some rescues seems, albeit in altered form, to be extrapolated from chapter 11 of the U.S. Bankruptcy Code, which provides for the prioritisation of certain pre-bankruptcy expenses within certain parameters and processes. There is no such doctrine or anything similar finding application within the context of the Companies Act.

Within the South African context, practitioners often apply the innovation to ensure that supplier creditors, who are unsecured, receive priority in payment for any post-commencement supplies made on credit to a company in business rescue; with the pre-commencement liability being subject to any proposed plan. Other practitioners extend this further and seek creditor support for paying such creditors' claims (including pre-commencement debt) in full. The advantages of this approach, in terms of lessening financial strain on the company, are fairly obvious. Supplier creditors, unlike many banks, often do not charge interest on supplies made to the company on a credit line. With trading stock at hand, the company is spared the agony of extending its "begging basket" to financiers who may be willing to extend the finance at significantly higher interest rates.

Quite often, the debtor's obligation towards its creditors precedes business rescue and, to borrow terminology used by the court, becomes "continually incurred" unless and until cancellation of the contract. In order to gain some form of potential preference, will contracts have to be cancelled and re-entered into and, if so, will attendant obligations, despite the contractual nexus referred to by the court, be accepted to constitute claims out of the costs (rather than as an incident of the contractual agreement)? Albeit clearly distinguishable, can this reasoning be extended to statutory obligations (which cannot be suspended or cancelled in terms of s136) such as the payment of taxes – often a continuing obligation in relation to a company registered for taxes?

Coming back to the declarator, it is unclear how, within the context of lease agreements, a liability for rental after commencement is to be treated if it does not fall within s135. Is there any other legal basis upon which the lessor can found a claim for priority for payment for outstanding post-commencement rental? Will a lessor be expected to accept a compromise of both pre and post-commencement claims for outstanding rental? If so, is such an expectation consistent with "balance[ing] the rights and interests of all relevant stakeholders..." as required by the Companies Act purpose provisions?

Is the lessor expected to raise an exceptio where a practitioner refuses to acknowledge the former's right to full payment in relation to post-commencement debt? A creditor-lessor's right to raise the defence of exceptio non adimpleti contractus and withhold counter-performance has received affirmation in BP Southern Africa (Pty) Ltd v Intertrans Oil SA (Pty) Ltd and Others (34716/2016) [2016] ZAGPJHC 310; 2017 (4) SA 592 (GJ) (25 November 2016). It has been accepted by the Supreme Court of Appeal in Murray N.O. and Another v Firstrand Bank Ltd t/a Wesbank (20104/2014) [2015] ZASCA 39; 2015 (3) SA 438 (SCA) (26 March 2015) that the cancellation of an existing contract by a creditor does not constitute an "enforcement action" in terms of s133(1).

It may be argued that the interpretation by the court has resulted in more questions than answers and perhaps laid bare the many practical challenges often presented by the current provisions, which could have been drafted more clearly. While the court sought to interpret the ambit of what finance is and provided some indication regarding the costs of business rescue proceedings, it will be interesting to see the manner in which the law develops. Will the courts try to make sense of the provisions as they stand or will the legislature take the helm and provide desperately needed refinement of the legislation?

Buba is an Admitted Attorney. He writes in his personal capacity.