Chapter 6 of the South African Companies Act, 2008, as a corporate restructuring regime, provides a formal restructuring tool for financially distressed (which exists when a company is unable to pay its debts as they fall due (cash-flow insolvency) or when a company’s liabilities exceed the value of its assets (balance-sheet insolvency) or when those events are likely to occur in 6 months (imminent insolvency) companies. In doing so, it seeks to provide for the efficient rescue and turnaround of financially distressed companies, in a manner that balances the rights and interests of all stakeholders. Key stakeholders, as we have seen in the recent business rescue of a state-owned enterprise in South African Airways, are the shareholders, lenders, employees and key suppliers to the business.
A chapter 6 rescue relies on three building blocks:
- an effective and binding statutory moratorium to provide breathing space for the rescue to succeed
- post-commencement finance or “oxygen in the tank” for the business to operate while it is financially distressed, with the rights of such post-commencement finance creditor to be protected in the event of a subsequent bankruptcy of the company
- an effective and binding restructuring plan
To a great extent these building blocks are included in chapter 6. However, many restructuring professionals have raised questions around the scope of the moratorium on legal proceedings and enforcement actions (it allows a creditor within a pre-rescue a reserved right to enforce a termination of the contract after the commencement of business rescue proceedings) and the position of post-commencement finance creditors. However, that is not the focus of this article.
The purpose of this article is to examine if a framework, recognising the required building blocks for a successful restructure, can be developed for a pre-insolvency restructuring and turnaround regime. There is little doubt that if such a regime existed in South Africa it would have been put to use in the South African Airways restructure.
What is a pre-insolvency restructure?
It is a corporate preventive restructuring regime aimed at a restructure to avoid the commencement of bankruptcy proceedings in the traditional sense as we know it. In doing so it (i) makes available all the key building blocks for a successful corporate restructure and (ii) allows a qualifying distressed company to avoid establishing formal rescue proceedings.
Several countries around the world are amending their restructuring legislation to implement a pre-insolvency mechanism. It exists in the United States as a Chapter II reorganisation. However, unlike the United States, the ideal outcome would be a twin restructuring regime:
- one permitting pre-insolvency eligibility requirements to prevent opportunistic filings, and
- another permitting formal restructuring like that we have under chapter 6 (but with stricter eligibility requirements than what we have).
It is not an either-or situation. A financially distressed debtor seeking to use a formal restructuring regime should, in my view, be subject to stricter eligibility requirements. At present the South African formal restructuring regime extends an “open ticket” for the commencement of business rescue. Many stakeholders argue that this “open ticket” has left the formal restructuring regime open to abuse. First of all, a financially distressed debtor wanting to enter a formal restructuring regime (like Chapter 6) must establish, independently, that the business has a higher going concern value than a liquidation value or outcome – it must show that the company is economically viable and in that sense identify the issues causing it to be financially distressed and how it intends to address those issues to maintain its going concern viability. Secondly, the financially distressed company must show that it has the support of a certain percentage of creditors. Otherwise, a going concern sale is more desirable if the problem, as it often happens, is not with the viability of the business but the lack of trust or confidence in management. Finally, the company must explain why it did not use the pre-insolvency restructuring regime or, why if it did, the pre-insolvency restructure failed. There may be good reason why the pre-insolvency restructure failed (for instance, the strict and short time made available to complete the restructure).
A financially distressed company seeking to adopt a pre-insolvency procedure should be subject to adequate controls to prevent abuse and opportunistic filings. For instance, it must be proven certain financial and viability requirements before it can embark on this procedure. These requirements will, by their very nature, require the support of key creditors. After all, if a distressed company does not use a pre-insolvency procedure, with the availability of the building blocks and more, there will be reason to believe that it is not capable of being rescued as it is not viable or does not enjoy the support or confidence of the creditors.
Fundamental, and at the core of the success of any pre-insolvency restructuring procedure, is the existence of a court, in the form of a specialised bankruptcy court, to oversee the pre-insolvency procedure.
So, in summary, what would the key building blocks be for an effective pre-insolvency procedure:
- the existence of financial distress
- economic viability as a going concern
- support of a certain percentage of creditors
- appointment of an independent, and court-supervised, practitioner to supervise the restructure
- limited moratorium and stay of all enforcement actions for an initial period, capable on good reason and cause demonstrated for a court, of being extended by a further (final) period
- special rules for the treatment of contracts (executory contracts included) and new financing or “oxygen in the tank”
- mediation and conciliation in which third parties are appointed to deal with disputes and disputed claims
- submission of a restructuring plan
- a restructuring plan involving dissenting parties on the reduction of staff by more than a certain percentage must be confirmed by a court