In this article we investigate whether, in South African law, a subordination agreement could constitute a "voidable disposition" as defined in section 26 of the Insolvency Act 24 of 1936 (the Act).
Section 26 of the Act provides that every disposition of property not made for value may be set aside by the court, if the disposition was made by an insolvent (whether an individual, company or close corporation) either:
- more than two years before liquidation and it is proved that immediately after the disposition was made, the insolvent’s liabilities exceeded its assets; or
- within two years of liquidation, and the person claiming under or benefitted by the disposition is unable to prove that immediately after the disposition was made, the insolvent’s assets exceeded its liabilities.
"Value" in this context has its ordinary meaning, that is any kind of consideration and not merely money. Whether or not value has been received for a disposition must be determined by taking all the circumstances under which the transaction was made into account.
A disposition is any transfer or abandonment of rights to property and includes a sale, lease, mortgage, pledge, delivery, payment, release, compromise, donation or any contract therefor but does not include a disposition in compliance with an order of the court.
What constitutes a disposition is not exhaustive and includes any conceivable means of disposing of property. In addition, the language indicates that, not only the actual physical payment of money or delivery or transfer of property, but also the conclusion of an agreement involving such payment, delivery or transfer for whatever reason, will constitute a disposition.
Property is either movable or immovable and includes contingent interests in property. Movable property is every kind of property and every right or interest that is not immovable property.
A subordination agreement is an agreement whereby a party transfers or abandons its rights to claims it has against debtors. As a right or interest falls under the umbrella of movable property and a disposition is defined as a transfer or abandonment of rights to property, it logically follows that a subordination agreement could fall under the meaning of a disposition of section 26 of the Act.
Particular care is required where a group company effects a subordination of its claims on loan account against a fellow group company, in favour of the debtor company's external creditors. This is a fairly common practice in modern commerce. Such subordinations are often required by the debtor company's bankers or as a method of restoring a company with a weak balance sheet to technical solvency.
A holding company that subordinates its claims on loan account against its subsidiary may be held to have received "value" in that the subsidiary continued to operate for its eventual benefit. There is no authority as to whether this would extend to a benefit that has not yet materialised or may in the future materialise. In the absence of special circumstances, however, the subordination of a claim against a holding company by its subsidiary, or against a subsidiary by a fellow subsidiary, must be treated with great caution. It has been said that "the continued financial stability of the whole group of companies" could constitute "value" in such circumstances. Of course it will be appreciated that the act of subordination weakens the balance sheet of the creditor company and may reduce it to technical insolvency.
A shareholder that subordinates his/her claims on loan account against the company may be held to have received "value", namely, the fact that the company continues to operate for the shareholder's eventual benefit. The same might apply to a creditor who trades extensively with the undertaking and in whose interests it is that it should continue to trade. A substantial creditor, who subordinates
his/her claim in order to "nurse" a debtor in the hope of an eventual recovery to financial health, may also be held to have received "value".
In circumstances where the disposition (the subordination) is made as a result of pressure upon the subsidiary or fellow subsidiary concerned by the directors of the holding company without regard to the interests of the subsidiary or fellow subsidiary, so that the subsidiary or fellow subsidiary is impoverished and forced into liquidation, there was clearly no benefit or "value" and the disposition (the subordination) would be set aside.
It is clear that a subordination agreement could be held to be a disposition in terms of the Act. One would need to prove that the subordination agreement was made for no or insufficient value more than two years before liquidation and that immediately after the disposition was made, the insolvent’s liabilities exceeded its assets. Alternatively, if made within two years of liquidation, the disposition would be voidable if the person claiming under or benefitted by the disposition is unable to prove that immediately after the disposition was made, the insolvent’s assets exceeded its liabilities.
An enquiry into "value" would of course, in practice, be unnecessary if the creditor subordinating a claim was a person or company of sufficient substance. The question of the creditor's solvency would not arise. The question of whether "value" was received, even in the broad sense contemplated above, would not arise where the subordination takes effect or is concluded less than two years before the creditor company is liquidated.
Although in principle, a subordination agreement could constitute a voidable disposition, there is no simple answer to the question in a particular case and each case must be dealt with on its own facts and circumstances.