Business rescue still the most sought-after solution

Although the South African economy is expected to continue stagnating under the pressures of issues ranging from labour unrest to rising debt levels, and many businesses are expected to be forced into restructuring to address their challenges, there is a general lack of understanding about the role that business rescue practitioners can play in helping ailing businesses return back to health. This was one of the key findings in the Deloitte Restructuring Survey 2014 that was launched in Johannesburg recently.

The survey on business restructuring – the first of its kind to be undertaken in South Africa – involved respondents from the legal, business rescue, corporate banking and debt teams at development finance institutions, according to Wanya du Preez, Senior Manager at Deloitte for Restructuring Services.

The manufacturing, retail, resources and construction sectors are the most likely to suffer financial distress in the current environment where 72% of respondents expect the economy to stagnate and result in increased company restructuring activity. A prime cause of the financial distress could also be increasing interest rates, linked to increased indebtedness of businesses.

Against a background of increasing pressure on management, many business leaders facing the burdens of a lack of cash flow, meeting tax payments, pressures on gross margins and covering overdraft and loan obligations from banks – all early signs of a business in distress – were not fully aware of the focus on ‘corporate renewal’ and requirements encompassed within Chapter 6 of the Companies Act dealing with business rescue.

The focus of the new South African legislation which was made effective in May 2011, is ‘business friendly’. A company in distress hands over control of its destiny to a business rescue practitioner and not its creditors. A distressed business electing business rescue as a solution to its financial problems, is given an opportunity to benefit from a creditor’s moratorium while the emphasis is placed on returning the business to health. However, one of the key criteria for qualifying for protection is that it can be proved that the company has a fair chance of recovery.

Within the Companies Act, which places emphasis on governance, it is a requirement that:
• Members of the board must consider business rescue as an alternative in the event of a company becoming financially distressed;
• If the board decides not to follow the business rescue course, it must account for this in a public notice to all stakeholders about why they are not considering this path and outline their reasoning;
• Directors realise that they can be held personally and criminally accountable for their actions if a business fails and it can be shown that they did not take adequate steps to mitigate against losses.

The Act also requires that once an application for business rescue has been filed, a practitioner has 25 working days to submit a plan of action for restoring a company’s profitability, which is subject to the approval of the majority of creditors. This serves to emphasise that business rescue is an urgent process, even though leeway is granted by the courts on these reporting periods, depending on the size and complexity of a business.

The role of the business rescue practitioner is to identify the key problems in the business and assess all financial restructuring options. These can include solutions ranging from shareholder-based plans, external investor funding, potential mergers and acquisitions and, if all else fails, liquidation.
Other aspects that make the South African regulations unique compared to its international counterparts, and are subject to ongoing debate within the business community, as well as legal testing, are the priorities accorded to creditors within the process.
These include
• The emphasis on preserving jobs and the priority ranking of the interests of employees;
• The business rescue practitioner is guaranteed fees ahead of other creditors;
• SARS as a creditor not automatically being granted preferential status; and
• Entities bringing funding to a distressed business being granted priority creditor status above other secured creditors who have supported the business financially while it was financially viable.

The challenges facing the relatively young business rescue industry in South Africa include:
• The insolvency mind-set within South Africa, which still prevails over the consideration of business rescue;
• Board of directors are waiting too long to file or sometimes filing for the wrong reasons;
• Limited sources of funding being available for companies in distress. This contrasts strongly to markets like the USA where there are firms that specialise in finance for distressed companies. In South Africa, only 17% of distressed entities expect distressed lending to be made available to them;
• The perceptions by respondents that creditors unnecessarily hamper the process by advancing their position through court proceedings;
• The belief, highlighted by 78% of survey respondents, that business rescue practitioners are not adequately skilled or qualified.

It is essential for the business rescue industry and companies that it can potentially assist, that these challenges are addressed. One of the potential solutions is that professional services firms like Deloitte can assist by supporting key stakeholders and boards, as well as remain active in supporting the sector.

Wanya du Preez