Financial Distress - your Obligations

Should a company be insolvent it must stop trading.

The Insolvency Act clearly stipulates that there are two types of insolvency:

  1. Should the liabilities of the business exceed its assets, the business is factually insolvent (also known as balance-sheet insolvency

  2. Should the company be unable to pay any money owed to its creditors on time, or put differently, when a company has enough assets to pay what is owed but does not have the cash reserves to make the payments that are due and payable, the company is deemed to be commercially insolvent.

 

Furthermore, in terms of the Companies Act the definition of financially distressed is:


“if it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months; or it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months.”


Section 129(7) provides:


“If the board of a company has reasonable grounds to believe that the company is financially distressed, but the board has not adopted a resolution contemplated in this section, the board must deliver a written notice to each affected person, setting out the criteria referred
to in section 128(1)(f) that are applicable to the company, and its reasons for not adopting a resolution contemplated in this section.”

Section 129 of the Companies Act stipulates that the members of a company that is financially distressed must:

  1. Apply for business rescue

  2. Alternatively notify all creditors of the current status quo of the company together with the reasons why no application for business rescue will be launched.

From the above it is clear that there is a legal obligation on the members to act swiftly should the company be deemed to be insolvent or financially distressed.

 

Failing these stipulations Directors and/or Members including Executive Managers may be held personally liable for company debts towards creditors. 

Normally, when confronted with these scenarios, liquidation or business rescue are thought of as the only options.


However, there is another option. This is that a financially-distressed company, may propose a compromise with its creditors in terms of section 155 of the Companies Act, No 71 of 2008. Most financially distressed companies should be able to trade themselves out of trouble in
terms of a realistic arrangement with their creditors. Such an arrangement can inter alia include a debt moratorium, more favourable payment terms, or a combination of the two, depending on the specific needs of the company.

In both these options, control of the company no longer lies with the directors and is relinquished to an outsider, namely the liquidator or the business rescue practitioner.


However, this is not the case should a company propose a compromise with its creditors, as the compromise will be an agreement between the company and its creditors and neither the Master of the High Court nor the Companies and Intellectual Property Commission will be involved in the process.

Should you be interested to make use of our Corporate Guarantees and Business Turnaround and Rescue services please click here to review our process.

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