Section 129(1) of the Companies Act allows a company in financial distress some breathing space through providing the board of directors of the company with the opportunity to apply for business rescue if there is a reasonable chance of rescuing the company.  However, there might be some instances where the board of a company in financial distress will continue to trade having decided that it is probable that the financial situation of the company will improve and that it will be able to meet its obligations.  Affected parties (shareholders, creditors and employees) may not be aware of this until it is too late and the company is beyond the point of being rescued and has to be liquidated.  This is where section 129(7) comes in and requires from the board that when it has reasonable grounds to believe that the company is financially distressed and they have not placed the company into business rescue, it must inform all affected persons in writing that the company is in financial distress and also provide reasons why they have not adopted a resolution to file for business rescue.  

The written notice sent to the affected parties must set out the criteria of financial distress being that it appears to bereasonably unlikely that the company will be able to pay all of its debts as they fall 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.  Such a notice will certainly have immediate and significant implications for the company, for example shareholders might stop investing in the company; creditors might want to renegotiate their payment terms or even cancel orders from the company; or employees could get anxious, involve trade unions and even resign in favour of a more secure work environment. The worst case scenario of course could be that banking institutions may refuse to provide financial support due to the written notice received and withdraw credit facilities that was available to the company.  Furthermore, it can be reasoned that Section 129(7) was designed to provide affected persons with the opportunity to apply to the court to place the company into business rescue because of the financial distress and the fact that the board did not want to adopt the resolution to file for business rescue.

The board of the company therefore has a challenging decision to make of either filing for business rescue (which has its own implications), or send a written notice out informing all affected parties about the company being in financial distress.  Should the Board decide not to do anything at all and the company goes into liquidation, this could also have some grave consequences for the board of directors.   For instance, failure by the board to have acted could imply that the board was trading recklessly, with gross negligence or with the intent to defraud which may lead to personal liability for the board for any loss, damage or costs sustained.

It therefore appears that the real challenge for the board of a company that is in financial distress does not lie in the decision that they have to make, but the consequences flowing from the decision they made (or did not make).

Ewald van Heerden
Partner: Technique & Innovation