Business rescue and the Companies Act

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In recent years there has been an increase in the number of failed companies in the region due to effects of the global recession.

Tapiwa Chizana

Zimbabwe has had its own economic challenges; therefore the evidence of struggling business is more apparent in our nation. Unemployment has increased to unprecedented levels as companies have been forced to lay off staff and/ or close down, due to the current difficult economic conditions.

It is within this context that companies have sought various remedies in an effort to resuscitate their operations and avoid liquidation.

One of the options pursued by companies has been to file for judicial management as provided for in Zimbabwe’s Companies Act. In terms of the Companies Act, a company may be placed under judicial management for mismanagement or if for any other cause the company is unable to pay its debts or is probably unable to pay its debts and has not become, or is prevented from becoming, a successful concern.

There has to be a “reasonable probability” that if the company is placed under judicial management, it will be enabled to pay its debts or meet its obligations and become a successful concern. Placing the company under judicial management should be deemed just and equitable by the High Court.

When a company is granted a judicial management order, the consequences are as follows:

The directors are legally relieved of their duties and responsibilities. The management of the company is assumed by a judicial manager.

The assets of the company are placed under the control of the judicial manager, who is then tasked with the responsibility of restructuring the company and resuscitating the business.

All legal proceedings against the company are “stayed” or suspended.

Creditors’ payments are suspended, and the company is protected from legal action by creditors.

The following are some of the advantages associated with placing a company under judicial management:
The primary advantage to the company is the granting of a “moratorium”, which is effectively a window period within which the company’s operations can be resuscitated before settling its previous debts. This helps the cash flow position of the company and the business rescue efforts.

In some instances judicial management may protect the company from unfair legal action being perpetrated by a third party which would be damaging to the company and prejudice all stakeholders.

Judicial management is a better alternative to liquidation, because the latter option does not preserve jobs and is often not beneficial to the creditors of the company.

In some instances the management structures of the company may be weak and the judicial manager may add the relevant business knowledge to assist the company move forward. The judicial manager would ordinarily contribute to the resolution of legal and financial matters.

The legal framework assists the judicial manager to preserve and protect the interests of all stakeholders, which is ordinarily difficult to achieve when managing a distressed company.
The judicial manager acts as a mediator among stakeholders, as trust is often absent where a distressed company has filed for judicial management.

Some of the disadvantages of filing for judicial management are as follows:

The directors lose control of the business. In some instances, these directors are also shareholders; hence there may be disagreement between the judicial manager and the shareholders on how the business is to be rescued.

There is a stigma associated with companies being under judicial management. Shareholders may be perceived to be seeking to avoid settling their obligations and hiding behind judicial management.

Banks are ordinarily cautious when lending to companies under judicial management. The absence of such financial support may then result in liquidation.

There is a cost associated with placing the company under judicial management, given the legal process required and the frequency of meetings required among stakeholders, to effectively carry out the process.

Despite the good intention of the legislative framework establishing judicial management, the reality is that there are certain shortcomings which, if not addressed, will reduce stakeholder confidence in the judicial management process.

Below are certain issues for consideration pertaining to judicial management in Zimbabwe.

The legal process is administratively cumbersome and expensive. This may discourage certain small to medium enterprises that should seek such relief, from doing so.

The judicial manager is not ordinarily able to suspend employee contracts as readily as is preferred. Most distressed companies are over-staffed and suspending employees’ contracts, though sympathetically unpleasant, may be one of the ways to relieve the company of its debt burden and remove excess or underperforming employees. Such employees can be re-employed as and when the company’s fortunes are restored.

There is currently no legislation for business rescue financing, which would regulate the provision and management of funding for distressed companies in Zimbabwe. Banks are unwilling to throw “good money after bad”. Therefore post commencement finance is difficult to obtain. One solution may be for post commencement finance to rank in preference (even before secured creditors), in the event that the business rescue process fails, and the company files for liquidation.

This will increase the willingness of banks to finance companies under judicial management as they would have a greater probability of recovering their money.

Though the directors are discharged of their duties, the legal framework does not place sufficient motivation on the directors to be part of the business rescue process as such responsibility primarily rests with the judicial manager.

There is a case to support continuity and consistency in having the directors stay on and assist the practioner in rescuing the company. The judicial manager would still retain the discretion to remove the directors if they are deemed incompetent. The directors are ordinarily privy to information and knowledge about the operations of the company.

According to the Companies Act a company is only allowed to be placed under judicial management when it is unable to pay its debts,as they fall due. By the time a company gets to that stage, it is very sick and the probability of recovery is low.

There needs to be an intervention before it is “unable to pay its debts”. Placing a company under a business rescue process when it is “financially distressed” may be a more helpful and pre-emptive measure.

“Financially distressed” is defined as a situation whereby a company appears to be reasonably unlikely to pay all its debts as they fall due within the immediately ensuing six months. The business will have greater chances of survival if the rescue process commences at the point of financial distress, as it will be in a better financial position than those seen currently under judicial management.

There are no detailed requirements specifying the information to be presented in the judicial managers plan to rescue the business.

The information required by the Companies Act is general and does not provide creditors and stakeholders with sufficient information to establish whether or not they can support the business rescue process.

There is no legal framework that allows creditors to form a committee and formally contribute to the business rescue process by making submissions to the business rescue practitioner, and enriching the practioner’s business rescue plan.

There is no legislated time- frame by which the business rescue plan needs to be implemented and completed. Neither is there a legal framework to enhance the accountability of the business rescue process, should the process continue for a prolonged period.

Foreign creditors and shareholders receive no preferential treatment. The degree to which the rights of foreign investors and creditors are recognised and supported by government agencies and the courts may encourage investment in Zimbabwe.

Every progressive nation has a business rescue legislation to protect companies from going into liquidation. Therefore it would be uninformed to suggest that such a mechanism be made redundant.

The Zimbabwe legislation for judicial management enshrined in the Companies Act was last updated in 1959. Much of the the world has changed since then.

South Africa recently revised its business rescue legislation after identifying certain short comings in its effectiveness. Despite some success in business rescue in Zimbabwe, it is possible that we will have more success stories when the related legislation is improved.

Tapiwa Chizana is a Partner at Deloitte & Touche and is involved in business rescue and judicial management. He writes in his personal capacity tapiwachizana@gmail.com

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