South Africa: Ranking Of Administration Costs Of And Claims Against A Company In Liquidation Post Business Rescue

Insolvency & Business Rescue News January 2012

Introduction

It is inevitable that a significant number of business rescue proceedings will fail and that the company under business rescue will be placed in liquidation. It is important for all affected parties, and in particular all classes of creditors, to know where they stand in regard to the recovery of their claims against the company if it is placed under business rescue, and if business rescue fails, if (or rather when) the company is thereafter placed in liquidation. Ideally the affected parties and other stakeholders such as the business rescue practitioner should know, even before a company is put into business rescue, what the end result is likely to be should the business rescue fail. In this three-part series of articles we first review the present dispensation of the ranking of claims against a company in liquidation, and we thereafter examine the rankings of claims against a company in business rescue, and finally claims against the same company if it is thereafter wound up.

Administration costs of and claims against a company in liquidation

Before we start the comparative exercise, it is useful to take a step back and review the treatment of administration costs of and claims against a company in liquidation.

Many business people are already familiar with the manner in which claims against the estate of a company in liquidation are ranked. At the risk of repetition and for the sake of background these rankings are summarised as follows:

• At the top of the pile are administration costs. These include the liquidator's fees, Master's fees, advertising costs, costs of maintaining and realising property of the estate (for example storage and auctioneer's fees) and generally all expenses associated with running the estate while the winding up process subsists.
• Secured claims – These are claims that are secured by a particular asset or assets encumbered in favour of the creditor. The liquidator maintains an encumbered asset account for each such claim. The creditor gets the entire proceeds of the asset/s after deduction of the realisation costs and the proportionate share of the Master's fee, liquidators' charges and bond of security.
• Next on the list are preferent creditors, who will get the first bite of the free residue (a free residue account is opened to receive funds other than funds dealt with in the encumbered asset accounts), being whatever funds are left after all of the administration costs and claims of secured creditors have been paid. The main categories of preferent creditors are SARS for unpaid taxes of all kinds and employees (up to limited statutory amounts).
• Lastly, and if there is anything left after all preferent creditors have been paid, the remaining free residue will be paid to the concurrent creditors on a basis pro rata to the value of their proved claims.

Although they are not strictly creditors, the shareholders of a company are theoretically entitled to a refund of any monies left over in the estate after all proved claims have been paid.

From a birds' eye perspective, the situation varies when a company is placed under business rescue. Claims against the estate do not necessarily lose their character but are dealt with on an entirely different basis.

• The first major point of distinction with liquidation proceedings is that there is no provision in business rescue for claims to be proved, nor does the business rescue practitioner have the power to either accept or reject claims or to categorise claims as secured, preferent or concurrent.
• The second point (a counterweight to the first) is that the manner in which any claim is dealt with, can be prescribed by the business rescue plan and if the plan is accepted by the creditors and the court, then whatever categorisation and/or ranking is attached to a particular claim by the practitioner in the plan, will be valid and binding. In a subsequent article we will deal with the possible implications and consequences of the lack of provision in the new Companies Act for a mechanism to approve or categorise claims against the estate.

Administration costs of and claims against a company under business rescue

The business rescue provisions in the new Companies Act provide for administration costs and the addition of certain new categories of claims and the ranking thereof.

The highest ranking claims are, in terms of section 143 read with section 135(3) of the Act, the fees of the business rescue practitioner and the practitioner's expenses associated with the business rescue process (for example, the fees of lawyers and accountants engaged by the practitioner to render specialist advice.) These can be seen as analogous to the administration costs of a company under winding up. They rank in priority to the claims of any secured or preferent creditors.

The next-highest ranking claims are, in terms of sections 135(1) and 135(3)(a) of the Act, those for any services rendered by employees of the company under business rescue. Such employees' claims are remunerated on the basis that they are deemed to be post-commencement finance. The pot from which such employees would be paid would in normal circumstances be the free residue of the estate after secured claims have been paid.

The next-highest ranking claims are, in terms of sections 135(2)(a) and 135(3)(b) of the Act, the claims of creditors who took security over the company's assets after business rescue proceedings commenced. Such claims are remunerated as secured post-commencement finance.

• It is important to note that provision for such claims is a radical departure from the legislative and common law position absent business rescue. It is not otherwise legally permissible for a creditor to take security over an asset of the company prior to liquidation. There are general provisions in the Insolvency Act rendering such a transaction voidable. There is also the specific provision of section 88 of the Insolvency Act, which provides that a mortgage bond over a debtor's assets registered fewer than six months prior to a sequestration order (winding up order in the case of a company or close corporation) does not confer any preference.
• In principle, encumbering an asset when the company is insolvent or would be insolvent after the asset is encumbered, is an undue preference to the relevant creditor and prejudices other creditors of the company. The implication is that a company under business rescue, which by definition must be in financial distress, would not be permitted to encumber its assets to a third party.
• However, the legislature clearly recognised that for most business rescues to succeed, post-commencement finance is indispensable, and in order to obtain such post-commencement finance it will be necessary for the company to encumber certain of its assets. Hence section 135(2)(a) expressly permits the securing of unencumbered assets after the commencement of business rescue.

Equal to secured post-commencement funders in ranking of creditors to be paid, will be the secured creditors who took security over the company's assets before the business rescue process commenced. It should not be forgotten that in theory at least, the first proceeds of any particular asset can only be encumbered to one creditor at a time. Thus there should be no overlap in the claims of secured creditors, whether or not their claims arose before or after commencement of the business rescue proceedings.

In the event that all of the above classes of creditors are paid out, the next-highest ranking creditors of a company in business rescue would be the providers of unsecured post-commencement finance, in terms of sections 135(2)(b) and 135(3)(b). Their claims rank above "all unsecured claims against the company", which must by inference include all preferent claims.

Since there is no express or implicit provision in the Act for the ranking of any other categories of claims against a company in business rescue, it would seem that all these claims must be dealt with in the business rescue plan.

Arguably, there is no true ranking of claims against a company under business rescue. There is a tension between section 135(3) and the cram-down provisions of section 152(4) of the Act. Conventional wisdom is that the claims of all secured and preferent creditors should rank above the claims of unsecured creditors. However, in light of section 152(4) it is conceivable that a secured creditor, even one which has provided post-commencement finance, could be deprived of its security by means of an approved business rescue plan. This is because the business rescue plan can provide in any manner for the affairs of the company to be restructured, assets to be sold or used for a particular purpose, and if the requisite majority in value of the creditors approve the business rescue plan then it matters not what the ranking of their claims would otherwise be. A court will have to determine the conflict between these subsections of the Act, probably at the instance of a secured creditor who will argue that the business rescue plan cannot be used to subvert the rankings set out in section 135(3).

By extension, the fact that the distinction between rankings of creditors is dissolved for the purposes of voting on a business rescue plan, means that preferent creditors (SARS and employees) may also lose their higher status. Ultimately it will be up to the business rescue practitioner to devise a plan that caters to the interests of all the creditors as a whole, rather than any particular classes of creditors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.