South Africa: No Preferential Creditor Status For SARS In A Business Rescue

Since the date of inception of the new Companies Act 71 of 2008, as amended (Act) (1 May 2011), we have seen numerous and informative judgments handed down by our High Courts in the various provinces dealing with business rescue proceedings.

On 31 October 2012, Judge Fourie, in the Western Cape High Court, handed down a seminal judgment in the matter of Commissioner for the South African Revenue Service v Beginsel NO & Others (Case No 15080, 31 October 2012), which dealt with, among other things, the manner in which concurrent creditors will be treated in business rescue proceedings.

We set out below, some of the salient points raised by Judge Fourie in his judgment which deals with the treatment of SARS and concurrent creditors in business rescue proceedings and the manner in which such creditors would vote on a business rescue plan; the validity of business rescue plans for their failure to comply with certain provisions in the Act and the sustainability of the company subsequent to the commencement of business rescue proceedings.

SARS as a concurrent creditor

Section 145(4)(a) and (b) of the Act deals with the voting interests attributed to creditors for purposes of voting on a proposed business rescue plan.

In this matter, SARS averred that on its interpretation of these provisions, it was of the view that the decision taken to adopt the business rescue plan was unlawful and invalid. While SARS agreed that the Act did not oblige a business rescue practitioner to confer a preference on SARS over unsecured creditors, it also averred that the Act did not oblige a practitioner to treat SARS as a concurrent creditor. In the circumstances, SARS held that it is in the discretion of the practitioner (by virtue of section 150(2)(b)(v)) to determine the order of preference for the payment of creditors subject, of course, to the order of preference conferred by section 135 of the Act.

SARS further argued that all preferent creditors, as contemplated by the Insolvency Act 24 of 1936 (Insolvency Act), should be categorised as unsecured creditors in terms of section 145(4)(a) of the Act and should therefore be entitled to vote at the value of their claim, whilst all other concurrent creditors (as envisaged by the Insolvency Act) should be categorized as concurrent creditors who would ordinarily be subordinated in a liquidation, as envisaged by section 145(4)(b) of the Act, and therefore entitled to vote at their liquidation value (generally a negligible or zero value). If this were the case, SARS would have had a vote at the value of its claim and it would have carried the vote.

The court held that the Act does not create statutory preferences as set out in the Insolvency Act and that, if the legislature had intended to prefer SARS above other creditors in business rescue proceedings, it would have explicitly stated so. Accordingly, the court held that SARS is not a preferent creditor in business rescue as it would be in a liquidation.

To support its contention, the court stated that the Act differentiates between secured and unsecured creditors in section 145(4)(a) with concurrent creditors forming part of the latter group. The court then went further to state that concurrent creditors can further be divided into "preferent" or "concurrent" unsecured creditors. The court held that the term "preferent creditor" generally refers to a creditor whose claim is unsecured but which ranks above the claims of concurrent creditors (ie unsecured preferent creditors). The court held that in assigning the phrase its ordinary meaning, it could not interpret the word "unsecured creditor" to refer only to "preferent unsecured creditors". Accordingly, in business rescue proceedings, the court held that SARS is to be treated like any other concurrent creditor of the company.

The court held that the reference to a "concurrent creditor" in section 145(4)(b) of the Act is not a reference to all concurrent creditors but rather a reference to those concurrent creditors who have subordinated their claims in a liquidation pursuant to a formal agreement to that effect.

Accordingly, all concurrent creditors vote at the value of their claim and only those whose claims have been formally subordinated in a liquidation, by virtue of an agreement to that effect, will vote at liquidation value.

Accordingly, SARS, together with all other concurrent creditors, whose claims had not been subordinated by agreement on liquidation, would be entitled to vote at value.

Compliance with provisions for business rescue plans

Section 150 of the Act delineates the framework for business rescue plans.

In this matter, SARS argued that the plan was invalid and unlawful on the basis that it failed to comply with specific provisions in section 150 of the Act. We do not intend to detail with each instance in which SARS argued that the plan failed to comply with the Act, suffice it to say that its concerns related to sections 150(2)(a)(ii) (list of the creditors of the company and a statement as to which are secured, statutory preferent and concurrent in terms of insolvency law), 150(2)(c)(iv)(aa) and (bb) (a projected balance sheet and statement of income and expenses) and 150(2)(b)(vi) (benefits of the business rescue as opposed to a liquidation).

The thrust of the court's ruling was that section 150(2) of the Act prescribes the content of business rescue plans in general terms and that the legislature could never have precisely prescribed the content for a business rescue plan as each will differ from case to case. Accordingly, the court held that substantial compliance with the provisions of section 150 would suffice. This would mean that where sufficient information, along the lines of that prescribed by section 150(2) of the Act, had been provided to enable interested parties to make an informed decision on the plan, there would have been substantial compliance with section 150 of the Act.

The court held that there was no merit in the submissions made by SARS in support of their contention that the plan should fail as a result of its failure to comply with the provisions of section 150 of the Act.

Continuation of business rescue proceedings

Section 140(2)(a)(i) and (ii) of the Act sets out when a practitioner is to make application to court to discontinue the business rescue process and place the company into liquidation. This would occur when there is no reasonable prospect for rescuing the company.

SARS argued that the business rescue practitioner is obliged, pursuant to section 141(2)(a)(i) and (ii) of the Act, to apply to court for an order discontinuing the business rescue process and to place the company in liquidation if he believes, at any point in the business rescue process, that the company does not have a reasonable prospect of being rescued.

The court considered what is meant by the phrase "rescuing the company". It confirmed that rescuing the company means achieving the goals envisaged by the business rescue process, namely the continuation of the company on a solvent basis or failing this, the achievement of a better return for the creditors and shareholders of the company than would result from an immediate liquidation of the company.

Both parties agreed that a "better return" would mean more money for distribution to the creditors. Whilst agreeing on the test to be applied, the parties differed in their application of the test to the facts. SARS felt that a liquidation of the company would achieve a better return for the creditors whilst the business rescue practitioners were of the view that a liquidation of the company would in effect give rise to a duplication of costs which had already been incurred in the business rescue process and that the implementation of the business rescue plan would yield a better return for the creditors than would be the case in a liquidation.

The court held that in deciding the matter it had to adopt a practical common sense approach. It stated that the court that granted the order for business rescue at the outset must have viewed the company as a viable concern; that the practitioners had taken control of the business and had managed to reduce the losses of the company and that the plan was already in an advanced stage. Accordingly, the court held that nothing would be achieved if the business rescue was converted into al iquidation and that business rescue proceedings would result in a better return for the creditors than would occur in a liquidation.

Conclusion

This is a refreshing and interesting judgment on business rescue as it is one of the few judgments handed down by our courts which deal with substantive aspects of business rescue. Most judgments to date have dealt with the procedural aspects of business rescue and the instances in which a court will be inclined to grant a business rescue.

This judgment clarifies, once and for all, the very important aspect of the manner in which concurrent creditors will vote in business rescue proceedings. Concurrent creditors stand alongside secured creditors and have the opportunity to have their say, namely to vote at value, either for the approval of the plan or for the rejection thereof, the latter probably resulting in the liquidation of the company.

As a result, all creditors in companies facing business rescue, will have an equal say about the company's future and the prospect of such company trading its way out of its financial distress and to a position of solvency.

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.