In August Stats SA revealed that 1,020 entities filed for liquidation in the first eight months of the year. In contrast, the Companies & Intellectual Property Commission (CIPC) recorded that only 230 companies entered into business rescue during the that period.
This stark contrast highlights the underutilisation of the business rescue mechanism and suggests that many companies may have defaulted into liquidation because their directors and shareholders were not aware of the potential benefits of business rescue. Engaging with a restructuring professional may have provided these companies with the opportunity to turn their businesses around, thereby avoiding liquidation.
Reckless trading and conducting a company’s business with the intention of defrauding creditors is addressed in section 22 of the Companies Act, as amended. In the case of Ozinsky NO v Lloyd & Others (1992), the court held that if a company continues to carry on doing business and incurring debts when there would be no reasonable prospect of the creditors receiving payment when due, it will in general be a proper inference that the business is being carried on recklessly.
Section 22(1) of the act provides that a company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. In the recent Supreme Court of Appeal (SCA) judgment of Venator Africa v Watts & Another, the SCA highlighted that the duty outlined in this provision is incumbent on the company and not directly on the directors of the company.
Section 22(2) of the act indicates that the CIPC may issue a notice to a company to show cause why the company should be permitted to continue carrying on its business, or to trade, if it has reasonable grounds to believe that a company is engaging in conduct prohibited by subsection (1), or is unable to pay its debts as they become due and payable in the normal course of business. This affords a company the opportunity to respond to the CIPC notice.
One should bear in mind that in 2015 the CIPC issued a guidance note on the application of section 22 on close corporations, where the commission emphasised that a consequence of this provision is that they “may” call on a company to show cause why it should be allowed to continue trading. The word “may” introduces uncertainty, weakening the enforcement mechanism intended by the act, and raises concerns about the CIPC’s role in proactively enforcing compliance.
To protect creditors trading with companies that are trading recklessly or not paying their debts, the CIPC should adopt a firmer and more proactive stance. Once the CoR 19.1 form — this is the notice the commission is empowered to issue in terms of section 22(2) of the act — has been issued by the CIPC, a company is required to show cause as to why it should be permitted to carry on business or to trade. Any decision by the company to disregard the CIPC notice might well have dire consequences for such a company.
Nova Propgrow Group Holdings is an example of a company that received a compliance notice from the CIPC. Its inability to comply with the CIPC’s notice to show cause resulted in Nova receiving a compliance notice restricting the company’s ability to dispose of immovable property and placing limits on its trading operations. The actions of the CIPC in relation to Nova highlight the importance of regulatory oversight in protecting creditors and ensuring that companies do not trade recklessly or under insolvent circumstances, to the detriment of stakeholders.
On receipt of the relevant CIPC notice, directors have no choice but to consider whether the company should start with business rescue proceedings on the basis that it is trading in conflict with the provisions of section 22(1) — reckless trading, or where it is unable to pay its debts as they become due and payable in the normal course of the company’s business. If the latter is applicable, the company would be considered financially distressed, and the directors are obligated to pass a resolution in terms of section 129(1) and place the company into business rescue.
A company will satisfy the financial distress test if it appears to be reasonably unlikely that it will be able to pay all of its debts as they become due and payable within the immediately ensuing six months (commercial insolvency); or it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months (factual insolvency).
In these circumstances, and in the event that the directors do not adopt a resolution as contemplated in section 129(1) of the act, they must deliver a written notice to each affected person as the only alternative available to them other than filing for the formal business rescue process.
• Dr Levenstein is director and head of insolvency & business rescue, and Mackechnie senior associate, at Werksmans Attorneys.
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