What can a company in financial crisis do? Here are three options
We are living in a time of economic uncertainty. Inflation is skyrocketing, Eskom is loadshedding, and food prices are the highest they’ve been in 14 years. These conditions are placing a lot of strain on business owners, and with the end of the financial year around the corner, some tough decisions regarding the future may need to be made, writes Anneke Barnard, Senior Manager - Estates, Business Restructuring at BDO South Africa
Shareholders and Directors have a responsibility to act at all times in the best interest of affected parties of a company. And so, when it comes to assessing a company’s health it’s standard protocol for each business to undergo a solvency and liquidity test, as prescribed by Section 4 of the Companies Act 71 of 2008.
In order for a business to satisfy the conditions of the test, according to the Companies Act, a number of factors need to be in considered. The assets of the company or if it’s a member of a group, aggregate assets must be “as fairly valued, equal or exceed the liabilities of the company […] or, if the company is a member of a group of companies, the aggregate liabilities.” In addition, the company must at all times be able to pay its debts as they become due, in the ordinary course of business for up to 12 months following the date of the test.
In the event that a company fails the solvency and liquidity test, the Board has to decide on a course of action for the company. What are the options if the business can no longer continue with its operations, or manage to survive under certain conditions? It’s a tough call that impacts creditors, shareholders, clients and employees alike.
Option 1: Liquidation
Initiated by the directors of a company, liquidation is the typical course of action when a business is insolvent, meaning its liabilities exceed its assets and its unable to pay its debts, as and when they fall due, with little or no prospect of its fortunes changing.
For an insolvent business liquidation can help in several ways. For one, it creates a ‘concursus creditorum’, which grants preference to creditors as a group over any individual creditor’s interests. Any legal proceedings are also suspended until a liquidator is appointed, following which, the control of assets fall under their control, which further benefits creditors. A company undergoing liquidation also doesn’t have to pay any upfront costs to a liquidator, whose renumeration is on tariff.
The downsides to liquidation is that it is effectively the end of the line. The death of the company where all staff will be made redundant, the directors will cease to have any power and a loss of any goodwill or brand association.
Option 2: Business Rescue
Business rescue is a good option for a company that is in financial distress, but holds some prospects for recovery. As a tool, business rescue allows a company to continue its operations on a solvent basis with the help of restructuring of its affairs.
The major benefit of business rescue is that it helps a business avoid liquidation. This in turns saves employees from losing their jobs, and creditors going unpaid. This path also leaves the door open for a business to recover, and signals this to all invested parties. Further advantages include the low costs involved to implement Business Rescue, as well as presenting an opportunity to streamline and restructure the company’s operations.
There are, however, certain provisos attached to Business Rescue. For one, it requires upfront funding to continue the company’s operations. Business Rescue is also not a guaranteed fix, meaning a fair number of companies that undergo the process cannot be saved.
Option 3: Deregistration
A company that opts for deregistration has ceased trading, is left with an inadequate amount or no assets at all, and holds no liabilities. These terms are stipulated under Section 82 of the Companies Act, which lays out the exact manner in which a company can be deregistered.
A business can be deregistered upon request from the company or any other third party. Typically, a company will deregister when there is no reasonable possibility of it being liquidated.
Once a company undergoes deregistration it is dissolved and its name is removed from the companies register. This is a fairly quick process, and no fees are payable to a liquidator or business rescue practitioner.
It’s important to remember however that once this process takes place a company can never be revived. Directors of a deregistered company are also still liable for any act or omission which took place while the company was in operation.