Section 129(7) of the Companies Act 2008 puts the board of the company between a rock and a hard place. The section reads as follows:
“If the board of a company has reasonable grounds to believe that the company is financially distressed, but the board has not adopted a resolution [to commence business rescue] the board must deliver a written notice to each affected person [such as creditors], setting out [certain prescribed information] and its reasons for not adopting a resolution [to commence business rescue].”
This sounds easy enough: Simply tell your creditors that you’ll continue operating the business, despite experiencing the temporary financial difficulties, and everything should be all right in due course. Right?
In term section 345 of the Companies Act 1973, a creditor can apply for the liquidation of a company if it can prove the company is unable to pay its debts; and it has been held by the courts that an admission by a company that it is unable to pay its debts is indeed sufficient proof. The same applies to an application for a court order to force a company to commence business rescue, in terms of section 131 of the Companies Act 2008.
So, sending out the notice in terms of section 129(7) could potentially trigger an application for the liquidation of the company or for the company to commence business rescue (both of which you wish to avoid). But the section is prescriptive: the board must send out the notice.
Hence, the rock and the hard place: breach the Companies Act which could result in personal liability for the directors, or potentially trigger a liquidation application or a forced business rescue application.
Let’s take a step back and consider some aspects in more detail:
When is a company financially distressed?
In section 128(f) of the Companies Act 2008 the term “financially distressed” means that it appears to be:
i. reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months, or
ii. reasonably likely that the company will become insolvent within the immediately ensuing six months.
The test in subsection (i) is a subjective test to be applied by the board based on objective criteria relating to the factual situation of the company.
It is, however, not clear whether the reference to “insolvent” in subsection (ii) refers to a commercial insolvency (where a company cannot pay its debts as they fall due), or a factual insolvency (whether the company’s assets exceed its liabilities). It is submitted that companies that foresee either factual or commercial solvency in the ensuing 6 months are affected by this section.
Once it has been established that your company is financially distressed, the second question is whether there are reasonable prospects of the company being rescued, given assistance in the form of business rescue proceedings, particularly a moratorium on legal action against the company.
If the answer to this second question is negative, then you may need to consider filing for voluntary liquidation of the company. Failing to do so could mean reckless trading, and directors being held personally liable for the debts of the company. At this point you should seek legal assistance.
But when there is a prospect of rescuing the company, the decision whether or not to commence business rescue must be considered. And the pertinent question raised here: Will your creditors be sympathetic to your position, given the national lockdown, the total decline in economic activity and the hope that business will eventually pick up again to a level where the company can service its debts?
Being financially distressed is, for obvious reasons, not a great place to be. Section 129(7) doesn’t make it any easier. Companies need to consider their position carefully and seek legal assistance in order to act appropriately, depending on their specific circumstances.