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A moratorium in business rescue and compromise – how does it work?

Fasken
Reading Time 5 minute read
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Overview

Chapter 6 of the Companies Act, 2008 affords a financially distressed company a fighting chance to restructure its financial obligations and avoid the destruction of value through liquidation for the duration of its formal chapter 6 business rescue proceedings. Such a moratorium is not available if a company seeks to conclude a restructure through a compromise or arrangement with all its creditors or members of any class of creditors.

The statutory moratorium is a protective bubble giving the company breathing space, in a chapter 6 environment, to find a restructuring solution. It is a key building block for the success of such a formal restructure. It halts, with certain exceptions, all legal proceedings and claims against the distressed company.

We will, in this first of a series or contributions on this topic, cover the application of the statutory moratorium in a formal chapter 6 restructure and its non-application in the informal compromise arrangement or contract between a distressed company and its creditors or a class of creditors.    

Business Rescue

A moratorium is automatic and triggered at the commencement of a formal chapter 6 business rescue. It halts the institution or continuation, during the business rescue proceedings, in any forum, of legal proceedings, including any enforcement action (a concept that has grasped the attention of our courts), against a financially distressed company or in relation to any property belonging to a financially distressed company or lawfully in its possession. A third-party company that is not the legal owner or in possession of property of a company under business rescue cannot rely on the moratorium as a defence to a claim against it. A company also cannot pay a judgment debt under a writ of execution after the business rescue has started.

On the face of it, this moratorium does appear to be wide and embracing of a total halt of all legal steps in favour of a distressed company (but, as we will unpack in later contributions, there have been significant inroads into the moratorium with the result that the bubble has been pierced and is not as strong as one would expect in a restructuring environment). This type of moratorium is also different from other jurisdictions where there is a time limit on the moratorium (something we believe should be introduced into chapter 6 to address the legitimate concern of many stakeholders around the length of chapter 6 business rescue proceedings in South Africa).

This moratorium is subject to a number of exceptions. Legal proceedings and enforcement action may be instituted or continued with in the following instances:

  • either with the written consent of the business rescue practitioner or with the leave of the court (this could open the door for the holder on an unperfected general notarial bond, in given circumstances, to approach a court to perfect its security interest and elevate its status to a secured creditor);
  • set-off is allowed against any claim made by a distressed company in any legal proceedings, instituted before or after the commencement of business rescue proceedings;
  • in relation to criminal proceedings against a financially distressed company or its directors or officers (a sensible and legitimate exception as it does not impact on the objectives of the restructure);
  • in relation to any property or right over which a financially distressed company exercises the powers of a trustee (likewise, a sensible exception as it does not impact on the objectives of the restructure); or
  • proceedings by a regulatory authority in executing its duties are allowed after written notification to the business rescue practitioner.

Guarantee or suretyship by a company entering business rescue

During business rescue proceedings, a guarantee or suretyship by the distressed company in favour of any other person may not be enforced by any person against the company, except with leave of the court and in accordance with just and equitable terms that the court, given the circumstances, may order. This is an explicit and clear stay of a suretyship or guarantee given by the company and does not have the same effect in relation to a suretyship undertaken by a third party for the obligations of any indebtedness of a distressed company seeking protection under chapter 6. 

Compromise or Arrangement with creditors

A company, irrespective of whether it is financially distressed and unless it has been placed under business rescue, may propose an arrangement or compromise of its financial obligations to its creditors. The adoption by a company of this informal restructuring tool does not trigger a stay or moratorium, leaving creditors open to instituting legal proceedings to frustrate the objectives of a restructure driven by a distressed company. Only when the compromise or arrangement is adopted and sanctioned by a court (it being doubtful whether the sanctioning is required to complete the binding effect of an adopted compromise or arrangement, given the wording of section 155 of the Companies Act, 2008) are creditors bound by the terms of the compromise or arrangement in respect of any claims they may have against the company. This is arguably the main reason why this tool has not been used very much in practice, as creditors are at liberty to institute legal proceedings at any time while the compromise or arrangement is being sought. It is the reason why the predecessor of business rescue, judicial management, gathered dust and was not widely used resulting in many a viable business going through liquidation. 

Any compromise or arrangement adopted or sanctioned does not affect the liability of any surety who has stood in for the debts of the distressed company.

Look out for our next article in which we will unpack this key building block for a successful corporate restructure in more detail.

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