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Advice to companies facing illiquidity as a result of Covid-19

Flowing out of the health and medical consequences of the coronavirus (Covid-19) and the measures being taken to contain and prevent the spread of the disease (including the temporary closure of businesses and the voluntary and compulsory quarantining of employees and management), is the economic fallout and the drying up of cash resources.
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Unless companies have sufficient cash reserves or the ability to source shortfall funding from their shareholders, banks or other financiers, they could well be faced with an inability to pay their debts which inability, strictly speaking, constitutes a ground for liquidation.

What should directors be doing at this time?

Prudent directors should take steps to become fully informed about the financial aspects of the crisis, i.e. is it only a liquidity crisis, is it temporary, is it permanent and what steps, remedies or relief are available to the company to help it through the crisis?

How do they go about doing this?

The Companies Act allows directors to rely on third parties by delegating to them formally or informally the authority or duty to perform one or more of such of the board’s functions as are delegable under law and to secure information, opinions, recommendations, reports or statements including financial statements and other financial data prepared or presented by employees, legal counsel, accountants or other professional persons retained by the company, the board or a committee; provided of course the person dealing herewith has the necessary skills or expertise and the directors reasonably believe that these are matters within that person’s professional competence. These persons include attorneys, accountants, auditors and any other persons possessing the necessary skills and expertise.

Under the new Companies Act, a director’s primary duty is to act in the best interests of the company, not those of its shareholders. Any decision taken by a director should only be taken if the director had a rational basis for believing and did believe that the decision was in the best interests of the company. If in arriving at that belief, the director first sought and obtained expert advice, this would be regarded as commendable.

The Companies Act further provides that wherever a director acted otherwise than with “wilful misconduct or wilful breach of trust” (i.e. recklessly or with fraudulent intent or purpose), a court “may relieve the director either wholly or partly from any liability on any terms the court considers just if it appears to the court that:
  • the director is or may be liable but has acted honestly and reasonably;
  • having regard to all the circumstances of the case, including those connected with the appointment of the director it would be fair to excuse the director”

A viable alternative to the unfortunate closure and liquidation of otherwise sound companies and businesses because of the coronavirus is business rescue. By definition, it is a statutory proceeding to facilitate the rehabilitation of a company that has become financially distressed and provides for the:
  • appointment of a business rescue practitioner to take over the management of its affairs, business and property whilst a temporary moratorium precludes its creditors from instituting legal proceedings against it;
  • proposal by the business rescue practitioner of a plan to rescue the company by way of restructuring its affairs, business, property, debts, liabilities and equity and if it is not possible for the company to continue in existence the business rescue practitioner can sell the business or other assets of the company provided that this results in a better return to the company’s creditors or shareholders than would result from the immediate liquidation of the company.

By definition, the term “financially distressed” means that a company is unable to pay its debts within the next six months (known as commercial insolvency) or that its liabilities will in the next six months exceed its assets (known as factual or balance sheet insolvency).

Business rescue can be achieved:
  • voluntarily – by the board of directors of a company passing a resolution to this effect; or
  • by an affected person (by definition a creditor, a shareholder, an employee or a union of which an employee is a member) applying to court for an order placing the company under business rescue.
Given the prevailing lockdown of our courts, the scope for compulsory business rescue is reduced.

Directors of companies in or facing financial distress should urgently secure expert advice as to whether or not the companies concerned should be placed in business rescue or liquidation or whether alternative steps should be taken such as approaching creditors and seeking indulgences from them, for example, time to pay debts, forgiveness of debts partially or entirely, and the like.

Accordingly, directors who act prudently and diligently, seek advice in order to become informed, and who act honestly and reasonably, and thereafter make decisions after being so informed, should not attract personal liability for any decisions they made, even where the decision appeared in retrospect not to be a good business decision.

Colin Strime, Director Fluxmans Attorneys
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