Why SA state owned enterprises should consider business rescue

As State Owned Enterprises (SOEs) continue to struggle under severe financial pressure, perhaps it is time for them to consider business rescue to alleviate continued financial distress and to avoid potential personal liability of directors who continue to run these companies and rely on the inevitable call up of a government guarantee.

This is according to Dr Eric Levenstein, director & head of the business rescue and insolvency practice at Werksmans Attorneys, who said that entering business rescue could be the first step to financial rehabilitation as president Ramaphosa noted that SOEs simply cannot borrow their way out of financial difficulty.

Many SOEs are financially distressed and if so, their boards are obligated to consider the definition of financial distress and further conduct a factual enquiry to determine whether or not the company is factually insolvent or commercially insolvent.

As recently reported, Eskom had forecast a R10 billion negative cash flow for the first week of February 2018, but was saved in recent days from the brink of defaulting on its debt by a one month R5 billion bridging facility provided by the Public Investment Corporation (PIC).

“Without it Eskom’s going concern status would have been potentially jeopardised, with Eskom being at risk for defaulting on its debt covenants with those financial institutions holding Eskom paper. Other SOEs are in similar financial distress.

“SOEs that find themselves in a precarious financial position and where they might well be unable to meet financial obligations as and when they fall due for payment, might well be candidates for business rescue.

“Directors of SOEs are obligated to consider the formal business rescue procedure or, at the very least, consider sending out a section 129(7) notice, placing all creditors on notice that the board is not proceeding with a resolution to place the company into business rescue, but has resolved to rather continue with the conduct of its business,” said Levenstein.

If so, the board must provide cogent reasons for not adopting a business rescue resolution.

Werksmans Attorneys pointed out that many boards rely on state guaranteed funding and call up guarantees to place the company into a financially viable position. Of course, if all the SOEs that are financially distressed call upon their government guarantees, the consequences of such call up could prove to be financially unsustainable on the South African fiscus. Whether or not government guarantees will be met, particularly where there has been mis-governance at board level, is open to question.

There is an argument that notwithstanding SOEs continued reliance on government guarantees, such ongoing reliance might still mean that the company is financially distressed,” said Levenstein. The question will be whether or not state guarantees can ensure that all the debts due by the company can be repaid, or whether certain creditors will remain unpaid.

“What is important for directors of companies that are financially distressed (including SOEs) to consider is that in terms of section 22 of the Companies Act, a company must not “carry on its business recklessly, with gross negligence with the intention to defraud any person or for any fraudulent purpose”.

“Directors at SOEs must take this section into account when determining whether or not it should continue to trade without the protection of a section 129(7) notice or, for that matter, filing for business rescue,” said Levenstein.

Werksmans Attorneys said that in terms of section 218, any person (including directors) who contravene any provision of the Act, is liable to any other person for any loss or damage suffered by that person as a result of that contravention. Therefore, a failure to send out a section 129(7) notice or filing for business rescue when a company, such as an insolvent SOE, continues to trade and take credit from suppliers, could result in individual directors being sued for damages in due course.

Generally, the prospect of SOEs entering the business rescue process remains uncertain. To date, we have not seen any SOE enter into the business rescue process, notwithstanding that the business rescue legislation has been operative since May 2011.

“What is clear is that there is workable restructuring mechanism, namely Chapter 6 of the South African Companies Act, which remains available for use by financially distressed companies. Notwithstanding, we are not seeing boards of SOEs using the advantages of the process to their benefit.

“SOEs appear willing to rely on the South African government to bail them out and, as we have seen in the case of SAA, on a recurrent basis.

“South Africa has very competent independent practitioners who have a great deal of restructuring expertise and a skill set which can assist in the process of restructuring financially distressed SOEs, on a robust and practical basis.

“This would allow the financially distressed SOE to exit on the other side of the process on a solvent basis, with jobs being preserved, together with the advantages of placing a profitable SOE back into the South African marketplace with obvious benefits to all,” said Levenstein.

Read: Here’s how much money state-owned companies owe in loans to SA banks

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Why SA state owned enterprises should consider business rescue