Tanyaradzwa Milne Manhombo
INTRODUCTION
In terms of the Insolvency Act [Chapter 6:07] (hereafter the Act) The purpose of the corporate rescue procedure is to facilitate the rehabilitation of financially distressed companies. The rehabilitation is achieved through the following three processes: displacement of the board of directors and management of the company by the corporate rescue practitioner; moratorium on claims against the company; and the development of a corporate rescue plan to either resuscitate the company or if that is not possible, to facilitate a higher return to creditors and shareholders than they would get through insolvency.
In March 2020, the Government of Zimbabwe declared the Coronavirus disease (COVID-19) a State of Disaster and imposed a national lockdown. COVID-19 measures have resulted in trade and tourism restrictions, low commodity demand, disrupted supply chains, a slowdown of global financial flows including credit availability, remittances and portfolio investments.
Amidst this global, regional and national economic crisis commercial entities face what is known as primary and secondary insolvency. The state of insolvency refers to a situation where a person, whether natural or juristic, is unable to settle financial obligations as and when they become payable (commercial insolvency). This is distinct from a situation where liabilities exceed assets (factual insolvency).
Primary insolvency is a situation where an entity has operational challenges such as insufficient raw materials which precludes the company from producing at optimal capacity. This results in production below breakeven capacity thereby causing financial stress as the entity cannot produce enough to satisfy all its liabilities. Secondary insolvency is a situation where an entity cannot satisfy its liabilities because of delayed payments by its own creditors. In the case of Zimbabwe both scenarios are common in the current environment.
Corporate rescue is therefore a mechanism to prevent commercial entities from being wound-up and dissolved. However, the current provisions of the Act are not suitable for rehabilitating and rescuing financially distressed companies in this COVID-19 induced economic crises.
It is suggested that the following temporary measures are necessary to help financially distressed firms to avoid insolvency.
1. Duty to notify affected persons
Corporate rescue proceedings may be initiated by voluntary means through resolution of a board of directors. In the case of voluntary corporate rescue, the board may resolve to commence corporate rescue where the company is financially distressed and there appears to be a reasonable prospect of rescuing the company (sections 122(1)(a)-(b)).
However, the use of the term “may resolve” implies that this is a discretionary and not a mandatory power by the board. The challenge arises in circumstances where the board of directors elects not to commence corporate rescue, despite there being reasonable grounds for believing that there is financial distress. This is because the board must notify each affected person on its reasons for its decision (section 122(7)). The purpose of this provision is to furnish affected persons with information and proof to enable them to apply for corporate rescue where the board elects otherwise.
An immediate notice of this nature may deprive a board of sufficient time to negotiate an informal framework or pre-packaged corporate rescue plan. The advantage of these pre-packaged plans is the avoidance of protracted negotiations and creditor buy-in. The corporate rescue plan is also more likely to succeed.
The danger with this requirement is the potential damage to the company’s reputation given that a prospect refers to something which may either occur or not eventuate. A section 122(7) notice has the potential that credit and overdraft facilities would be cancelled; suppliers will insist on cash on delivery; and creditors will demand immediate payment of claims.
Faced with COVID-19 challenges, it is submitted that section 122(7) may be counterproductive. This finding is based on the fact that jittery creditors, who themselves would most likely be facing liquidity challenges, would prematurely and hastily push otherwise solvent and viable firms into insolvency at the first sign of trouble.
2. Suspension of Director Liability
The Act does not appear to have a direct sanction or penalty for contravention of section 122(7). However, section 117 and 118(1) of the Act impose personal liability on directors for fraudulent or reckless, and insolvent trading. Failure to issue such a notice would be reckless and could infer an intention to defraud the company’s creditors.
In the current COVID-19 economic climate, it is recommended to suspend the duty to notify, to prevent a flood of insolvencies. This should be coupled with a suspension of the corresponding director liabilities for a certain period of time. It should be noted that the envisaged suspension would primarily relate to insolvent trading as opposed to fraudulent and reckless trading.
Examples of such legislation is found in The United Kingdom (UK) Corporate Insolvency and Governance Act 2020, in which director liability in respect of wrongful trading (insolvent trading) is excused during the period between March-September 2020. In South Africa, the Companies and Intellectual Property Commission (CIPC) has temporarily suspended its powers to issue compliance notices in circumstances of suspected fraudulent, negligent or reckless trading. For the reasons outlined above, it is recommended that the lawmaker temporarily suspends the liabilities and duties of directors in respect of negligent, reckless or fraudulent trading.
3. Position of Guarantor and Surety
Once corporate rescue proceedings are commenced there is an automatic moratorium on legal proceedings, including enforcement actions against the company in any forum. A moratorium is one of the means through which a financially distressed company is to be rehabilitated and is a crucial element in any corporate recue framework. The moratorium extends to claims against a company based on a guarantee or suretyship. Such a claim can only be instituted with leave of a court.
However, section 126(2) of the Act does not extend to sureties or guarantors. This is because the moratorium is a personal right. Furthermore, regardless of the contents of a corporate rescue plan, a creditor still retains its rights against sureties for the debts of a company in corporate rescue.
This is a potential loophole which creditors may exploit to the detriment of sureties and guarantors. In light of the economic difficulties caused by the Covid-19 pandemic it is argued that a moratorium should, in the interim, be extended to sureties and guarantors when corporate rescue proceedings are commenced. A surety or guarantor, whether natural or juristic, deserves just as much protection as the principal debtor company in corporate rescue.
4. Suspension of Contracts
An important feature of corporate rescue is the bar against variation of employment contracts during the course of corporate rescue proceedings. Any variation or retrenchment should be in terms of the relevant labour law. This statutory bar on variation of contracts does not apply to all other types of agreements. The corporate rescue practitioner may partially, conditionally or entirely suspend any obligation or agreement to which the company is a party immediately prior to the commencement of corporate rescue. The agreement or obligation would have to fall due during the course of corporate rescue.
It is clear that this provision seeks to balance the need for the company to restructure its affairs whilst balancing the need for employees to be protected in the process. However, in light of Covid-19 induced challenges on business, it is argued that section 129(1) of the Act be suspended to enable the corporate rescue practitioner to partially or entirely suspend employment contracts as well.
To balance the social needs and welfare of employees, an employer company under corporate rescue would be required to pay employees a survival allowance not less than twenty five percent of the gross income of the employee. This would provide a sufficient safety net for employees and businesses to survive the Covid-19 economic crises.
5. Post Commencement Finance
Post-commencement finance refers to funding that is made available to a company after the commencement of corporate rescue proceedings for purposes of enabling a company to continue trading. This finance is necessary for successful corporate rehabilitation frameworks for the payment of employees, maintain supplies of goods, and meet overhead costs. However, financiers are averse to lending to companies under rehabilitation because of the inherent risks associated with companies in financial distress.
Section 128(2) of the Act enables a company undergoing corporate rescue to obtain post-commencement finance through the hypothecation of its assets that, “to the extent that it is not otherwise encumbered”. Claims by post-commencement finance creditors will only be paid after the corporate rescue practitioners claim for remuneration and expenses. The same priority applies to employees claims as well, regardless of whether or not the post-commencement financiers claim is secured by an asset.
Unfortunately, because of the effects of sections 127(3) and 128(2) of the Act pre-existing security-holders are not subordinated to post-commencement security holders which is contrary to the intended purpose. In response to this very real challenge, the USA Chapter 11 Bankruptcy Code provides for what is referred to as “super-priority” or “super-preferences”. A super-priority status refers to provisions which rank post-commencement claims over pre-commencement creditors resulting in preferential ranking for post-commencement loans.
A further drawback is in the statutory ranking of creditors which is a disincentive to financiers and precludes them from extending post-commencement finance. This is because the statutory ranking in section 128(3) of the Act equates pre-commencement and post-commencement creditor claims. In view of the Covid-19 induced economic crises, it is recommended that, on an interim basis, the Legislature considers providing post-commencement financiers super-priority status in order to provide an incentive to fund companies in financial distress.
6. Duration of Corporate Rescue
Corporate rescue proceedings are meant to be as short and efficient as possible to ensure that creditors’ debts and obligations are settled at the earliest possible period. In light of that, corporate rescue procedures should not exceed a period of three months (section 125(3)). In situations where corporate rescue proceedings cannot be completed within a three-month period then the corporate rescue practitioner may extend the duration through an order of court (section 125(3)). During the course of the extension period, the corporate rescue practitioner is required to prepare a progress report on the status of the rescue on a monthly basis.
The first point is that COVID-19 is a pervading reality with no clear end in sight. That said, the three-month period is too short given the challenges induced by COVID-19. It is recommended for the period to be extended to twelve months with a requirement for the rescue practitioner to file a report with the Master of the High Court requesting for a further extension if the need arises.
This recommendation is borne from the fact that the requirement for the corporate rescue practitioner to make an application for an extension beyond three months is expensive and burdensome. Furthermore, the requirement to provide monthly reports to all affected persons is a further administrative burden.
7. Management Displacement
Section 130(2) of the Act effectively dissolves the board of directors and places control of the commercial entity in the hands of a corporate rescue practitioner. This is known, in insolvency, as management displacement. However, in the current circumstances it is not the management which has necessarily caused the circumstances leading to financial distress but an external unforeseen factor.
A corporate rescue practitioner comes with great cost and may not be appropriately qualified to manage the affairs of the company. In circumstances where financial stress is induced by COVID-19 it is recommended for management to retain control of the entity under the supervision of the Master of the High Court in what is known as a temporal debtor in possession relief.
8. Conclusion
Some of these proposals have been adopted in other foreign jurisdictions such as the United Kingdom Corporate Insolvency and Governance Act 2020; South Africa Companies and Intellectual Property Commission (CIPC) Regulations; Singapore COVID-19 (Temporary Measures) Act 2020; and USA Chapter 11 Bankruptcy Code.
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