Companies facing financial distress suffer from rapidly growing tax liabilities, increase in debt, lack of cash flow, and a breach of contracts. Financial distress should cause a business to consider business rescue before its effects become irreversible, which could lead to the company's liquidation.
The fiduciary duties and responsibilities of a director are governed by Section 76 of the Companies Act 71 OF 2008 (hereinafter referred to as "the Act") and South African common law. Further, directors are required to consider the King IV Report on Corporate Governance ("King IV "). Each individual director has a fiduciary responsibility to act in the best interest of the company and consider the impact on all stakeholders, not just shareholders. Therefore, there is a responsibility not to act recklessly.
As such, to fulfil his or her duties, a director is obligated to vote in favour of business rescue if:
· In the next six months, it seems reasonably unlikely that the company will be able to pay all of its debts, as they fall due;
· they believe that should the company continue to operate at the current levels of financial distress, the company is likely to become insolvent within six months
When deciding on whether to place the company under business rescue a director must also consider their personal liability. Directors may be held liable for any losses, damages or costs incurred and sustained as a direct or indirect consequence of acquiescing in carrying on the business despite knowing it was conducted in a reckless manner. This provision is contained in Section 22 of the Act read with Section 77.
Legal implications of placing a company under business rescue proceedings effectively places a Moratorium on legal proceedings. This means creditors cannot take any legal action against the company or enforce any security over its assets without the court's or business rescue practitioner's permission. Section 136(2) of the Act provides that the business rescue practitioner has the power to entirely, partially or conditionally suspend the obligations of the company that arises under an agreement to which the company was a party at the commencement of the business rescue proceedings; and would otherwise become due during those proceedings.
The financial advantages of business rescue proceedings are that it may provide a better return for creditors. The opportunity to reorganise and restructure the distressed organization may ensure better returns for parties all involved as opposed to if the organization were liquidated. Business rescue may help the company achieve solvency and avoid liquidation.
Voting against business rescue may increase the risk of liquidation later. A company under business rescue is preferable to a liquidated company.
Directors may be held liable for any losses, damages or costs incurred and sustained as a direct or indirect consequence of acquiescing in carrying on business despite knowing the business was conducted in a reckless manner.
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