New Act not clear about position of secure creditors in business rescue

© Sebastian Duda – za.fotolia.com

So why is the position of secured creditors in business rescue causing so much stress? At the heart of the problem is that the new Companies Act does not deal expressly with the position of secure creditors in business rescue.

But why should it? Their rights are already secured - or are they?

In the facts of a recent case (DH Industries v Gribnitz), the Plan made provision the discharge of 75.75% of all creditors' claims. If this was upheld, it meant that all creditors, including those with guaranteed claims, would not have been able to enforce their claims. These creditors understandably protested - and applying trite principles the court held that the legislature could not take have intended to have taken away existing rights - and protected them.

Alternative view

But there is an alternative and controversial view. The primary purpose of business rescue is to ensure a better outcome to affected persons (creditors, employees and shareholders) than would be the case in insolvency.

Voting for a Plan is also a creditors' democracy. Creditors, whether secured or unsecured, vote simply according to the value of their claims. The Act therefore expressly a majority of creditors, based on value only, to control the fate of the Plan, and therefore the company in rescue. Secure creditors have their own protection - they can use their own voting muscle (they are often the largest creditors by value) to block a Plan which does not suit them.

The Act could arguably, in the scheme of allowing the opportunity for a large majority of creditors by value - 75% of creditors present and voting is required - could in theory vote out vote a secured claim.

Such an outcome would of course potentially have far reaching consequences. Creditors who have security could in theory, where their claims are less than 25% of the value of all claims, be deprived of such security. This would fly in the face of the sacred concept of the protection of accrued rights as expressed in the Gribnitz case. But is such an outcome, by allowing all creditors equal voting rights, not expressly contemplated in the Act.

SARS not protected

We know that the Act does not protect SARS in business rescue as it does in insolvency - where SARS enjoys an express statutory preference. In circumstances where a sufficient majority of creditors believe that business rescue could be achieved by altering the rights of creditors , then why is this not possible. Surely the very fact that all creditors, including secured creditors, have equal voting rights was intended to protect secured creditors, but not so far as protecting them from the exercise by 75% or more of all creditors of their rights to secure what they believe is a better outcome for all affected persons.

It must be borne in mind that the approval of a Plan expressly binds all creditors. Using purposive approach ie what is the overriding purpose of the legislation. The Kariba case found this to be constitutional, even to the extent that the rights of creditors were altered. The court in Gribnitz did not agree with the Kariba decision. We are none the wiser as to a decisive or correct position.

Deprivation of the rights of a secured creditor in certain circumstances may be regarded as extreme - but the chapter on business rescue was intended to be a bold commercial intervention. Perhaps the Act does not go far enough in making it clear - either way - what is intended. Either the language does not match the purpose, or the Act has a different purpose!

Another controversial issue is the ranking of creditors' claims in business rescue, particularly as regards the position of pre business rescue secured creditors. The Act attempts to provide for this in s135, but does not do so with sufficient clarity. Another recent controversial case, Merchant West, indicated that even unsecured post commencement finance outweighed pre business rescue secured claims.

Purpose of legislation

At first blush this would, once more, seem to be an unlawful deprivation of the rights of secured creditors. But if the purpose of legislation is to achieve business rescue then should a practitioner not be able to borrow money to keep the business of the company alive. One would not question a blood transfusion if this was the only way to save a patient.

But there is at least one - possibly critical - difference in the two situations. The legislature expressly contemplates the voting of a Plan to be the democratic exercise of rights according to value. It is one thing if the required majority is of the view that rights of security need to be altered to rescue the company - it is possibly quite another for a practitioner to take this step before these rights are exercised. To counter this, the Plan could ratify or reject the practitioner's decision - or does his decision bind the company since he is, by law, equivalent to the CEO of the company whilst in rescue?

These are all issues which need to be tested - probably in the highest courts of the land. Acts are intended to be clear, but seldom are in every respect since they cannot always foresee all their practical consequences. The crucible of reality eventually discloses, through judicial refinement, their true intention.