As more financially-distressed businesses seek solutions after Covid-19, the pros and cons of business rescue must be weighed up against those of liquidation to protect the interests of all involved
For many years, restructuring and insolvency practitioners have debated whether a structured winding-up, via a business rescue process, is the best option for a company in distress, or whether, if it is clear that a business cannot be returned to solvency through a business rescue, it should simply be placed into liquidation.
In the current Covid-19 environment, this question is more important than ever.
The question arises as a result of the definition of business rescue under section 128(b)(iii) of the Companies Act, which states:
"(b) “business rescue” means proceedings to facilitate the rehabilitation of a company that is financially distressed by providing for—
(iii) the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximises the likelihood of the company continuing in existence on a solvent basis or, if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company;" (emphasis added)
For a company to commence business rescue proceedings voluntarily, its board may pass a resolution that the company voluntarily begin business rescue proceedings and place the company under supervision, if the board has reasonable grounds to believe that: (a) the company is financially distressed; and (b) there appears to be a reasonable prospect of rescuing the company.
Since the definition of business rescue contemplates an alternative scenario to the survival of the company on a solvent basis, a "successful" business rescue will be one which results in a better return for creditors or shareholders than would result from the immediate liquidation of the company.
Many businesses today meet the definition of "financial distress" as contemplated in the Companies Act, through no fault of their own and solely as a result of the impact of Covid-19 and government-imposed regulations. Many will have strong relationships with their supply chains and be alive to the impact that the cessation of their business or non-payment of outstanding invoices will have on suppliers.
In the circumstances, where the continuation of a financially-distressed business on a solvent basis after a business rescue may not be possible, the boards of these companies may consider business rescue as an alternative to a liquidation, expecting to achieve at least a better return for their creditors than they would receive from an immediate liquidation of the company.
Although business rescue is a value-destructive process, the general view is that it is less value destructive than a liquidation. A business rescue might achieve a better return than a liquidation for several reasons. These include: post-commencement finance being made available to fund the process, which is given a preferred status; a better sale value for assets; and a better return for employees. Another reason could be that the company operates in a heavily-regulated industry, which requires licences. The most common example is the mining sector. We are seeing more and more reputable businesses entering business rescue for strategic reasons and it appears that the stigma of business rescue is not as bad as it was. This further improves value retention versus a liquidation.
For example, a mining company’s mining right is extinguished on the final liquidation of the company holding that right (except where the right is encumbered as security for a mortgagee bank) and it reverts to the state. As a result, a liquidator cannot extract any value from the mining licence held by the company prior to its liquidation. This is not the case in a business rescue, when an unencumbered mining right may be ceded or sold, with the required ministerial consent, to another holder. So although the mining company may not be able to survive in its current guise, through a business rescue process more value can be achieved through the realisation of the asset - i.e. the mining right.
Similarly, in the broadcasting and telecommunications sector, for example, a licence may be suspended or cancelled by the regulator when the licensee is placed in liquidation or is placed under "judicial management". Once the suspension or cancellation has taken effect, the licensee must immediately cease to provide any service in respect of which the licence was granted. Although the relevant legislation does not refer to "business rescue", and although there is a school of thought that suggests that a reference to judicial management includes business rescue, a suspension or cancellation is unlikely in the context of business rescue.
In the case of a company which, despite being financially distressed, has a few months runway before it needs to close its doors, with no realistic prospect of a return to solvency in sight, a structured winding down in a business rescue may well be the best option to achieve maximum value from its assets. Although companies can trade in a liquidation scenario, arguably trading in a business rescue scenario destroys less value. This is particularly the case given the timelines from the commencement of business rescue to the appointment of the business rescue practitioner, versus the timelines from the commencement of a winding up to the appointment of a liquidator.
The big issue however, is that someone will have to fund that process, which includes the business and the costs of the business rescue practitioner, whereas in a liquidation the business effectively ceases on a liquidation order being granted and the liquidator earns his remuneration through the realisation and disposal of assets. It is also worth mentioning that insolvency enquiries into voidable dispositions or the conduct of directors do not occur in a business rescue. That can make a business rescue more attractive to concerned directors, although unattractive to creditors who hold strong views in this regard.
With the above in mind, there is certainly no “one-size-fits-all” answer. Each matter must be evaluated on the facts and circumstances of the financially-distressed company. The directors and even the proposed business rescue practitioner must make a responsible decision to commence business rescue and accept the appointment. If the company is best dealt with in a liquidation, then that option must be pursued.