Learning from Edcon’s misfortunes

Edcon, one of southern Africa’s largest non-food retailers, which has operated for 90 years, has been placed in business rescue. This has significant consequences for retail in South Africa as well as for many stakeholders, including thousands of employees, creditors and shareholders. The outcome of this process will not be known for some time.

There are important insights in this development for all businesses facing a future likely to be fraught with uncertainty and challenges, particularly in the wake of Covid-19. Businesses that act swiftly may endure.

Recent background

The principal divisions of Edcon are Edgars, Jet and Thank U. Thank U includes credit, insurance, cellular, e-commerce and Edcon's loyalty programme. Edcon also previously owned CNA, but on 4 February 2020 announced the sale of that division (comprising 167 stores) to a consortium majority owned by Astoria Investments.

In February 2019, Edcon was recapitalised. Management also announced a turnaround plan which would focus on store rationalisation, re-alignment of the property portfolio, tight cost management, better customer focus and growing the credit business and customer base.

The turnaround plan was undermined by economic and political challenges, constrained consumer spending and competition. These difficult trading conditions were compounded by the Covid-19 crisis. On 26 March 2020, Edcon announced that turnover had fallen by 45% compared with the same period last year. Its failure to meet its March sales targets and the expected difficulties in collecting its debtors’ book meant that Edcon only had sufficient liquidity to pay salaries. Management forecast the group would lose a further R800 million as a result of the lockdown, adding to the pressure on liquidity.

On 29 April 2020 Edcon announced it had been placed under business rescue. This was not much of a surprise, given its inability to trade from its various stores during the lockdown period and its financial performance up to that point.
Now Edcon is under business rescue, control and management of the company vests in a business rescue practitioner (BRP) who will have the unenviable task, in consultation with key stakeholders, of developing and implementing a business rescue plan. The plan will either allow Edcon to trade out of its financial difficulties or provide a better return to creditors than they would have received from an immediate liquidation.

Given the magnitude of the Edcon business, the BRP will be working closely with Edcon's management. Although the Companies Act provides that the BRP must publish a plan within 25 business days of his appointment, it is almost certain that this time period will be extended by Edcon’s creditors, as the statutory time period is considered insufficient for a BRP to undertake the necessary investigations and discussions to publish a viable business rescue plan (particularly in a business the size of Edcon).

The business rescue process brings about a legal moratorium, subject to certain exceptions, where, broadly, no creditors of Edcon can institute or proceed with legal proceedings to enforce their rights. The moratorium does not prevent any creditor from enforcing rights against any guarantor of the company in business rescue. In the interim, suppliers to the company may find themselves without any legal recourse against the company, and in the long run with only a concurrent claim that will be subject to a significant compromise.

In addition to the legal moratorium, the BRP may exercise his/her right to suspend or, with the leave of the court, cancel any obligation of the company arising out of any agreement to which the company was a party prior to the commencement of the business rescue and which would become due during business rescue, and which the BRP believes is unduly onerous.

Unpacking the effect on stakeholders

Several Edcon landlords across South Africa may find themselves with a tenant unable to pay rental during the business rescue process and find that their pre-commencement claims are subject to a significant compromise.

Secured lenders (for example, a creditor who has taken a cession of Edcon's debt, or who holds a notarial bond registered in its favour over the assets of Edcon) will have some form of security to rely upon and from which to obtain payment, although there is always a risk of a shortfall, depending on the nature and value of the secured assets. As a result, secured lenders may be tempted to provide post commencement finance (PCF) in the hope of improving their position. This will no doubt only be considered where there is additional security available (which is unlikely), or where current secured lenders are prepared to subordinate their debts to the PCF providers (although we do not see this happening in practice).

Ordinary trade creditors will only have a vote in the business rescue process in respect of their pre-commencement debts and will probably face a significant compromise of those claims. The upside for all creditors (and in this regard, suppliers) is that a successful rescue of Edcon will hopefully result in future trade and opportunities to recoup losses through future business. The rights of many secured lenders may well be governed by various inter-creditor as well as subordination agreements. Secured creditors are likely to seek to clarify their ranking in terms of their inter-creditor agreements, if they have not done so already, as well as to establish what rights they have in regard to the voting on any business rescue plan to be put forward.

Employees will face a particularly difficult time, given that their continued employment is uncertain and there is a muted job market. The Companies Act provides them with some protection, because the BRP is not allowed to suspend or cancel any term of their employment contract. Any unpaid salaries during the business rescue process are treated as PCF. Employees are also entitled to form an employees' committee which can liaise with the BRP as well as make representations to the general body of creditors prior to the voting on a business rescue plan. Given the large number of employees that may lose their livelihood, it is important that their voices be heard. The Labour Relations Act remains applicable and employees must be dealt with in terms of this Act.

Finally, shareholders may find themselves looking in from the cold as they will only have a right to vote on the business rescue plan if it alters the rights of any class of holders of the company’s securities.

Edcon’s business rescue can also have an unintended knock-on effect on suppliers and supply chains, who may also go into business rescue or liquidation as a result of Edcon's non-payment of debt.

Avoiding the same fate

To avoid an outcome similar to Edcon’s, businesses should be aware of poor financial outcomes following key management decisions; macro-economic events and their impact on key customers and clients (Covid-19, for example); the inability to adapt to a changing market; declining credit quality; the inability to settle debts timeously (liquidity issues); over-leverage; lack of investor/key supplier and/or customer support; and impending covenant breaches.

Any of these indicators could signal potential distress which should trigger a company’s board to take proactive action and seek assistance promptly from appropriate restructuring experts. Boards that respond quickly may be able to turn the tide earlier.