To circumvent liquidation, proactive engagement with creditors at the early stages of financial distress is imperative

It is well documented that the COVID-19 pandemic is taking its toll on businesses. Commerce in most sectors are fighting to keep their doors open, grappling with creditors to avoid winding up proceedings and its far-reaching implications.

In the past few months our offices have experienced a significant increase of queries relating to creditors threatening with liquidation proceedings. In this article we explain what can be done in these situations.

The impact of COVID-19

In a recent survey by Stats SA, the national statistical service of South Africa, conducted during the lockdown, they asked a total of 707 businesses in the formal sector how the current crisis is affecting their business operations. In their response to the survey, the businesses outlined the pandemic’s detrimental impact on turnover, trading, workforce, imports and exports, purchases and most importantly, the business survival.

The outcome is an unfortunate indicator of Businesses being confronted with insolvency and many critics believe the impact is much greater.  Here are some of the key findings:

  • Four in ten businesses conveyed that they cannot continue to operate:

42.4% of the respondents indicated that they will not have the financial resources to continue with their operations, with 54% confirming that they will only be able to survive without a turnover for one to two months.

  • Almost half of responding businesses have temporarily closed their doors: 

The hospitality, construction, manufacturing, trade and mining reported the highest percentages of temporary closure.

  • Five in six businesses have experienced a drop in turnover:

85.4% of the participants indicated that during the period of March to April 2020, turnover was below the normal range.

  • Almost two-thirds of businesses feel that this pandemic will be worse than the 2008/09 recession:

The recent findings published by the National Dynamics Coronavirus Rapid Mobile Survey, reported that approximately three million people lost their jobs over the lockdown period in South Africa.

The pandemic forced businesses to enter into unforeseeable and unplanned commercial loan agreements in an attempt to keep the boat afloat and to settle burdensome overheads. Creditors are now implementing legal proceedings against their debtors to save their own businesses through relying heavily on liquidation proceedings. But is this the right legal avenue to follow?

Action of motion proceedings?

To understand the possibility of a creditor instituting legal proceedings, it is important to shortly address the difference between action and application proceedings. A creditor can either institute legal proceedings by application on notice of motion supported by affidavits, or by summons initiating action or trial proceedings. Liquidation proceedings are in the form of motion proceedings.

The most salient distinction is that action proceedings envisage the presentation of facts and evidence verbally in court during a trial, whereas application proceedings envisage the presentation of facts and evidence in affidavits that will be read by a judge before hearing arguments in court on the issues raised in the affidavits.

It is imperative to note that application proceedings are usually heard in court shortly after their initiation, whereas action proceedings may be heard several years after their initiation. Application proceedings are usually disposed of more expeditiously than action proceedings. As a result, application proceedings are generally cheaper and lead to a relatively speedy resolution of disputes compared to action proceedings.

Liquidation proceedings are the easy way out for creditors in need of expeditious results. It may be for this reason that creditors are often advised by their legal representatives to follow this route.

Section 345 Notice of the companies act

The initiation of action proceedings usually commences with a letter of demand, demanding debtors to make payment, following with a summons if payment is not made.

Liquidation proceedings, initiated by creditors, usually originates by instructing the Sheriff of the relevant court to serve a Section 345 notice of the Companies Act on the registered address of the Company. Section 345’s effectiveness lies in the threat of a liquidation application based on the deeming provisions relating to commercial insolvency.

It is trite law that commercial insolvency, being the inability of a company to pay its debts as it becomes due and payable, justifies the liquidation of a company. When faced with a section 345 demand based on an amount that is allegedly due and payable, the options of a company are limited. The Company has 21 days to either pay, secure or settle the amount claimed to the satisfaction of the creditor or alternatively, show on a balance of probability that the alleged indebtedness is disputed on bona fide and reasonable grounds.

If the company neglects to adequately respond to a section 345 demand within 21 days it will run the risk of being deemed to be unable to pay its debts and ultimately face a liquidation application based on its deemed commercial insolvency.

If a company elects to dispute the alleged indebtedness it must send a detailed response within the three weeks allowed for under section 345 of the Act recording the basis upon which the alleged liability to pay is disputed, mindful also of the legal principles that will apply, if a liquidation application is to follow.

Liquidation proceedings are not intended to be used as a means of deciding claims which are bona fide and reasonably disputed. Its foundation lies in the fact that court will not entertain factual disputes in application proceedings because of the need to hear oral evidence to properly adjudicate the factual disputes. An application for liquidation will thus fail if the alleged liability to pay is disputed on bona fide and reasonable grounds.

Creditors frequently exploit the shortcut of utilizing liquidation application proceedings as debt collecting tool with an attempt to scare the debtor to pay immediately. This is a common tactic used by legal representatives to force debtors to pay unrealistic amounts purportedly due.

It has crystallised in numerous of case law that the unjustified attempt to liquidate is a clear abuse of court processes and to be deprecated. Such application will be mala-fide and courts easily grant punitive cost orders against such applicants.

Factual Dispute & Bona Fide Defence:

The question to consider is whether the specific matter can be argued on paper through application proceedings or if oral evidence and witnesses are required to properly adjudicate the matter.

Legal representatives of creditors should, before instituting liquidation proceedings, consider if there is real, genuine and clear factual issues at hand that cannot be realized on paper. Real issue of fact can be described as real, genuine bona fide dispute of fact that can only exist where courts are satisfied that the party who purports to raise the dispute has in his affidavit seriously and unambiguously addressed the facts said to be disputed.

Thus, it is imperative to ascertain and address the facts in dispute and the grounds upon which the dispute is founded.

Conclusion

To circumvent liquidation, proactive engagement with creditors at the early stages of financial distress is imperative. An open line of communication and the right legal team to provide advise and guidance are key.

Companies should immediately obtain legal assistance when faced with an application for liquidation in terms of Section 345 of the Companies Act.

The legal representative will identify if the application is a misuse of legal process or may even recommend alternatives like business rescue proceedings to save your business.