A company in financial distress presents its creditors with a compromise – pitfalls creditors should be aware of

Both liquidations, and the subsequent winding up of the affairs of a debtor company by its liquidator, and business rescue proceedings are stringently regulated by legislation and liquidators and business rescue practitioners are subject to oversight by the Master of the High Court (Master) and the Companies and Intellectual Property Commission (CIPC) respectively. The same cannot be said in the case of a company proposing to enter into a compromise with its creditors.

Section 155 of the Companies Act, No 71 of 2008 (Act) sets out the procedure to be followed and requirements to be met for a compromise to be proposed to creditors of a debtor company. The majority of the provisions of s155 relate to formal and procedural requirements, and once the requisite majority vote has been obtained at a meeting convened for this purpose, there is little left for a disgruntled creditor to do. The only option available to such creditor is to oppose the sanctioning of the scheme of compromise by the court , which is required to make it final and binding on all the creditors of the company. To be successful with such opposition, a creditor must show that it would be just and equitable for the court to reject the scheme - not an easy burden to meet. Having already compromised its claim where the majority of the debtor company’s creditors voted in favour of the compromise, is a minority creditor to then still approach a court, incur legal costs, to try and make out a case that the compromise is not just and equitable with a substantial evidential burden in proving this?

Should creditors be presented with a compromise by a debtor company, it may at first sight seem like a “quick-fix” and easy way to acquire immediate financial relief for a portion of its debt, however, there are a few factors weighing against voting in favour of a compromise. In a compromise, creditors will indirectly be held liable for the costs to pay the receiver, appointed to administer all the claims of the creditors of the debtor company and the compromise process, despite such receiver not being subject to the same legislative regulation or oversight required from the Master and CIPC.

The consequences of a compromise are not too different from that of the adoption of a business rescue plan, being that creditors in both instances, if they vote in favour of the compromise or business rescue plan, will compromise their claims against the debtor company and will have no further claims against the debtor company in terms of that specific debt. One major disadvantage of a compromise is the loss of a creditor’s right to hold officers and directors liable for any contravention of the Act. A compromise is, however, in one instance more beneficial than business rescue: the Act makes provision for a creditor to retain its right to go against the surety of the debtor company.

Creditors can conceivably waive their rights in terms of the proposed compromise, to proceed against the directors in terms of s424 of the old Companies Act, No 61 of 1973 (Old Act) in regard to reckless trading by the director pre compromise. Creditors will have no investigative power, through the receiver of the debtor company, to investigate reckless or negligent conduct of officers and directors of the debtor company. A compromise can therefore be a safeguard for reckless officers and directors to avoid any liability. There will also not be any opportunity for creditors to have a transaction, liable to be set aside in terms of insolvency legislation, investigated and set aside. Therefore, if there are facts to substantiate a possible successful enquiry in terms of s424 of the Old Act, then creditors are advised to vote against the compromise and rather institute an application for the winding up of the company. A liquidator, unlike a business rescue practitioner, has the necessary powers to investigate the dealings of the company prior to liquidation and where necessary, to set aside any transactions which may be voidable or seek to hold the directors of the company liable in the event of fraud, reckless trading or other contravention of the law.

Creditors, who receive an offer of compromise, must seek legal advice on the terms of the compromise before deciding whether to vote in favour of such compromise, or rather apply to court to commence business rescue proceedings or if the facts are evident that the company is unable to pay its debts, apply to court to wind-up the debtor company.