Financially distressed companies – What about the employees?

Despite the efforts of world leaders, including the South African president, it is becoming clearer by the day that this pandemic will cause thousands of businesses in South Africa to suffer financial distress, which in turn will result in many businesses filing for business rescue or liquidation. One of the questions that we get asked most when companies contemplate whether to file for business rescue or liquidation, is, what about our employees?

In this article, we will consider this question and at the same time try to answer most of the employment related questions that were posted during the first Webinar we hosted on 23 April 2020.

The effect of business rescue proceedings on employment contracts

General position

Section 136 of the Companies Act 71 of 2008 (Companies Act), which deals with the effect of business rescue on employees and contracts, states:

 

“(1) Despite any provision of an agreement to the contrary:

(a)   during a company’s business rescue proceedings, employees of the company immediately before the beginning of those proceedings continue to be so employed on the same terms and conditions, except to the extent that –

(i)    changes occur in the ordinary course of attrition; or

(ii)   the employees and the company, in accordance with applicable labour laws, agree different terms and conditions; and

(b)   any retrenchment of any such employees contemplated in the company’s business rescue plan is subject to section 189 and 189A of the Labour Relations Act, 1995 (Act 66 of 1995), and other applicable employment related legislation.”

Section 136 (2A) of the Companies Act further states that, despite being able to entirely, partially or conditionally suspend the company’s obligations under most contracts that were concluded by the company prior to the commencement of business rescue, a business rescue practitioner is not entitled to unilaterally suspend any provision of an employment contract.

The effects of the provisions listed above are the following:

(i)    As a starting point, when business rescue proceedings commence, the employees of the company will continue to be employed on the same terms and conditions, subject to the following exceptions:

• If changes occur in the ordinary course of attrition (e.g. through resignation for personal reasons or retirement); or
• the employees and the company, in accordance with applicable labour laws, agree different terms and conditions.

(ii)   If a business rescue plan makes provision for the retrenchment of employees, the retrenchment will be subject to section 189 and 189A of the Labour Relations Act (LRA), which are the provisions in the LRA which deal with retrenchments in the normal course.

Companies under business rescue will therefore continue to pay their employees their normal salaries and the employees will be expected to continue doing their jobs while the company is under business rescue, subject to the exceptions listed above.

Varying terms and conditions of existing employment contracts

Once parties have agreed on the material terms of an employment contract, its terms are fixed in the sense that neither party may unilaterally vary them unless the original contract provides for a variation (as mentioned above, this will apply even if the employer company is placed under business rescue). Therefore, an employer must obtain the employees’ consent to a proposed change to terms and conditions of employment.

If an employer or business rescue practitioner elects to unilaterally implement changes to the terms and conditions of employment of its employees, employees will have recourse, which may include a strike, a referral to the CCMA or a breach of contract claim. There is also a fine line between a dismissal based on the employer’s operational requirements (retrenchment) in this context, and a dismissal due to an employee’s refusal to accept a demand in respect of any matter of mutual interest between the employer and the employee (which may include a refusal to agree to new terms and conditions of employment). The latter dismissal is automatically unfair.

If an employer or business rescue practitioner needs to change terms and conditions of employment contracts in order for the company under business rescue to remain financially viable or to save jobs in the long run, it is essential to articulate a commercial rationale for insisting that employees accept the proposed changes. Only then can the employer, or business rescue practitioner, possibly justify the extreme sanction of dismissal if employees do not agree. The cases, which support this idea, impose a very high standard. 

Section 189 and 189A procedure during business rescue

Sections 189 and 189A of the LRA regulate retrenchments and the process to be followed. It requires the consulting parties to embark on a joint-consensus seeking process and to consult on a list of prescribed topics. These topics include alternatives to dismissal as well as the operational requirements of the company.

It is important to note that the obligation to consult commences as soon as the employer, or business rescue practitioner, contemplates that employees may need to be retrenched. A decision regarding retrenchment may not be taken before the employer, or business rescue practitioner, has consulted with its employees. Should an employer contemplate dismissing a large number of employees, section 189A of the LRA imposes a mandatory consultation period of 60 days.

Consultation must be meaningful. Although the form of consultation is not prescribed, employers should, at the very least, ensure that its employees are able to engage meaningfully. Although not preferred, corporate entities may be able to embark on consultations via Teams or Zoom for example. However, employers with less skilled employees who do not have access to the necessary infrastructure to consult online, will have to think of alternative ways to engage with its workforce. This may include requiring them to nominate representatives for consultation, if no trade union or workplace forum already has that right.

What if the company under business rescue is unable to pay the employees?

Under certain circumstances, the company under business rescue might reach a stage where it is unable to pay its employees. If this happens, these employees will be regarded as creditors of the company and will have claims against the company.

It is important to take note that for purposes of the employees’ claims against the company, there is a distinction between remuneration that became due and payable before the company was placed under business rescue, and remuneration that became due and payable after the company was placed under business rescue.

Keeping the above in mind, the employees’ claims will rank as follows against other claims:

• The practitioner, for remuneration and expenses of the business rescue proceedings.
• Employees for any remuneration which became due and payable after business rescue proceedings began.
• Secured lenders or other creditors for any loan or supply after business rescue proceedings began, i.e. secured post-commencement finance.
• Unsecured lenders or other creditors for any loan or supply after business rescue proceedings began, i.e. unsecured post-commencement finance.
• Secured lenders or other creditors for any loan or supply made before business rescue proceedings began.
• Employees for any remuneration which became due and payable before business rescue proceedings began.
• Unsecured lenders or other creditors for any loan or supply before business rescue proceedings began.

 

If there is no money left to pay the employees of the company under business rescue or if the company under business rescue is only able to partially pay the employees of the company, and this is set out in an approved business rescue plan, the employees of the company will not be entitled to claim the balance of their claims against the company.

The effect of liquidation on employment contracts

General position

By virtue of the transitional provisions in item 9(1) of Schedule 5 of the New Companies Act, the liquidation process of insolvent companies is still regulated by Chapter XIV of the Companies Act 61 of 1973 (Old Companies Act). Section 339 of the Old Companies Act states, that in the winding-up of a company unable to pay its debts, the provisions of the law of insolvency shall, in so far as they are applicable, be applied mutatis mutandis in respect of any matter not regulated by the Old Companies Act. In light of the aforementioned, the provisions of the Insolvency Act 24 of 1936 (Insolvency Act) will apply to the winding-up of insolvent companies.

Section 38 of the Insolvency Act, which deals with the effect of liquidation on employment contracts, provides that employment contracts are suspended from the date the provisional order of liquidation of the employer (or final order if it is granted without a provisional order) is granted. During the period of suspension, the employees are not obliged to render any services to the company and are also not entitled to receive their salaries or wages, nor do any of their employment benefits accrue to them. However, section 38(3) of the Insolvency Act states that an employee whose contract of service is suspended, is entitled to unemployment benefits in terms of section 35 of the Unemployment Insurance Act (Act 30 of 1966), from date of such suspension (subject to the provisions of that act).

Termination of employment contracts during liquidation

Section 38(4) of the Insolvency Act states, inter alia, that a liquidator can terminate the employment contracts of employees (subject to certain requirements being fulfilled). A liquidator may not terminate an employment contract, unless he/she has consulted with:

• Any person with whom the employer was required to consult by virtue of a collective agreement (as defined in section 213 of the LRA); or
• A workplace forum (as defined in section 213 of the LRA) (only if there is no collective agreement in place); or
• A registered trade union representing employees who are likely to be affected by the termination of the employment contracts (only if there is no collective agreement in place).
• A registered trade union representing employees whose contracts of service were suspended and who are likely to be affected by the termination of the employment contracts; or
• The employees whose contracts of service were suspended and who are likely to be affected by the termination of the employment contracts or their representatives nominated for that purpose (if they are not represented by a trade union).

During the consultation referred to above, the parties must aim at reaching consensus on appropriate means and ways to save the whole business or part of it by:

• the sale of whole or part of the business; or
• transferring the business as a going concern in terms of section 197A of the LRA; or
• by a scheme or compromise; or
• in any other manner.

Once the liquidator has consulted with the parties listed above, the liquidator is entitled to terminate the employment contracts of the employees, without any further requirements needing to be fulfilled.

Unless the liquidator and the employee(s) have agreed on continued employment, in view of saving whole or part of the business, all suspended employment contracts will terminate 45 days after the date of appointment of the liquidator in terms of section 375 of the Old Companies Act.

Claims that employees will have against the company

An employee whose contract was suspended or terminated, is entitled to compensation from the company under liquidation for losses suffered by reason of the suspension or termination of the employment contract prior to its expiration. Such an employee can also claim severance benefits from the estate of the insolvent employer, in accordance with section 41 of the Basic Conditions of Employment Act, 1997 (Act No. 75 of 1997).

With a liquidation, the creditors will be paid in the following order:

• Secured creditors (special mortgage, landlord’s legal hypothec, pledge or right of retention);
• Costs of the liquidation (which will include, inter alia, the sheriff’s charges incurred since the liquidation and fees payable to the Master in connection with the liquidation);
• Costs of execution (which will include, inter alia, the taxed fees of the sheriff or messenger in connection with any execution upon any property of the company in liquidation and in connection with any proceedings which resulted in that execution);
• Former employees of the company for:

salary or wages due to the employee, for a period not exceeding 3 months (subject to the statutory limitation in place at that time);

any payment in respect of any period of leave or holiday due to the employee which has accrued as a result of his or her employment by the company under liquidation in the year of insolvency or the previous year, whether or not payment thereof is due at the date of sequestration (subject to the statutory limitation in place at that time);

any payment due in respect of any other form of paid absence for a period not exceeding three months prior to the date of the sequestration of the estate (subject to the statutory limitation in place at that time); and

any severance or retrenchment pay due to the employee in terms of any law, agreement, contract, wage-regulating measure, or as a result of termination in terms of section 38 of the Insolvency Act;

• SARS, as well as other statutory obligations that the company has (as set out in section 99 of the Insolvency Act);
• Payment of claims that were secured by a general mortgage bond; and
• Unsecured creditors.

Conclusion

We hope that this newsletter has shed some light on the effect of business rescue and liquidation on employment contracts. Our Business Rescue, Restructuring and Insolvency team at Cliffe Dekker Hofmeyr can assist all role players in the business rescue and liquidation sectors on all issues, including the effect of business rescue and liquidation proceedings on employment contracts. Therefore, if you have any further questions, please contact us, in order for us to set up a consultation as soon as possible.