Navigating a new beginning: Liquidation guidelines for insolvent companies

Let us assume that the directors and management of a company have now considered (a) the essential key points for businesses in financial distress, (b) the risk of directors’ liability in financial distressed times and (c) whether the company should be placed in business rescue. It then turns out that the situation is so dire that the only option left is to liquidate the company in order to prevent any further damage. 

The purpose of liquidation proceedings

Where a company’s financial position is so dire to the extent that it is no longer able to continue trading, the appropriate course of action is a liquidation process. The purpose of liquidation is to wind up the company’s affairs by selling the company’s assets either by way of private treaty or public auction in order to pay the costs of its winding up as well as its creditors. Any residue thereafter is divided amongst the company’s former shareholders in line with their rights and interests in the company. 

The test for insolvency

A company is said to be insolvent if its liabilities exceed its assets (this is known as factual insolvency), or if it cannot pay its debts as and when they fall due (this is known as commercial insolvency). The latter is the more appropriate test for insolvency as companies are often factually solvent whilst unable to pay their debts due to cash-flow issues. When such insolvent circumstances result in a company no longer being able to trade, its assets are liquidated.

In South Africa, insolvent companies are liquidated in terms of Chapter 14 of the Companies Act 61 of 1973 (old Companies Act), while solvent companies are liquidated in terms of the new Companies Act. For purposes of this article we will only focus on the processes relating to insolvent companies. 

Modes of commencement of liquidation proceedings

An insolvent company may be wound up voluntarily or by the court. A voluntary winding up process/proceeding can be either by members’ voluntary winding up or creditors’ voluntary winding up.

Voluntary winding up

A company may be liquidated voluntarily if the company passes a special resolution resolving that it be so liquidated. The special resolution must thereafter be filed with the Companies and Intellectual Properties Commission (CIPC) together with several other prescribed forms and documents.

The commencement date of voluntary liquidation will accordingly be the date that the special resolution is filed. The Registrar of Companies shall then forthwith after the registration by him of the special resolution transmit a copy thereof to the Master of the High Court (Master).

Advantages and disadvantages of voluntary winding up

Some of the advantages of a voluntary winding up are that it is quick, simple, inexpensive and expedient.

However, some of the disadvantages are that insolvency enquiries cannot be conducted and often creditors’ rights are frustrated because they will not immediately know that the company has passed a resolution to be liquidated.

Winding up by court order

A company may be liquidated by court order on various grounds set out in the old Companies Act. Some of the more common grounds that are used frequently in practice are in instances where the company is unable to pay its debts as described in section 345 of the old Companies Act, or if it appears to the court that it would be just and equitable that the company should be liquidated.

An application to court may, subject to certain provisions, be made by a creditor, the company itself or any of the shareholders.

The liquidation of a company by court order shall be deemed to commence at the time the liquidation application is presented to the court.

Advantages and disadvantages of winding up by court

One of the advantages of a winding up by court is the availability of the mechanism of an insolvency enquiry. In certain instances, the appointment of a liquidator by the Master may happen quicker once an order for liquidation has been granted by the court.

However, some of the disadvantages are that this process is expensive because it requires the preparation and issuing of a formal application to the High Court. If the application is opposed, it may take months to finalise. 

Appointment of a liquidator

The appointment of a liquidator is made by the Master. The creditors or members will nominate a liquidator of their choice by submitting their nominations to the Master. Once the liquidator has been appointed, he/she will attend to the administration of the estate, which includes liquidating the assets of the company and thereafter distributing the proceeds to the relevant stakeholders.

In a voluntary winding up, the liquidator may without the sanction of the court exercise all powers by the old Companies Act given to the liquidator in a winding up by the court, subject to such directions as may be given by the company (in the case of a members’ voluntary winding up) or the creditors (in the case of a creditors’ voluntary winding up) in general meeting.

Legal consequences of liquidation proceedings

Once the directors and management of the company have managed to navigate their way through the various processes of commencing liquidation proceedings and taken steps to appoint a liquidator of their choice, it is important to note that the placing of a company in liquidation gives rise to various legal consequences.

Some of the primary consequences to take note of are the following:

General moratorium on civil legal proceedings

All civil proceedings instituted by or against the company are automatically suspended until the appointment of a liquidator. Additionally, any attachment or execution put in force against the estate or assets of the company after the commencement of liquidation shall be void.

Every person who, having instituted legal proceedings against the company which were suspended by the liquidation, intends to continue same (and every person who intends to institute legal proceedings for the purpose of enforcing any claim against the company which arose before the commencement of the liquidation) shall within four weeks after the appointment of the liquidator give the liquidator not less than three weeks’ notice in writing before continuing or commencing the proceedings. If notice is not so given, the proceedings shall be considered to be abandoned unless the court directs otherwise.

Custody of and vesting of company property

In practice, we often find that there may be a delay in appointing a liquidator following the placing of the company in liquidation, either voluntarily or by the court. It is therefore important to note that at all times while the office of the liquidator is vacant or the liquidator is unable to perform his/her duties, the property of the company shall be deemed to be in the custody and under the control of the Master until the appointment of the liquidator has been made.

Effect of liquidation on uncompleted contracts

In general terms, the liquidation of a company does not automatically suspend or put an end to the contracts concluded by the company prior to being placed in liquidation. However, the liquidator steps into the shoes of the company and must, within a reasonable period, decide whether he/she intends to perform in terms of the contract or not. If the liquidator fails to decide within a reasonable time, it will be assumed that he/she has no intention of performing in terms of the contract.

The liquidator cannot be compelled by the other contracting party to render specific performance in terms of the contract; however, the other contracting party remains vested with its normal common law contractual rights to cancel the contract after liquidation. Where the liquidator elects to not abide by the contract, the other contracting party will have a concurrent claim for any damages suffered as a result of the breach of contract.

Effect on leases

Where the company is a lessee of assets (movable or immovable) in terms of a lease agreement at the time of being placed in liquidation, the lease is not immediately terminated by the liquidation. The liquidator must within a period of three months of his/her appointment make an election on whether he/she wishes to cancel or continue with the lease and must notify the lessor of his/her intentions by giving the lessor written notice to that effect. If the liquidator does not notify the lessor of his/her intentions within that period, the liquidator will be deemed to have cancelled the lease at the end of the three-month period.

Until such time as the liquidator has made an election, the lease remains in operation and any rental amounts which become due after liquidation must be paid by the liquidator. Any rentals that became due from the date of liquidation to the date of cancellation of the lease will be treated as preferent claims and paid out of the administration costs. Any other claims that the lessor has as a result of the breach of the lease will be treated as a concurrent claim.

It must, however, be noted that notwithstanding the election available to the liquidator in relation to the continuance of the lease, the lessor retains its usual common law contractual rights, including the right to cancel the lease after the liquidation of the company, where the company was already in breach of the lease prior to being placed in liquidation.

Effect on employment contracts

The proposition that liquidation does not suspend the company’s uncompleted contracts is, however, qualified to some extent. In this instance, the liquidation of a company will suspend the employment contracts between the company and its employees with immediate effect. 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. The employees may however be entitled to receive unemployment benefits from the date of suspension of their employment contracts.

The liquidator may elect to terminate the employment contracts but only after he/she has consulted with the employees and/or any of the employees’ representatives in an effort to reach consensus on appropriate measures to rescue the whole or part of the company and consequently avoid retrenchments.

All suspended employment contracts, not already terminated by the liquidator, will automatically terminate 45 days after the date of the final appointment of the liquidator.

Employees will have a limited preferent claim for a portion of their salary and wages due but unpaid at the date of liquidation, as well as for any contributions which were to be made by the company on the employees’ behalf. Any amounts which remain due to the employees over and above their preferent claim, will be treated as a concurrent claim.

Conclusion

Navigating a new commercial beginning can at times be a daunting process, especially in light of the current international economic strain and uncertainty surrounding the COVID-19 pandemic. The Business Rescue, Restructuring and Insolvency team at Cliffe Dekker Hofmeyr possesses the specialist knowledge, skill and experience to guide you through the process of closing one chapter in the entrepreneurial journey with the potential to start anew, which is the overarching purpose of the liquidation mechanism. Directors and stakeholders should take note of the procedures outlined above when trying to mitigate the fallout of the current economic climate, and when deciding which course of action is most appropriate in the circumstances. We are willing and able to assist in these unprecedented times.