Trust Maanda
Legl Position
CORPORATE rescue of a company can be granted upon a certain test being satisfied.
The company must pass the test. The test is in Section 121(1)(b) of the Insolvency Act.
The test to be applied when assessing if a company should be placed under corporate rescue is whether or not the company is financially distressed.
The exercise involves an objective test, by the court which is called upon to look at all the financial circumstances of the company, including its ability to meet its obligations as they fall due.
Section 121(1)(f) of the Act defines the term “financially distressed” as follows: “(f) ‘financially distressed’, in reference to a particular company at any particular time, means that —
(i) it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months; or
(ii) it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months …”.
From the first part of the test, a company will be regarded as being in financial distress if there is a reasonable likelihood that the company may reach a point within the next six months where it will no longer be able to pay its debts as and when they become due and payable.
“Reasonable likelihood” connotes that there must be a rational basis for the conclusion that the company may not be able to pay its debts within the next six months.
This amounts to an informed prediction, and must be based on the current financial position of the company, and upon consideration of all relevant factors that may, in the foreseeable future, impact on the company’s liquidity. These factors are many and differ from company to company. The factors to be taken into account also include the competence of management and their capacity to take fiduciary duties seriously.
Courts have created a checklist to be used before a court grants a corporate rescue application.
The court needs to consider the following:
The cause of the financial failure;
The remedy for the failure;
Whether there is a reasonable prospect that the remedy will be sustainable; and
whether there are concrete and objective ascertainable details beyond mere speculation that the remedy is sustainable.
The second part of investigation into the financial distress of the company deals with insolvency.
A company is technically insolvent (and thus financially distressed) if its liabilities exceed the assets.
In determining whether there is a reasonable likelihood that the company will be insolvent within six months., a court must consider the complete financial position of the company.
After all other circumstances have been considered, including considering alternative fair values of the assets and liabilities, factoring in reasonably foreseeable assets and liabilities, as well as considering any other proposed measures taken by management such as subordination agreements, recapitalisation or letters of support, a company will be regarded as being in financial distress where it is insolvent.
Identifying when a company is financially distressed is not easy because the process of doing so is not straightforward. The evaluation of a company’s solvency state relies on the cash flow and balance sheet tests.
These are not intended to be accurate mechanisms employed to determine the exact financial situation of a struggling company but are used as a statutory rule to determine whether a company is insolvent for certain legal purposes.
A company is normally found by the court to be financially distressed, especially in a situation where it is unable to pay salaries to its employees, trade creditors, and regulatory authorities, like the National Social Security Authority (“NSSA”) and the Zimbabwe Revenue Authority (“ZIMRA”). Other indicators include failure to pay electricity bills, water bills, professional membership fees for senior employees, and insurance policies. Financial distress is linked to liquidity problems.
A reasonable prospect of successful rescue proceedings is more than a superficial case or an arguable possibility.
There must be a reasonable prospect, which means that it must be a prospect based on reasonable grounds. Mere speculation is not enough. The applicant who seeks to satisfy the court of the prospect, must establish these reasonable grounds in accordance with the rules of court applications which, require that it must do so in its founding papers.
The prospect of rescue must accordingly be considered in the light of the objectives of business rescue proceedings which are: to facilitate rehabilitation of the company in order to (a) return the company to solvency, or (b) provide a better return for creditors and shareholders than what they would achieve through liquidation.
An applicant for business rescue proceedings must therefore place before Court a factual basis for its argument that there are reasonable prospects that the objectives can be achieved.
Corporate rescue proceedings are not for terminally financially distressed corporations but for ailing corporations which, given time, can be rescued from dying and become solvent again.
Trust Maanda is a legal practitioner and a partner at Maunga Maanda And Associates. He writes in his personal capacity. He can be contacted on +263772432646 or [email protected].
