Both big and small businesses alike have undoubtedly felt the effects of the COVID-19 global pandemic. With the five different levels of lockdown came the placing of various restrictions, which meant that different sectors of the South African economy had to be closed. This has resulted in many businesses finding themselves under financial strain. Some business owners have even been forced to make the difficult and unfortunate decision to permanently shut their doors. In an instance where a company simply cannot keep afloat, it will have to undergo liquidation proceedings and insolvency law will apply. Once the liquidation of the company’s assets has been finalised, the company will be dissolved and cease to be a legal entity.
The Companies Act 61 of 1973 and the Insolvency Act 24 of 1936 regulate the winding-up of insolvent companies and govern the manner in which their assets are to be dealt with. The winding-up of a solvent company is dealt with in terms of the Companies Act 71 of 2008, and will not be traversed herein.
Commercial insolvency vs factual insolvency
Insolvency law is a special debt enforcement procedure that was developed to ensure the fair treatment of all creditors, the equitable distribution of the debtor’s assets, as well as the protection of all parties’ interests. Where a business can no longer pay its debts as they fall due, the company is said to be commercially insolvent. This is distinguishable from factual insolvency, where a company’s liabilities exceed its assets, which does not call for a business to be wound up. Conversely, a company may not be able to meet its financial obligations while still having its assets exceed its liabilities. Therefore, the proper way to determine whether or not a company should be liquidated is by testing for commercial insolvency.
When a company ceases to be commercially solvent, it must take steps to improve its liquidity, undergo business rescue proceedings, or undergo liquidation proceedings. Where a company cannot improve its solvency, and business rescue efforts prove to be unsuccessful, a company will need to be liquidated and wound up.
Preference order of creditors
During liquidation proceedings, a liquidator will be appointed to take control of the assets of the company and sell them. The proceeds of the sales, less costs associated with liquidation, will then go to the company’s creditors. If there is money left after the creditors have been paid, the shareholders will be paid. The order of preference of payment is as follows:
- Payment to creditors with secured claims in the form of a special mortgage, landlord’s hypothec, pledge or right of retention;
- Payment to creditors with unsecured claims, with preferent creditors being paid first, and concurrent creditors being paid thereafter; and
- Payment of amounts due to shareholders, in accordance with the shareholders’ rights and interests.
Ways in which liquidation proceedings may be initiated
Liquidation may come about either as a result of a court order or voluntarily, by a special resolution made by the company’s board of directors. A court of law may also be approached to set aside liquidation proceedings or the dissolution of a company as a result of liquidation.
A court may be approached to seek an order liquidating a company in the following instances:
- If the company commenced business prior to the Registrar certifying that it was entitled to do so;
- If the company has not commenced business within a year of its incorporation, or has suspended its business activities for one year;
- In the case of a public company, if the members of the company are fewer than seven;
- If 75% of the issued share capital of the company is lost or has become useless for the business of the company;
- If a company is not able to pay its debts as they fall due;
- In the case of a foreign company, if the company is dissolved in the country where it was incorporated; and
- If it appears that it would be just and equitable to have the company liquidated.
The company itself, a creditor or shareholder may seek a court order to commence liquidation proceedings. The commencement date of the liquidation will be deemed to be the date on which the liquidation application is presented to court.
Where the winding-up of a company is based on a special resolution by the board of directors, such special resolution must be registered with the Companies and Intellectual Properties Commission. The commencement date of the liquidation will be deemed to be the date on which the special resolution was registered.
Liquidating a company by way of special resolution by the board of directors tends to be simpler, less costly and more expeditious than doing so by way of court order.
The legal consequences of liquidation
The commencement of liquidation proceedings does not come without consequences. Once the ball to wind a company up is rolling, the company can no longer conduct its business activities as per usual. A company will continue trading only where it is in the best interests of the creditors and only with the permission of the court or the company’s creditors and shareholders. Where a contract is cancelled due to the commencement of liquidation proceedings, the contracting party may have a claim for breach of contract against the company, and will be treated as a concurrent creditor.
Third parties will also be affected by the start of liquidation. Some consequences are as follows:
- Employment contracts will be automatically suspended and may later be terminated by the liquidator, and employees whose salaries and wages were due but not paid by the date of the liquidation will be treated as preferent creditors;
- Any share transfer is void if the liquidator has not consented thereto;
- The disposition of property is to be made only in accordance with a court order;
- All civil proceedings against the company are suspended;
- Any attachment or execution that was put in force becomes void; and
- Save for residual powers, all powers and duties of the directors are terminated and are vested in the liquidator.
Conclusion
Businesses globally have been placed under enormous financial strain during this unprecedented time. However, winding-up is but one of the several routes that may be taken by a company that finds itself in financial distress. We at K & CO Inc. are industry professionals who are equipped to guide and advise you should your company be considering liquidation as an option.