Steinhoff in South Africa: How valid is that guarantee?

Steinhoff International Holdings NV (SIHNV) and its subsidiaries engaged in the manufacture and retail of furniture, household goods, and clothing. It once operated thousands of stores in over 30 countries, but became embroiled in significant financial irregularities that were uncovered in December 2017.

The Steinhoff saga has resulted in a number of lawsuits instituted against the company, its directors and auditors, both in South Africa and other jurisdictions such as the Netherlands and Germany.

One of these lawsuits unfolded in South Africa's Western Cape High Court, when it recently handed down judgment in the matter of Trevo Capital Ltd & Others v Steinhoff International Holdings (Pty) Ltd & Others. The High Court was tasked with interpreting the financial assistance provisions of the South African Companies Act (the Companies Act).

The South African Scheme of Arrangement

The genesis of the matter is to be found in a South African statutory scheme of arrangement proposed by Steinhoff International Holdings (Pty) Ltd (SIHPL), Steinhoff's South African holding company, to its creditors and in terms of which it sought to settle all claims against SIHPL and its South African subsidiaries (the Scheme). The Scheme, in broad terms, makes provision for three classes of creditors (market participant creditors, financial creditors and contractual creditors) and then goes on to propose different settlement terms for claims of the respective classes of creditors. The distinction between the creditors were in large based on the nature and legal basis of their respective claims against SIHPL. The South African Scheme was one part of the overall settlement. The other part was suspension of payments proceedings for the ultimate parent company (SIHNV) in the Netherlands.¹

Dissatisfied with the proposed terms of the South African Scheme and how the market participant creditors in particular would be treated in comparison with others, certain disgruntled creditors approached the High Court contending that the guarantee-type claims of the financial creditors were based on financial assistance advanced by SIHPL in contravention of the solvency and liquidity requirements provided for in the Companies Act, 2008 and were therefore void. Thus, the challenging creditors contended that the financial creditors were being overcompensated under the Scheme to the detriment of the other classes of creditors.

Section 45 of the Companies Act, 2008

Section 45 of the Companies Act sets out certain requirements that have to be met before a company is permitted to provide financial assistance to a related or inter-related company.

Financial assistance in this context includes lending money (other than in the ordinary course of the company's business), guaranteeing a loan or other obligations and securing any debt or obligation.

One of the requirements for valid financial assistance is that the board directors of the company must be satisfied that, immediately after providing the financial assistance, the company would meet a statutory solvency and liquidity test, i.e. the company's assets must exceed its liabilities and that the company must be able to pay its debts as they become due within the ensuing 12 months (the Solvency and Liquidity Test).

In addition the board must be satisfied that the terms under which the financial assistance is proposed to be given are fair and reasonable to the company and there must also be a special resolution by shareholders in place, passed within the preceding two years, authorising the financial assistance.

Failure to comply with the above requirements renders the financial assistance void.

SIHPL financial assistance

The applicants contended that the SIHPL financial assistance in this particular matter related to the following claims of the financial creditors under the Scheme:

• convertible bonds issued to investors by Steinhoff Finance Holding GmbH (SFHG) (a related party to SIHPL) in 2014 with the obligations thereunder then guaranteed by SIHPL (the 2014 Guarantee); and


• a conditional payment undertaking (CPU) entered into between SIHPL and the same bondholders as part of an English law governed company voluntary arrangement (CVA) for certain Steinhoff Group entities, which restructured their debts, following the December 2017 revelations of financial irregularities.

The legal enquiry

The High Court's judgment deals, in the first instance, with the question as to whether: (i) the applicants had standing to bring the application, and (ii) the provisions of section 45 applies to financial assistance being provided to a related company that is a foreign (non-South African) company.

Both the above questions were answered by the High Court in the affirmative. The main focus, however, is on the judgment insofar as it relates to the question whether:

• the Steinhoff board of directors complied with the Solvency and Liquidity Test when they in 2013 (and prior to uncovering of the financial irregularities in December 2017) passed a resolution authorising the granting of the 2014 Guarantee; and


• the CPU constituted financial assistance as contemplated in section 45 of the Companies Act.

2014 Guarantee

On the 2014 Guarantee issue, there was no dispute between the parties that the 2014 Guarantee constituted financial assistance. The disputed issue was whether the board of directors could in the circumstances have been satisfied that the Solvency and Liquidity Test had been met.

The applicants argued that:

• it is now known that, due to the financial irregularities, SIHPL's profits and asset values were significantly inflated over an extended period of time;


• the goodwill and intangible assets reflected in the financial statements were significantly overstated, as was the valuation of certain subsidiary companies, at the time of applying the Solvency and Liquidity Test;


• taken the above into account and based on expert opinions, SIHPL was, in 2013 at the time the resolution was passed, not in a financial position where the Solvency and Liquidity Test could have been met;


• in the circumstances and given the unreliability of the financial statements the SIHPL board, acting reasonably, could not have satisfied itself that it met the Solvency and Liquidity Test—this position being further exacerbated by the fact that both SIHPL's CEO and CFO at the time knew of the irregularities and failed to disclose these at the relevant board meeting.

SIHPL on the other hand argued that:

• at the time that the decision was taken by the board of directors the financial information at its disposal reflected a position that met the Solvency and Liquidity Test;


• in considering the test, reliance was placed on external advisors' opinions;


• there was no evidence at the time that the financial statements and information relied on were unreliable;


• a determination under section 45 must be based on the facts, information and documentation available to it at the time the decision is taken. The test it argued cannot be one founded in hindsight.

The High Court agreed with the applicants that there is a measure of reasonability that must be present in the board's decision. However, in then siding with SIHPL, it criticised the applicant's hindsight approach and "ex post facto analysis of the company's financial position" with reference to the accounting irregularities uncovered some three years later. It was held, given the considerations taken into account by the SIHPL board at the time, it cannot be said that the board acted unreasonably in relying on the financial information then before it when approving the financial assistance.

Noteworthy though is that the High Court did not expressly rule the so-called hindsight approach was per se incorrect, but in coming to its decision rather sought to place more reliance on a South African procedural and evidentiary rule. In that regard, the High Court determined that where there is a genuine dispute of fact between the parties, then it must be determined in SIHPL's favour in circumstances where SIHPL's version of events was not untenable or far-fetched. The High Court also held, with reference to the CEO and CFO's knowledge at the time that, given the number of board members, it cannot be validly suggested that the entire board's decision was tainted.

CPU

The CPU issue involved a complex set of facts and legal intricacies that followed the uncovering of the financial irregularities and a call by bondholders on the 2014 Guarantee that SIHPL was unable to comply with.

In very brief and simplistic terms, the failure to abide by its obligations under the 2014 Guarantee resulted in a financial restructuring of SIHPL and the Steinhoff Group which amongst other matters, entailed that the bondholders had their existing debt restated in the CVA pursuant to revised terms:

• The maturity date of the convertible bonds were extended to 31 December 2021;


• The SFHG debt in terms of the bonds were restated or reconstituted on the basis that:
  
  • the bondholders would extend a cashless loan to a newly formed SIHPL group company, Lux Finco 1, (the Lux Finco Loan);
  
  
  • the cashless loan proceeds would be on-paid to SFHG who would then in turn settle its obligations towards the financial creditors under the convertible bonds;


• SIHPL and the bondholders would enter into the CPU in terms of which:
  
  • SIHPL acknowledged its liability as guarantor;
  
  
  • SIHPL and the bondholders agreed to the restatement of the indebtedness under the 2014 Guarantee and pursuant to which repayment would be deferred and could not be demanded before 31 December 2021;
  
  
  • SIHPL's liability would be capped at an amount equal to the amounts payable under the convertible bond;
  
  
  • Payments would be applied to the Lux Finco Loan.

The above terms were reflected in the CVA which, as mentioned, was sanctioned by the English courts.

SIHPL argued in the High Court that the CPU did not constitute new financial assistance in that:

• SIHPL assumed no further debt;


• payments thereunder would only reduce SIHPL's crystallised and existing debt that arose under the 2014 Guarantee;


• the CPU was therefore a mere restatement of the obligations under the 2014 Guarantee.

SIHPL therefore contended that it did not need to have complied with the requirements of section 45 of the Companies Act since the CPU was not a new obligation.

The High Court rejected SIHPL's argument, holding that:

• SIHPL's argument failed to take into account that the restatement of a debt on different terms and conditions and involving at least one different party creates a new debt under applicable South African law.


• There is moreover a distinction between guaranteeing a specific debt and generalized exposure to a certain ceiling or amount of debt.


• The board also cannot authorise financial assistance with reference to the "financial ceiling of such assistance", i.e. that the exposure will not be more than previously authorised financial assistance—the board must be alive to the actual or potential recipient and the terms of such assistance that shareholders previously approved.

In taking a substance over form approach, the High Court further held that the CVA resulted in SIHPL's debt under the 2014 Guarantee being discharged with a new debt being created, i.e. Lux Finco's debt under the Lux Finco Loan. The CPU was in turn held to constitute new financial assistance to Lux Finco in that it replaced the 2014 Guarantee and protected the bondholders in the event of a default on the part of Lux Finco under the Lux Finco Loan.

As such, it was determined that the CPU constituted financial assistance and, mindful that it was agreed by the parties that no test under section 45 was conducted at all by the SIHPL board, the CPU was therefore deemed void by the High Court.

Conclusion

The High Court's judgment is of significant importance specifically in the context of a financial restructuring scenario, whether through a scheme of arrangement, business rescue (a South African process to restructure the affairs of a financially distressed company and in which process it was recently held that section 45 does find application) or an informal workout.

The board of a company, business rescue practitioners, investors and financiers must be alive:

• to the requirement that a resolution under section 45 must be reasonable with reference to the facts and information available. A mere tick-box exercise could be found unsatisfactory where information reasonably at their disposal could point to a situation where the tests are not met;


• to the fact that a decision to provide financial assistance is specific to the actual or potential recipient and the terms of the assistance cannot be simply blessed with reference to the fact that it does not exceed an existing "cap or financial ceiling" on debt;


• to considering whether any restructuring of a debt which have arisen through any financial assistance of sorts could result in it being construed and interpreted as creating new financial assistance albeit that the ultimate exposure and the debtor remaining the same. The court's substance over form approach should therefore similarly be adopted in such an assessment.

The judgment remains the subject of an appeal and, mindful of its novel nature and both factual and legal complexities thereof, it is left to be seen whether the South African Supreme Court of Appeal will agree with the High Court.

What would be particularly interesting is how the Court of Appeal will treat an aspect that the High Court did not pay much attention to, namely that the CVA is English law governed, was sanctioned by the English Courts and expressly provides that nothing therein should be construed as discharging SIHPL's liability to the bondholders—a position contradicted by the High Court's judgment that the CVA created a new obligation.

As the judgment did not directly affect the Scheme, it should also be noted that, in the interim period, the Scheme has been approved by the requisite majority of creditors. The Scheme now stands to be sanctioned by the High Court with that application also being opposed by certain disgruntled creditors. It is anticipated that the hearing of this application will take place in the first quarter of 2022.