Navigating business rescue of state-owned entities in South Africa

Business rescue in South Africa is a legal process designed to facilitate the rehabilitation of financially distressed companies, akin to other corporate rescue / statutory reorganisation mechanisms adopted elsewhere in the world. The process is governed by the South African Companies Act, 2008 (the “Companies Act”). It’s not very often that state-owned entities (“SOEs”) are the subject of business rescue proceedings, and only a handful have arisen since the inception of the Companies Act. There are, of course, inherent reasons for this – including that SOEs often receive financial support / bailouts from the government, which delay or prevent the need for business rescue. When an SOE commences business rescue proceedings, there are added complexities that in one recent case resulted in the removal of a restructuring practitioner. Although scathing to the practitioner, the Judgment has broader relevance in underscoring the complexities and care needed to manage an SOE through a business rescue in South Africa.

Let’s review first the three core features of business rescue under the Companies Act.

1. Objective of business rescue: The primary aim of business rescue is to provide a company with temporary relief from its creditors, allowing it to restructure its affairs, business, property, debt, and other liabilities. The goal is to maximize the likelihood of the company continuing on a solvent basis or, if that is not feasible, to achieve a better return for the company's creditors and shareholders than would result from immediate liquidation.
2. Role of the business rescue practitioner (BRP): The BRP is pivotal in the business rescue process. Appointed as an officer of the court, the BRP assumes the responsibilities, duties, and liabilities of a director of the company. The BRP is expected to act with the necessary competence, independence, and skill to manage the company's affairs during the business rescue proceedings. 
3. Business rescue plan: A critical component of the business rescue process is the development and approval of a business rescue plan. This plan outlines the proposed strategy for rescuing the company and must be approved by the creditors (or when shareholder rights are affected by the plan, creditors and shareholders). The Act specifies time periods within which the BRP must execute their duties, including the publication of the business rescue plan within 25 days of their appointment, although it is not uncommon for this period to be extended with approval from creditors (or otherwise allowed by court order).

Peculiarities of business rescue for state-owned entities

Where an SOE is subject to a business rescue proceeding, the restructuring is further complicated due to the interplay with other statutes, the involvement of government bodies, and societal matters.

1. Compliance with the Public Finance Management Act, 1999 (PFMA): State-owned entities are subject to the PFMA, South Africa’s primary public finance management law. The PFMA imposes specific financial management and reporting obligations on SOEs, which a BRP must navigate. Importantly, the PFMA takes precedence over the Companies Act in the event of any conflict. This means that the BRP must ensure compliance with both the Companies Act and the PFMA, which can complicate the business rescue process for an SOE.
2. Reporting obligations: The BRP must regularly report to the executive authority responsible for the SOE, typically the Member of the Executive Council (“MEC”) for the relevant government department. This includes providing updates on the financial status of the entity and the progress of the business rescue proceedings. 
3. Governmental oversight and approval: The involvement of governmental bodies adds a layer of complexity to the business rescue process. For instance, any significant financial decisions, such as securing post-commencement finance (“PCF”), may require approval from the National / Provincial Treasury or other relevant authorities. This oversight is intended to ensure that public funds are managed effectively and transparently, but can lead to delays in procuring the necessary funding. 
4. Prioritization of employees' salaries: In the case of SOEs, the payment of employees' salaries is a critical issue to ensure continued operations. The Companies Act prioritizes the payment of post-commencement salaries over other creditors. The failure to do so can lead to significant operational disruptions and legal liabilities.
5. Potential for political and social implications: The business rescue of SOEs often has broader political and social implications. These entities typically provide essential public services and employment opportunities. The failure of an SOE can have far-reaching consequences for the impacted community and the government. It is accordingly important to maintain transparency and accountability throughout the business rescue process to mitigate these risks.

The above features were emphasised in a recent high court judgment, MEC for the Department of Community Safety and Transport Management of the North West Provincial Government vs Thomas Hendrick Samons N.O and Others, dealing with the removal of a BRP in terms of section 139(2) of the Companies Act (“Judgment”). Section 139(2) permits the court’s removal of a BRP for (amongst other grounds) incompetence and negligence.

The judgment

1. The case involves the removal of Thomas Hendrick Samons as the BRP of North-West Transport Investment (SOC) Ltd and its subsidiaries, North-West Star (SOC) Ltd and Atteridgeville Bus Service (SOC) Ltd (the “NTI Companies”). The application for Mr. Samons’ removal was initiated by the MEC for the Department of Community Safety and Transport Management of the North-West Provincial Government (“COSATMA”).
2. The NTI Companies:
   1. are, in terms of the PFMA, provincial government business enterprises, responsible for bus transport services to commuters in the North West and Gauteng provinces in South Africa,
   2. were placed in business rescue due to severe financial distress and operational challenges, initially identified in an external report, commissioned by the MEC of COSATMA, which highlighted the dire financial state of the companies. The report revealed (amongst other things):
      1. that the NTI Companies were hopelessly insolvent, with a bank balance of ZAR2.5 million and liabilities nearing ZAR250 million,
      2. that the entities would only survive with considerable financial support, requiring an immediate cash injection of ZAR250 million to settle accumulated liabilities and medium-term working capital support of ZAR15 million per month over a six-month period,
      3. the NTI Companies had been operating without a board since 2018, and their fleet was in serious disrepair, with over two-thirds of their 612 buses being non-operative, and
      4. additionally, the companies were in arrears with most suppliers, leading to frequent disruptions in bus services;
   3. recommending that business rescue could be a potential solution, while also recognising that it might not be the ultimate answer, and advising the MEC to seek further legal advice on both business rescue and liquidation options.
3. Following a decision taken in 2022, the NTI Companies were placed under business rescue to address the above challenges to restructure operations, secure necessary funding, and improve governance and accountability to prevent further financial deterioration. Mr. Samons was then appointed as the BRP for the NTI Companies.
4. When later considering the COSATMA’s application to remove Mr. Samons, the court’s opening remarks about business rescue included its observation that business rescue is only appropriate for entities with reasonable trading prospects, potential for commercial viability, and where creditors would benefit from its success. However, the NTI Companies were the opposite—hopelessly insolvent and reliant on extensive financial assistance to continue operations. It is in this context that the court made the following findings:
   1. that Mr. Samons was incompetent and failed to conduct himself with the proper degree of care in the performance of his functions, contravening various statutory provisions, particularly the Companies Act and the PFMA. Specific instances of incompetence (which the court noted had led to significant financial and operational difficulties) included:
      1. the failure to publish the business rescue plan timeously. Specifically – Mr. Samons did not dispute that for over two years he had made various decisions for the NTI Companies, entered into various PCF agreements and attempted to dispose of the assets of the NTI Companies without an approved plan and without the approval of COSATMA under the PFMA;
      2. the failure to publish annual financial statements. The annual financial statements for 2019 to 2024 were neither prepared nor made available. The BRP informed the Auditor-General 18 months after his appointment about his difficulties in compiling these statements, attributing the delays to uncooperative officials. The court was scathing of Mr. Samons’ and noted that:
         1. the BRP was expected to manage the process skilfully and independently, not just blame the officials - he failed to inform the MEC of the challenges, nor did he report the entities' affairs to the MEC. He failed to deal with this issue with the degree of urgency and competence required of him.
         2. to make matters worse, the BRP misrepresented the situation to creditors and other affected parties, falsely claiming that financial statements were being finalized at a time when this was plainly untrue. There can be no doubt, the court said, that such misleading statements were prejudicial to the creditors and affected parties.
         3. the BRP did not have current financial records including the management reports, in place (for the duration of the business rescue proceedings), again attributing this to uncooperative officials. He was unable to provide the Provincial Treasury with such information. The BRPs shortcomings not only illustrated his incompetence but his failure to act with a level of skill and case expected of him as a BRP. He did not keep the MEC informed, compromising the financial reporting obligations of the MEC, Provincial Government, and Provincial Treasury under the PFMA.
      3. the failure to prioritize employees' salaries. It was undisputed that employees had not received their salaries monthly. In his defence, the BRP pointed out that to keep the bus operations afloat, he had no option but to pay various suppliers, prioritising payments to creditors, and only paying employees if there were remaining funds. The court found that the BRPs reasoning clearly showed that he failed to appreciate that he had little or no discretion regarding the payment of salaries. It is statutorily prescribed that at post-business rescue stage, salaries are prioritised above creditors. The court found that the BRPs conduct in prioritising payment(s) to creditors was in contravention of the section 144(2) of the Companies Act, which stipulates that employees are preferred unsecured creditors, and pointing out that the rationale of business rescue is to preserve the business coupled with the interest of the employees.
      4. the failure to comply with the PFMA and Treasury Regulations.
         1. The BRP claimed he wasn't required to report to COSATMA or the provincial government, stating he had reported to the Gauteng Provincial Department of Roads and Transport and the Auditor-General. The court emphasised that in business rescue, the BRP assumes the role of the NTI companies’ accounting authority and external oversight is conducted through the Auditor-General’s office and the provincial legislature. The PFMA, which takes precedence over the Companies Act, mandates that the BRP comply with reporting obligations for state-owned entities. Mr. Samons, however, failed to fulfil his legal duties, not submitting the necessary financial reports to COSATMA, the North West Provincial Treasury, or the Provincial Government. His assertion that he didn't need to report to COSATMA or the provincial government was incorrect.
         2. Despite requests for information, “on the current financial operations and management of funds”, Mr. Samons’ response that “he had not prepared any financial reports” was deemed untenable and showed incompetence.
         3. The court also found that the BRP had improperly ceded claims and encumbered property without necessary approvals (from at least the Treasury), showing a limited understanding of his statutory duties under the PFMA. His actions demonstrated incompetence and a failure to adhere to legal requirements, imposed under the PFMA.
   2. The BRPs actions prejudiced the affected parties, including employees and creditors, with the court noting that Mr. Samon's conduct resulted in the NTI Companies debt escalating to almost over ZAR1 billion (about US$56 million). The BRP’s failure to comply with statutory reporting obligations under the PFMA undermined the credibility of the business rescue process. The court found that the BRP was ultimately obligated to act impartially and transparently with affected parties, and to advise them that the chances of the entities being successfully rescued were slim. His primary duty was to continuously assess the NTI Companies' financial prospects and the extent of their distress, a responsibility he failed to fulfil.
   3. Additionally, the BRP did not maintain transparency and accountability in managing the SOE's affairs, failing to report the financial status of the entities and the progress of the business rescue proceedings to the executive authority, leaving the MEC “in the dark regarding the financial circumstances of the very entities which the applicant,… is in control of” under the PFMA.
5. Consequently, the court ordered Mr. Samons’ removal as the BRP in terms of section 139(2) of the Companies Act and mandated that the costs of the application be paid by Mr. Samons (in his personal capacity) and Tansnat Coach Lines (Pty) Ltd (“Tansnat”) jointly and severally. Tansnat was the main creditor and supplier of buses to the NTI Companies. In the proceedings, Tansnat opposed Mr. Samons’ removal as the BRP and joined issue with him.
6. In a counter-application, the respondents (in the main the BRP, supported by Tansnat) sought an order for the payment of ZAR615 million from COSATMA, claiming that an agreement had been reached for this funding to be provided to the NTI Companies. However, the court found that there was no agreement on the funding amount, and the respondents' claim was based on an alleged oral agreement between the legal representatives of the parties. The court determined that no such agreement had been finalized or approved by COSATMA, leading to the dismissal of the counter-application with costs.

The core principles outlined by the Judgment are as follows:

1. Competence and independence of the BRP: The BRP must possess the necessary skills and independence to manage the business rescue process effectively (including the proper comprehension and balancing of competing interests of various stakeholders). 
2. Timely development and approval of the business rescue plan: The BRP must adhere to statutory timelines for developing and publishing the business rescue plan. Delays in this process can jeopardize the success of the business rescue proceedings. Key to this is the BRPs primary duty to continuously assess the entity’s financial prospects and distress.
3. Compliance with statutory reporting obligations: The BRP must ensure compliance with all relevant statutory reporting obligations, including those under the PFMA. Failure to do so can result in legal challenges and undermine the credibility of the business rescue process.
4. Transparent and accountable management: The BRP must maintain transparency and accountability in managing the SOE's affairs. This includes regular reporting to the executive authority and other relevant stakeholders.

Conclusion

The North-West Transport Investment case highlights that the business rescue of SOEs in South Africa is a complex process that requires careful navigation of both the Companies Act and the PFMA. Whilst concerns remain over whether business rescue is suitable for financially distressed SOEs – it can still be a viable option. The outcome of the business rescue process largely hinges on the unique circumstances and challenges faced by the financially distressed SOE, along with the prevailing economic conditions and industry dynamics. Some SOEs also have their own statutes which might impact the business rescue process or even if it can be placed in business rescue.

Given the inherent complexities in an SOE business rescue, the Judgment underscores the importance of competence, transparency, and accountability in managing the business rescue process effectively. By adhering to these principles, BRPs can enhance the prospects of successfully rescuing financially distressed SOEs and ensuring their continued contribution to public service and economic development.