When companies are placed in business rescue Section 135 of the Companies Act 71 of 2008 (“the Act”) provides for a very innovative manner in which the company under business rescue may obtain new finance and credit. This is called post-commencement finance (“PCF”). However, banks and other financial institutions would thus far appear to have been reluctant to get involved and it would appear that they do not necessarily believe that a company under financial distress and under business rescue could present an investment opportunity. It is furthermore not sure as to whether commercial banks in South Africa are prepared to take over the security of another bank and to further get control by advancing PCF.

Historically, before the Act came into law, financial institutions and creditors who have had dealings with liquidators of liquidated companies clearly understood the notion of “costs of administration in the winding-up process. This simply meant that any goods supplied to or services rendered to a company in liquidation must be paid first as a cost of administration and only once such costs were paid in full may any distribution be made to the company’s creditors on their claims that existed upon the commencement of winding up proceedings from the proceeds of the assets realised in the liquidation process.

Often liquidators require financial assistance in the winding up process and may, upon their powers having been extended as such by the High Court, obtain a loan subsequent to the date of provisional liquidation. Such loans are also, at all times, payable as a “cost of administration” in the winding up process in preference to creditors in the winding-up process.

Akin to the loans so being advanced to liquidators of companies in liquidation and ranking ahead of creditors PCF under business rescue also, by statute, enjoys such a “super-preferent” status.

The process of procuring PCF is however much less cumbersome under business rescue in that there is no need to approach the High Court for such funding.

In addition, the Act provides that, should the enticement of this super preferent status fail to be of interest to financiers that the business rescue practitioner may obtain finance secured by assets of the company.  It is even possible to provide already encumbered assets as security to PCF lenders where the value of the asset so encumbered is such that it protects the interests of existing secured creditors.

The most fundamental aspect of PCF and the role of the business rescue practitioner is the issue of cash-flow forecasting. In most business rescue cases the company will only have the cash to survive from day to day. Daily cash-flows and forecasts are under these circumstances maintained by the business rescue practitioner because he has no choice other than to do so in order to assess the performance of the business. However, in many cases, the business rescue practitioner, upon his arrival on the scene at the company, find that there was no pre-existing cash flow forecasting done by the company.

The return negotiated by prospective lenders on PCF loans may be very attractive to such lenders because there is perception of high risk attached to such loans compared to normal commercial loans. The truth is however that, by virtue of the super preferent nature of such loans, the extra security that may be provided by the business rescue practitioners and the statutory protection afforded, PCF lenders often enjoy better protection under business rescue than “normal” lenders. For the past almost four decades providers of debtor in possession (DIP) facilities under Chapter 11 of the American Bankruptcy Code have been investing as distressed lenders and enjoyed good returns.

The assessment of a company’s post commencement financial requirements and the amount of PCF needed during the business rescue period would require a detailed cash-flow forecast. The business rescue practitioner needs to understand the sensitivities relating to the cash flow based on the history of the business and the impact of a possible liquidation on the PCF. The business rescue practitioner needs to assess the terms in the PCF compared to the terms of commercial loans, if available.

The loan agreement will have deal with the duration and pricing and fees relating to the loan which by its very nature may be substantially more onerous than run of the mill loan agreements.  Variances need to be expected and the reporting thereon is crucial

The notion of so-called “vulture funding” and the concept of “loan to loan” are well established in other jurisdictions such as the USA where distressed investors earn above average returns and often take control of the equity in distressed companies by virtue of the funding provided.

It is time that South African entrepreneurs become aware of these opportunities.

SOURCE: Debtor-in-possession Financing – American Bankruptcy Institute

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.