I recently concluded that banks or other financial institutions are not sources for post commencement finance (“PCF”) in business rescues as is envisaged in terms of Chapter 6 of the Companies Act 71 of 2008. It also became clear that none of the South African commercial banks have thus far developed any “products” that can be described as ideal for “distressed funding”.
I suspect that commercial banks might feel that it is simply not an area where they will find a return or where there will be sufficient volumes to justify the development of such banking products. It is also understandable that conventional governance of depositors’ and shareholders’ funds will not permit distress lending.
It is must however also be understood that where a bank is exposed as a creditor in a business rescue matter that they will evaluate the matter on its own merits been made clear that the availability of and the providing of PCF is not entirely “embargoed” by banks.
We have found that the bank, as a PCF lender, would consider granting PCF when, under circumstances where the bank can be described as a “defensive pre- commencement lender” seeking to maximize the value of its pre-commencement claim. The bank may then agree to provide PCF in an amount designed to ensure a successful reorganization and which may be conditional upon them being involved in the business rescue decision making process.
At a minimum, such PCF would be expected to cover anticipated working-capital and the expenses in the business rescue process needed for the period necessary to effect operational changes or restructure the debtor’s business. In some instances, however, the nominal amount of the PCF may significantly exceed the debtor’s working-capital needs, even with the additional costs that will be incurred because of the debtor’s filing for business rescue. The effect of such a higher nominal amount of PCF may be that that the company under BR will have the benefit of increased creditor confidence and as consequence of which suppliers may be more willing to provide products on terms more advantageous to the company than what they would have been prepared to do under regular uncertain business rescue circumstances.
Furthermore, customers may continue to utilise the company’s service with the confidence that the company will ultimately emerge from Business Rescue. It is therefore so that a relatively large PCF facility can decrease the negative operational impact of a BR filing. I suspect that South African banks have thus far provided the most PCF to date but also believe and will not be surprised if all this is “defensive” PCF financing.
It has been alleged that there is an unwritten rule or understanding amongst banks in South Africa that the one bank will not bail out a company with PCF to enable a company to repay its debts with another bank. We have practically experienced in recent dealings with a parastatal lender that the borrowers had to certify the lender that the finance being obtained by shareholders (two levels up) were not to be utilised for purposes of settling the debts of a company under business rescue.
We have also found in practice that a further major stumbling block for potential PCF financiers arises when there is a pre-commencement cession of book debts in favour of a bank as security for its overdraft of whatever is owing to the bank. There is a view that banks are in terms of its cession of book debts entitled to rely on book debts created post the commencement of business rescue proceedings as additional security. This is despite them not having provided the finance that enabled the BRP on behalf of the company to render the service or manufactured the product that enabled to BRP on behalf of the company to create the invoice. All of this post the commencement of business rescue proceedings.
Its seems untenable that the PCF financier may not, as first charge, rely on the proceeds of the post BR book debts. The law in this regard needs to unfold We are of the view that in order for PCF to succeed under such circumstances the BRP needs to enter into an agreement with the bank in order to have future debts released from the cession.
It is clear to us that distressed funding or, PCF, remains one of the most topical issues in restructuring businesses and for the business rescue process to work. There is no doubt that the ability of a company under business rescue to continue trading or carrying on with its business activities depends entirely on its ability to procure PCF in some form or another.
Internationally the motivation of distressed investment funds to get involved in PCF of debtor in possession finance under Chapter 11 in the USA (“DIP finance”) is often very different from that of commercial banks. While a commercial bank may seek to profit through fees and interest earned over the course of a long-term relationship with a borrower, the business model of distressed investment funds is entirely different.
We need to look at the various forms of PCF that are available. First, there is conventional post commencement trade credit and in terms of the Companies Act the BRP may incur credit in the ordinary course of its business. This will be treated as PCF and suppliers and trade creditors typically extend this credit on similar terms as existed before the commencement of BR proceeding if they are comfortable that the debtor has sufficient cash flow to pay them on a timely basis. Such PCF enjoys the protection of section 135 of the Act and must be repaid in the order that such debts were incurred.
Second, Secured PCF which is permitted in terms of the Companies Act and under which circumstances the BRP obtains post commencement credit secured by either a lien or pledge or any other agreed form of security over assets that are otherwise unencumbered. This may appear to be preferable and safe in theory but distressed businesses under business rescue usually do not have unencumbered assets, any equity in assets that are already encumbered, or all their assets are fully encumbered by other lenders. Security for the PCF lender is therefore a logical option to have, but usually of little practical assistance.
However. an alternative, in rare cases, is a second or reversionary form of pledge or lien over assets already encumbered. This is done in the USA under Chapter 11 procedure in terms of what is called Super Priority Secured Financing. How it is works is that, under circumstances where a debtor under Chapter 11 is unable to obtain credit in any of the traditional DIP finance ways, the Bankruptcy Court can allow the debtor to obtain financing secured by a first lien on already encumbered assets of the estate. This means that secured creditors that already have liens on the assets will be pushed down or “primed”. This must be done with Bankruptcy Court approval, and creditors whose liens are being “primed” must have the opportunity to object.
The only way the Bankruptcy Court will allow such financing is if the debtor makes an appropriate case that it is unable to obtain credit in any other way and it must be demonstrated that the creditor whose security is eroded is “adequately protected.” This essentially means that the creditor whose lien is being primed needs to be shown that even though its lien is being pushed down, it will not be unduly harmed by this event.
Hans Klopper of Independent Advisory
- Perlman F.G, Baer H.P, Kevane H, Bagby I, Corbi R.J, Farnsworth S, Krause S, Kriegel M, Lucas J.W and Maman M : “Debtor-in-Possession Financing: Funding a Chapter 11 Case” American Bankruptcy Institute
- Salerno TJ, Kroop J.A and Hansen C : “The Executive Guide to Corporate Bankruptcy” – Second Edition (BeardBooks 2010)