Essential key points for businesses in financial distress July 2020

By KYLENE WEYERS, Published in COVID-19 Company Law

South Africa, and the world at large continue to be rocked by the COVID-19 pandemic. One of the hardest hitting consequences of COVID-19 is the impact on businesses throughout South Africa following the national lockdown. Almost no sector remains untouched and businesses in all sectors have been hit hard.

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It is important, therefore, for companies to have a proper plan in place to restructure their affairs in these challenging times.

Here are 10 key points for businesses to consider:

1. Take a reality check

Are you already in financial distress? This may be a tough reality to face, but it is an essential starting point. Many businesses in financial distress are in denial. They stop looking at their bills and stop reading angry emails from creditors.

The first step is admitting that your business may be in trouble and that something needs to be done.

Acknowledging your situation, looking it squarely in the face, and taking action is infinitely preferable to burying your head in the sand.

2. Ensure that your books and records are up to date

It is essential that you determine your business' financial position and, in particular, the extent of your assets, liabilities and monthly expenses.

You need to know who your creditors are, what you owe them and when the amounts owing will fall due. You also need to check who your debtors are, what they owe you and when they are going to be able to pay you.

3. Do the solvency and liquidity test to determine if you are financially distressed

The Companies Act (71 of 2008) provides many helpful tools for directors to apply in these challenging times, including the solvency and liquidity test provided for in s4.

A company satisfies the solvency and liquidity test at a particular time if the assets of the company (fairly valued) equal or exceed the liabilities of the company (fairly valued); and it appears that the company will be able to pay its debts as they become due in the ordinary course of business. Directors would need to consider the company's financial information and financial statements.

If it appears to be reasonably likely that you will not be able to pay all your debts as they become due and payable within the immediately ensuing six months, or that the company's liabilities will exceed its assets within the next six months, then you are financially distressed.

These tests must be applied more carefully and prudently, especially now. If a company is financially distressed, or if it does not pass the solvency and liquidity test, it is crucial that steps be taken to restructure its affairs.

Determining financial distress has far greater consequences for a director than a simple balance sheet consideration. In terms of s129(7) of the Act, there is an onerous obligation placed on the board of directors of a company where, if the board determines that a business is in fact in financial distress, they are to either adopt a resolution to commence with business rescue proceedings, or alternatively, deliver a written notice to each of its creditors, employees, trade unions and shareholders, setting out its reasons for not voluntarily commencing business rescue proceedings.

Failure to adhere to provisions as set out in the Act could result in a director being held personally liable for all the debts of a company. Section 77 speaks to this personal liability and explains that, where a director knowingly carried on the business of the company recklessly or with the intent to defraud creditors or other stakeholders, he/she shall be held personally liable for any loss incurred by the company. Section 214 goes even further to provide for criminal liability for those directors at the wheel of a company which is being traded recklessly.

4.Talk to your insurer

Business Interruption cover is an important insurance offering in both short and long-term insurance for businesses. Consult with your broker and/or insurer to check whether you are covered under your insurance policy. If you are not, this gives you the opportunity to address the lack of appropriate cover in order to mitigate the potentially disastrous results a pandemic could have on your business in the future.

5.Talk to your suppliers, creditors & customers

Have an open and honest discussion with your suppliers and creditors and see if you can work out an agreement on the best way forward. Most people are willing to work with you if they believe that you will eventually pay what you owe. Keep the lines of communication open. If you are not transparent with major creditors, the environment may become hostile.

It is also important to concentrate your efforts on your business's best customers. Focusing on your most reliable and profitable customers can be an effective method of improving your cash-flow.

It is essential to gain the support of your bank by being open and transparent about the situation you are in. If you proactively approach your bank with a sound plan to improve your financial situation and repay that loan, the bank is more likely to work with you. It is also in the bank's best interest to have you work through these challenging times so that you remain a customer in the long-term.

6.Call in outstanding debts

Often, businesses allow outstanding debts to go unpaid for significant periods of time, potentially resulting in cash-flow problems. A growth in accounts receivable is a common cause of a company's insolvency issues.

One way to deal with late payments is to contact your debtors with a reminder notice. If they still fail to pay, consider handing over the debt for formal collection. In future, you could offer early payment discounts to increase the flow of cash into the company.

7.Cut costs

Many businesses experience cash-flow problems due to excessive spending. This can be on salaries, equipment, marketing or other operating costs. One way to increase cash-flow is to cut costs and reduce unnecessary spending. This may mean disposing of non-key assets, letting go of staff or cutting the marketing spend.

Make a list of all your expenses on a spreadsheet and go through it carefully (with your accountant if necessary). How much can you save and where? You could consider creating a document called a 'break even analysis' which tells you the minimum sales level required in order not to sustain a financial loss.

8.Your mental health is important

It is a very stressful experience to have a business in financial distress and it can take a personal toll. During these tumultuous times, it is important that you look after your emotional, psychological and social well-being, as it affects how we think, feel, and act. It also determines how we handle stress, relate to others, and make choices in our businesses.

Chat to your doctor or a mental health professional if you are in need of help.

9.Use your imagination in crisis management

Accept that we may not be able to return to our familiar pre-crisis reality. Pandemics, wars, and other social crises often create new attitudes, needs and behaviours which need to be managed.

Imagination – the capacity to create, evolve, and exploit mental models of things or situations that don't yet exist – is a crucial factor in seizing and creating new opportunities, and finding new paths to growth. Imagination is also one of the hardest things to keep alive under pressure, but companies that are able to do so can reap significant value.

With imagination, we can do better than merely adapting to a new environment – we can thrive by shaping it.

10.Get help from insolvency specialists

You may be considering your options and wrestling with the survival of your business. Getting qualified help is likely to save you money, and also your business, in the long run.

If you think your business is in financial distress and you need help with a plan of action, it is best to approach an experienced specialist in business rescue, restructuring and insolvency law to assist you to understand your business's financial position and the options you have available going forward.

COVID-19 is one of the most extraordinary and disruptive life events of our era. Government has launched various support and relief measures that are being implemented to cushion the economic effects of COVID-19, and to assist ailing businesses. Although these measures will keep some businesses alive and some people employed, the economic pain is still going to bite and will continue to do so for the foreseeable future.

Life and business on the other side of COVID-19 will be a "new normal" and South Africans will need to learn and adapt to a new way of life and doing business. However, businesses should use these challenging times to be innovative and improve. The focus should not merely be to adapt to this new environment, but to find ways to thrive in the "new normal".

The light at the end of the tunnel is that a pandemic is always temporary. We will, eventually, come out on the other side to pick up the pieces and start rebuilding.

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Weyers is a Senior Associate at Cliffe Dekker Hofmeyr.