Potential claims from surety holders after Business Rescue.

02 Jan 2022 By Pat Pattinson

BUSINESS RESCUE

Beware of potential claims from surety holders after Business Rescue

By: Pat Pattinson

Unless an adopted Business Rescue Plan clearly prohibits it, a creditor may enforce its rights in terms of its suretyship agreements, even if the original debt has been compromised in the plan. The issue has been widely debated but has finally been put to rest in the South African Supreme Court of Appeal (SCA) judgement of Van Zyl v Auto Commodities (Pty) Ltd.

The judgement made it clear that an adopted Business Rescue Plan does not affect nor extinguish the liability of a suretyship agreement unless clearly provided for in the adopted business rescue plan. 

CREDITORS MAY CLAIM FROM VALID SURETIES

Any creditor that holds a valid suretyship agreement may therefore continue to act on those agreements even when the principal debt is no longer due by the business as a result of a compromise contained in an adopted Business Rescue Plan. The exception here is when the Business Rescue Practitioner made provision in the plan for the cancellation of such suretyship agreements and the creditors adopted this proposed plan with this condition in place. This is however very unlikely to be the case.

To illustrate the impact of the judgement, let’s consider an adopted Business Rescue Plan for Business Z, with a 70 cent to the Rand compromise to creditors and with the creditors retaining the right to pursue their valid suretyship agreements.

Creditor A was owed R 1m, but as per the adopted Business Rescue Plan received R 700 000. This creditor is however in possession of a valid suretyship agreement from a director of Business Z and the creditor successfully acts on this agreement. As a result, the creditor is paid the R 300 000 shortfall (with some legal fees, interest etc) by the director.

SURETIES CAN CLAIM THEIR PAYMENTS FROM A BUSINESS IN RESCUE

The potential risk to Business Z is based on the surety’s (the director) right to exercise his/her common law right of recourse against the principal debtor (Business Z) by suing the principal debtor for any amounts claimed from and paid by a surety to a creditor who held a valid suretyship agreement to claim as a result of the implementation of the Business Rescue Plan.

The director would therefore be in a legal position to claim from Business Z the R 300 000 he/she paid to Creditor A after the adoption of the Business Rescue Plan. This cannot be prevented in the Business Rescue Plan as the debt will only become due sometime after the adoption of the proposed plan.

In another reported SCA matter (Zungu-Elgin Engineering (Pty) Ltd v Jeany Industrial Holdings (Pty) Ltd and Others (1138/2019) [2020] ZASCA 160 (3 December 2020) (Zungu-Elgin Case)) it was determined that a surety would have a legal right to claim from the principal debtor any amounts paid as a result of a creditor exercising their rights in terms of a valid suretyship agreement.

The judgement in the Zungu-Elgin Case further expressly confirmed that the right of recourse arises against the principal debtor when the surety pays the debt owed by the principal debtor to the creditor, again confirming that Section 154(2) of the Companies Act does not alter this common law position.

BUSINESS BUYER BEWARE

A further risk is where a business is sold as part of a Business Rescue process to a completely new owner and a creditor successfully acted on its suretyship agreement, resulting in that surety having to settle the creditors’ shortfall. That surety will have the legal right to claim this amount from the new owners of the business.

Suretyship agreements must be handled with care, and the possible repercussions from those agreements must be considered by practitioners when publishing a Business Rescue Plan, even if it is not a requirement of Section 150 of the Companies Act.

THE SOLUTION

As part of a practitioner’s investigation into the affairs of the business and while considering the claims from creditors of the business, the practitioner could confirm which creditors hold sureties and who in the business provided these sureties.

This information will provide the practitioner with two very basic avenues to mitigate the risk of a surety settling a creditor’s claim and then laying a claim themselves against the business at a later stage.

Option 1

It is important to clearly state in the proposed Business Rescue Plan that no creditors will be allowed to act on any sureties should the proposed plan be adopted. A practitioner should never try to hide this clause/condition in the fine print or state it in a way that could allow for any misinterpretations.

There is a risk that – should any creditor with a valid surety object to the clause/condition – a practitioner may be requested to amend the plan to remove the clause/condition.

Option 2

A practitioner who has investigated the affairs of the business and is thus aware of who signed sureties could request that those who signed surety provide the business with a waiver stating that should any creditor act on their respective sureties, that the signees will not pursue the business for any amounts they may have to pay as a result of the surety being settled.

As both these options require input from third parties, both options may fail. In such an instance transparency is vital, especially if the business or part thereof is sold.

Although a potential investor or buyer is expected to perform their own due diligence, a Business Rescue Practitioner and/or the directors of a business could be held liable if they were aware – or should reasonably have been aware – of these sureties and the resultant risk presented to a buyer and/or investor without disclosing this information as per Section 214(1)(b) of the Companies Act.

 

 “The views and opinions expressed in this article belong solely to the author and are not in connection with or associated with his business, organisation, committee, association or other group or individual. The contents of this article are for informational purposes only and are not intended to be legally binding or constitute advice in any manner whatsoever and is provided without prejudice.”

Beware of potential claims from surety holders after Business Rescue