Company Announcement - Section 129(1) of the Companies Act allows a company in financial distress some breathing space through providing the board of directors with the opportunity to apply for business rescue if there is a reasonable chance of rescuing the company.  However, there might be some instances where the board of a company in financial distress will continue to trade having decided that it is probable that the financial situation of the company will improve and that it will be able to meet its obligations.

Shareholders, creditors and employees may not be aware of any issues until it is too late and the company is beyond the point of rescue and has to be liquidated.  This is where section 129(7) comes in. The section requires the board to inform all affected persons in writing that the company is in financial distress when it has reasonable grounds to believe that the company may be in trouble. If the company has not been placed into business rescue, it must provide reasons as to why they have not adopted a resolution to file for business rescue. This written notice sent to the affected parties must set out and make clear the criteria of financial distress, including that it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become payable within the immediately ensuing six months; or it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months.

Such a notice will certainly have immediate and significant implications for the company, for example shareholders might stop investing in the company; creditors might want to renegotiate their payment terms or even cancel orders from the company; and employees could get anxious, involve trade unions and even resign in favour of a more secure work environment.

The worst case scenario of course could be that banking institutions may refuse to provide financial support due and withdraw credit facilities that were available to the company.  Furthermore, it can be reasoned that Section 129(7) was designed to provide affected persons with the opportunity to apply to the court to place the company into business rescue because of the financial distress and the fact that the board did not want to adopt the resolution to file for business rescue.

The board therefore has a challenging decision to make on either filing for business rescue (which has its own implications), or sending a written notice out informing all affected parties about the company being in financial distress.

Should the board decide to do nothing and liquidation ensues, there could be some grave consequences for directors. For instance, failure by the board to have acted could imply that the board was trading recklessly, with gross negligence or with the intent to defraud which may lead to personal liability for any loss, damage or costs sustained. It therefore appears that the real challenge for the board of a company that is in financial distress does not lie in the decision that they have to make, but the consequences flowing from the decision they made (or did not make).