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Is the Test for Reasonable Prospect objective or subjective?

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Business rescue has been in operation since May 2011.  The current statistics indicate that since May 2011, approximately 2040 entities have been placed into rescue.  Of these, approximately 1 100 are still in business rescue.  The statistics indicate that approximately 280 were substantially implemented.

The purpose of this article is not to comment on whether business rescue has been successful in South Africa.  In my view it started badly but many lessons have been learnt.  It is now a real part of the business and legal world and the more we think about it and try and understand it, the better for all of us.

An extremely interesting topic was debated at the recent TMA (Turnaround Management Association) workshop.  The topic was the essential cornerstone of business rescue, namely whether there is a reasonable prospect of rescuing the company.  In terms of Section 131 of the Companies Act 71 of 2008, a court, faced with an application in terms of Section 131 must consider and decide whether there is a reasonable prospect for rescuing the company.  After deciding, the court must either put the company into business rescue or the company must be liquidated.

The focus of my article is to consider whether a court faced with an application in terms of Section 131 should adopt an objective or a subjective approach.  Personally, I think that the consideration of whether to adopt an objective or subjective approach does not only apply to the courts but it applies even more importantly to those people assessing the distressed company and deciding whether there is a reasonable prospect of rescue.  When I refer to these people, I mean expert advisors who are doing a pre-assessment or a business rescue practitioner who has become involved in the matter and is attempting to understand the company.

The challenge is therefore to decide whether to adopt an objective or subjective approach in determining reasonable prospect.  At the TMA discussion an extremely important point was made by one of the attendees, namely that if the business rescue practitioner accepts the appointment without carefully considering whether there is a reasonable chance of rescue, the practitioner is reckless.  I fully agree with this sentiment.  It was also emphasised at the discussion that at the Section 147 meeting (the first meeting of creditors), the issue of reasonable prospect must be dealt with thoroughly and completely and not in vague and general terms.

I am therefore of the view that whoever (whether it is a Judge or anybody else) examines whether there is a reasonable prospect, such examination must be based not on a strictly objective or a strictly subjective approach.  In my view the approach must be a subjective approach based on strict proven objective business facts.  The approach cannot be a subjective approach without objective facts but equally cannot be a solely objective approach.

The most important message that I want to get across is that the court or anybody else considering whether there is a reasonable prospect of rescue, must look at the question through the eyes of a reasonable businessman.  The question is whether a reasonable, experienced businessman in that particular field would conclude that there is a reasonable prospect of success given the objective proved and not disputed facts.

My friend, Lara Kahn, correctly said at the discussion group that the Oakdene case which was decided in the Supreme Court of Appeal (Oakdene Square Properties [Pty] Limited vs Farm Botasfontein [Kyalami] [Pty] Limited [609/2012] [2013] ZASCA 68) is not particularly helpful.  It is the leading authority on the point and the Oakdene case essentially indicated that reasonable prospects must be based on reasonable grounds.  An attendee at the discussion made an extremely valid point by emphasising that the enquiry must be focused on whether there is a business, what is the business model and what is the business offering.  This person said that business must be tested from a venture capital position, meaning what would an objective outside venture capitalist say about the business and would the venture capitalist invest money in the business.  To do this, you would have to conclude that there is a reasonable prospect and the continued operation of the business must make commercial sense.

With due respect to the courts, it is my view that decisions are being made by the courts on certain facts (which are often is dispute) leading to the conclusion that there is a reasonable prospect of rescue.  An example of this is the case of Master Trucking (Pty) Limited and Pienaarsrivier Plant Hire (Pty) Limited.  The judgment was handed down on 19 May 2016 by the Honourable Gutta J in the High Court of South Africa (North West Division, Mahikeng).  In my view, again with respect, this judgment is incorrect.  The court incorrectly concluded there was a reasonable prospect of rescuing these companies.

The Judge said in paragraph 28 of the judgment that when considering the allegations made by a proposed investor as well as the proposed business rescue plan, it lead the Judge to conclude that the prospect of rescue had been based on reasonable grounds and the proposed business rescue plan had a reasonable prospect of success.  This is misplaced reasoning because the issue is not whether the proposed business rescue plan had a reasonable chance of success.  The issue is whether the business of the company can be rescued.

The Judge emphasised that there was a dispute of fact on the papers concerning the company's financial affairs and the Judge accepted the applicant’s version.  In my view, the enquiry is whether a reasonable experienced businessman in that field would conclude that there is a chance of success given the undisputed and accepted facts.

Another attendee emphasised that he had read many business rescue plans and the concept of “turnaround potential” was emphasised.  Turnaround potential can only be identified and analysed if full and proper technical and financial detail is given as opposed to what happens in many business rescue plans, namely extensive quotations “ad nausea” from Chapter 6 of Act 71 of 2008.

In my view the Honourable Gutta J overemphasised the saving of the jobs of 300 employees and also overemphasised the speculative probability of an investor buying into the company.  The Judge also referred to the fact that if certain debtors are collected, it could lead to a possible rescue.  In my view all book debts have to be collected (either in a liquidation or in a rescue) and it does not help to say that collectables can be used as working capital as part of the turnaround strategy.

The Honourable Brand JA in the Oakdene case said in paragraph 21 that:

“[21.2.1]    With this rather lengthy prelude, I can now revert to the pertinent question:  Does Section 131(4) afford a discretion in the strict sense or not? I think the short answer is ‘No’.  In a case such as this, the court’s discretion is bound-up with the question whether there is a reasonable prospect for rescuing the company.  The pertinent requirement in Section 131(4), namely that the company must be financially distressed, seems to turn on a question of fact.  As to whether there is a reasonable prospect of rescuing the company, it can hardly be said, in my view, that it involves a range of choices that the court can legitimately make;  of which none can be described as wrong.

On the contrary, as I see it, the answer to the question whether there is a reasonable prospect, can only be ‘Yes’ or ‘No’.  These answers cannot both be right.  The question is comparable to the decision whether or not the conduct of the defendant in a case based on negligence needs the standard of the reasonable person, or whether their negligent conduct should attract legal liability and thus be regarded as wrongful.  Hence it involves a value judgment.”

I respectfully agree with the Judge of Appeal because he has indicated that the test is objective in that it must be based on the standards of a reasonable person (a reasonable businessman).  Most importantly, the Judge emphasised, as well, that the decision involves a value judgment.

I accordingly think that the factors set out in the TMA practice note are vitally important.  Some of these factors are:

  • The business and ongoing sources of income;
  • Availability of post-commencement finance;
  • Value of the brand and perception in the market place of the company;
  • Total commitment of the current management team and their interaction with affected parties, being creditors and lenders;
  • New markets and products available to the company linked to the availability of new technology;
  • Socio-economic factors which must include government spending and the demands of that particular industry;
  • The advantage of the moratorium and the option of cancelling or suspending obligations and the contract.

I believe that the consideration of reasonable prospect is not a specific event that takes place at a particular time.  It is rather a process which evolves as the business continues and most importantly, the business rescue practitioner is obliged in terms of Act 71 of 2008 to continually assess whether there is still a reasonable prospect of rescue.  I think Professor Marius Pretorius, at the discussion group, put it aptly and correctly when he said that reasonable prospect is like a “house of cards”, meaning that all aspects of the rescue are completely interdependent on one another and are extremely delicately balanced.

In order for the house of cards not to fall, all the factors in the business rescue must be investigated, analysed and reviewed on an ongoing basis.

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K J Braatvedt
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