The South African Judgment That Could Limit Post-Commencement Financing in Business Rescues: A Reassessment of Creditor Classification

Wescoal Mining (Pty) Ltd v Phahlani Lincoln Mkhombo NO and Others 2023 (Case No 2023-079991, Gauteng Division, Johannesburg).

Introduction

1. The recent judgment from the High Court of South Africa in the case involving Wescoal Mining (Pty) Ltd, Salungano Group Ltd, and others poses critical questions about the interpretation and practical application of the Companies Act 71 of 2008 (the "Companies Act"), specifically concerning business rescue proceedings. Presided over by Judge Wilson, the case grapples with the issue of defining who qualifies as a "creditor" with voting rights during the business rescue process, a question pivotal to the adoption or rejection of business rescue plans.

2. The primary focus of the dispute lies in the interpretation of Chapter 6 of the Companies Act, which deals with business rescue. The applicants, Wescoal and Salungano, sought an urgent declaration affirming the validity of a business rescue plan. This plan initially believed to have garnered the requisite 75% approval from creditors, later came under scrutiny due to miscalculations in vote tallying. The first respondent, Mr Mkhombo, who is the business rescue practitioner for Arnot, recalculated the votes and found that the threshold had not been met, prompting the need for a new meeting. Crucially, the applicants contested the inclusion of votes from Mashwayi Projects (Pty) Ltd, a post-commencement creditor, arguing that such creditors should not have voting rights in business rescue proceedings.

3. The court's judgment endorsed this view, asserting that only pre-commencement creditors should have voting rights. Judge Wilson based this conclusion on a textual interpretation of the Companies Act, focusing on the statute's purpose and the rights it confers upon different classes of stakeholders. The judgment thereby raises substantial concerns about the commercial implications of excluding post-commencement creditors from such crucial decision-making processes, especially in the arena of business rescue financing.

4. This analysis will dissect the judgment to scrutinise its legal reasoning, with a particular focus on its repercussions for post-commencement financing, a cornerstone for many firms in distress. The author will argue that the judgment, despite its diligent exploration of statutory text, is commercially unsound and creates an environment potentially detrimental to the very objective of business rescue—preserving the social and economic value of ailing businesses.

The Facts of the Case

5. The case revolves around Arnot Opco (Pty) Ltd, referred to as Arnot, a company that owns and operates a coal mine in Middleburg, South Africa. Despite sitting on a substantial reserve of thermal coal, Arnot found itself in financial distress, necessitating business rescue proceedings. The first respondent, Mr Phahlani Lincoln Mkhombo, was appointed as the business rescue practitioner for Arnot.

6. Two companies, Wescoal Mining (Pty) Ltd (Wescoal) and Salungano Group Ltd (Salungano), are the applicants in this case. Both are creditors of Arnot, with Wescoal being a wholly-owned subsidiary of Salungano. The applicants sought an urgent court declaration to confirm the validity of a business rescue plan that was preliminarily adopted during a meeting convened by Mr Mkhombo on 28 July 2023. The core proposal of this plan was the sale of Arnot and its mine to Ndalamo Coal (Pty) Ltd (Ndalamo), the third respondent.

7. Ndalamo, initially cited as a respondent, applied for leave to intervene as an applicant, supporting the relief sought by Wescoal and Salungano. The fourth respondent, Mashwayi Projects (Pty) Ltd (Mashwayi), opposed the application. Mashwayi is notable for being a cessionary of various creditors of Arnot and also holds a lease on some of Arnot's rail allocation.

8. During the meeting on 28 July 2023, the business rescue plan involving the sale of Arnot to Ndalamo was put to a vote. Initially, it appeared that the plan had received the requisite 75% approval from creditors. However, Mr Mkhombo subsequently reviewed the vote tally and concluded that the 75% threshold had not, in fact, been met. This led him to revoke the initial declaration of the plan's approval and to schedule another meeting.

9. The crux of the dispute concerns the voting rights of Mashwayi, categorised as a post-commencement creditor. The applicants contended that Mashwayi's votes should not have been counted in the first place. They argued that, when excluding Mashwayi's votes, the business rescue plan did indeed meet the 75% approval threshold.

10. The case thus grapples with the definition of "creditor" under the Companies Act, specifically, whether a creditor who becomes involved after the commencement of business rescue proceedings should have voting rights in those proceedings. The court's decision in this regard carries weighty implications for the treatment of post-commencement creditors and, consequently, the financing landscape for companies in business rescue.

Analysis of the Applicant's Argument

11. The primary thrust of the applicants' argument focused on the validity of a business rescue plan, which was subject to a vote during a meeting convened on 28 July 2023. Wescoal and Salungano, the applicants, sought a court declaration to confirm that this plan had been validly approved, thereby allowing for the sale of Arnot to Ndalamo. The plan's approval was initially thought to have met the legal requirement of 75% support from creditors. However, this conclusion came into question following a recalculation of votes by the first respondent, Mr Mkhombo, the business rescue practitioner for Arnot.

12. The applicants took issue with the inclusion of votes from Mashwayi, the fourth respondent, in the vote tally. Mashwayi is categorised as a post-commencement creditor, and the applicants posited that such creditors should not be entitled to vote in business rescue proceedings. The central premise underlying this contention is an interpretation of Chapter 6 of the Companies Act, which governs business rescue. The applicants argued that the term "creditor," as used in this chapter, refers only to those creditors who were involved with the company at the time when the business rescue proceedings commenced.

13. To substantiate their claim, the applicants initially questioned the very status of Mashwayi as a creditor of Arnot. They contended that Mashwayi should not have been allowed to vote based on arguments about the interpretation of a lease agreement between Arnot and Mashwayi. However, this line of reasoning was not pursued further in the proceedings.

14. The applicants then honed their argument to focus on the statutory interpretation of the Companies Act. They claimed that, according to the Act, post-commencement creditors such as Mashwayi are not "creditors" with "voting interests" in the approval or rejection of a business rescue plan. In other words, the applicants sought to establish that the term "creditor," within the context of Chapter 6 of the Companies Act, pertains only to those who were creditors at the time when business rescue proceedings were initiated.

15. By excluding Mashwayi's votes, the applicants claimed that the business rescue plan would have achieved the requisite 75% approval, even based on the revised vote tally performed by Mr Mkhombo. Therefore, they sought an urgent court declaration affirming the plan's validity, thus allowing the sale of Arnot to proceed as initially agreed upon.

16. The applicants' argument hinged on a specific interpretation of the Companies Act, targeting the exclusion of post-commencement creditors from the voting process. Their contention raised significant questions about the scope and meaning of "creditor" in business rescue proceedings, questions that have far-reaching implications for the financing and rescue of distressed companies.

Analysis of the Respondent's Arguments

17. The respondent's arguments in this case are rooted in several key contentions that challenge both the procedural and substantive aspects of the business rescue proceedings. Represented by Mr Symon and Mr Cremen, the first and second respondents, Arnot and Mr Mkhombo, put forth a detailed case defending the validity of the 28 July meeting and questioning the applicant's conduct throughout the process.

18. One of the principal arguments raised by the respondents pertains to the issue of notice under section 151(2) of the Companies Act. They dispute the contention that Mashwayi did not receive adequate statutory notice for the 28 July meeting. Mr Symon argues that Mashwayi, despite its claim only being accepted a day before the meeting, must have known about the meeting at least five days in advance. He asserts that this constitutes "substantial compliance" with the Act's requirements, thereby validating the meeting.

19. Furthermore, the respondents take issue with the applicant's attempt to "short-circuit" the business rescue process. They assert that the pace and progress of the proceedings are within the discretion of the business rescue practitioner and that the applicants are attempting to usurp this authority. This argument is particularly significant because it raises questions about the balance of power and the scope of judicial intervention in business rescue proceedings.

20. Another salient point made by the respondents is against the court "reverse-engineering" the outcome of the 28 July meeting by discounting Mashwayi's votes. Mr Symon criticises this approach as inappropriate, suggesting that it would unfairly interfere with the business rescue practitioner's duties and the integrity of the process. This argument touches upon the delicate balance that courts must maintain between providing legal oversight and interfering with executive decisions in business rescue scenarios.

21. Lastly, the respondents subtly question whether the decisions taken by a business rescue practitioner should be categorised as "administrative action" under the Promotion of Administrative Justice Act (PAJA). Although the court and parties ultimately decide to proceed without delving into this matter, the respondents raise it as a point worth considering, highlighting the complex nature of the legal framework surrounding business rescue.

22. The respondents multi-faceted defence that engages with both the procedural and substantive elements of the case. Their arguments raise critical questions about the extent of judicial oversight, the responsibilities and powers of business rescue practitioners, and the procedural validity of business rescue meetings.

Analysis of the Question of Law

23. In this case, the crux of the legal debate revolves around the interpretation of the term "creditor", as it appears in Chapter 6 of the Companies Act, which governs business rescue proceedings. Specifically, the court needed to decide whether post-commencement creditors, like Mashwayi, have the legal right to vote in the approval or rejection of a business rescue plan. The judgment, rendered by Judge Wilson J, hinged on statutory interpretation, as the Companies Act itself does not explicitly define the term "creditor."

24. Wilson J relied on a purposive approach to statutory interpretation, examining both the text and the broader objectives of the Companies Act. The court considered the definition of "affected persons" in section 128 of the Act, which includes creditors along with other stakeholders such as employees and shareholders. The judgment reasons that the Act aims to include only those creditors who have an interest meaningfully comparable to other affected persons at the time business rescue proceedings commence. Judge Wilson J argued that post-commencement creditors do not fall under this category and, therefore, should not be allowed to vote in the approval of business rescue plans.

25. Further, the court looked at section 150 (2) (a) (ii) of the Companies Act, which mandates that a business rescue plan should contain "a complete list of the creditors of the company when the business rescue proceedings began." Wilson J interpreted this as an indication that the Act does not intend to give post-commencement creditors a vote in the approval of business rescue plans.

26. The judgment also referenced Section 135 of the Companies Act, which deals with post-commencement finance. While this section provides post-commencement creditors with a preferential claim against the company, it does not explicitly afford them voting rights. Wilson J found this omission significant, interpreting it as a legislative choice to exclude post-commencement creditors from the decision-making process related to business rescue plans.

27. In sum, the legal question was resolved primarily through a purposive interpretation of the Companies Act, leaning heavily on the perceived legislative intent and the overall goals of the Act. The judgment concluded that the term "creditor," as used in Chapter 6 of the Companies Act, does not include post-commencement creditors, and thus, they do not possess voting rights in business rescue proceedings. This interpretation holds significant implications for the structuring of financial agreements and the strategy employed in business rescue scenarios.

Critical Examination of the Court's Reasoning

28. The logical steps and legal principles employed by the court in arriving at its conclusion merit rigorous scrutiny.

29. One of the principal methods employed by the court is purposive interpretation. The court delves into the broader objectives of the Companies Act and invokes these to narrow down the definition of "creditor" to only those in existence at the commencement of business rescue proceedings. While purposive interpretation is an established method of legal exegesis, the court's reliance on it here raises questions. Specifically, it assumes a legislative intent without concrete evidence, thereby infusing its interpretation with a degree of subjectivity that may not align with the statute's text or previous case law.

30. The court also cites section 150 (2) (a) (ii) of the Companies Act, which necessitates a "complete list of the creditors of the company when the business rescue proceedings began," as proof of the Act's intent to exclude post-commencement creditors. This interpretation seems to stretch the language of the Act. The section mandates the inclusion of existing creditors in the business rescue plan but does not explicitly exclude post-commencement creditors from voting. The court's extrapolation of this section to make its point could be viewed as a logical leap unsupported by the text itself.

31. Moreover, the court refers to Section 135 of the Companies Act, which deals with post-commencement finance, as another linchpin in its argument. The court posits that since the section offers preferential treatment to post-commencement financiers but does not explicitly afford them voting rights, it implies their exclusion. This argument appears to rely on the absence of evidence as evidence of absence, which is a precarious logical position to adopt.

32. The judgment also seems to overlook the commercial implications of its interpretation. By categorically denying voting rights to post-commencement creditors, it could potentially discourage post-commencement financing, a crucial element in any business rescue. This aspect is not adequately addressed in the court's reasoning, which seems focused more on a theoretical interpretation of legislative intent than on the practical consequences of such an interpretation.

33. While the judgment is meticulously reasoned, it leans heavily on certain assumptions and interpretive methods that are open to question. The court's interpretation, although grounded in a traditional approach to statutory interpretation, may not fully align with the text of the Act or the commercial realities that the Act seeks to address. By way of example, section 145(4)(a) of the Act is very clear in stating that both secured and unsecured creditors have a voting interest equal to the amount due to them from the company. The definition of a voting interest is, therefore, already clearly delineated in the Act, making the court's journey down this particular rabbit hole both unnecessary and troubling. This divergence from both the spirit and the letter of the law casts doubt on the validity of its judgment.

Critical Examination of the Judgment's Outcome

34. The outcome of the judgment has far-reaching implications that extend beyond the immediate parties involved. Notably, the court's decision to limit the voting rights solely to pre-commencement creditors could fundamentally alter the landscape of business rescue proceedings in South Africa.

35. For the parties directly involved, the court's decision delivers a significant blow to Mashwayi Projects, who, as a post-commencement creditor, loses its voting rights and thus its ability to influence the business rescue plan. This outcome can discourage companies like Mashwayi from participating in business rescue processes in the future, given that their financial interests would be imperilled without corresponding voting rights. Similarly, for Arnot and Mr Mkhombo, the judgment undermines their latitude in conducting business rescue proceedings by limiting the pool of stakeholders who can influence the plan.

36. The broader implications on the legal landscape are equally profound. The court's interpretation of the term "creditor" could serve as a precedent in future cases, further entrenching the exclusion of post-commencement creditors from the voting process. This could have a chilling effect on post-commencement financing, a crucial aspect of successful business rescues. Companies in distress often rely on such financing to maintain operations while they negotiate a rescue plan. The court's decision, by removing the voting rights of these financiers, makes such financing a less attractive proposition. The risk is amplified, yet the ability to mitigate that risk through voting is curtailed.

37. Furthermore, the court's narrow interpretation could inadvertently create an environment conducive to speculative behaviour. By limiting the voting rights to pre-commencement creditors, the court could incentivise these parties to manipulate voting to their advantage, potentially at the expense of the distressed company's long-term viability.

38. The judgment also raises concerns about judicial discretion in interpreting statutes. While the court's approach is rooted in established principles of statutory interpretation, the expansive leeway it takes in interpreting the Companies Act could set a precedent for future judgments. This raises questions about the balance between judicial interpretation and legislative intent, a subject that merits further investigation.

39. This judgment has a profound impact that not only affects the immediate parties but also has the potential to reshape the legal and commercial framework surrounding business rescue proceedings. While the court's reasoning is detailed, the practical ramifications of its decision could be detrimental to the very objectives that business rescue proceedings aim to achieve.

Moral and Broader Takeaways from the Judgment

40. The judgment in question presents a compelling scenario for reflecting on the broader ethical implications and moral lessons that arise from it. One immediate ethical consideration is the issue of fairness in legal procedures, specifically in the realm of business rescue. The court's decision to exclude post-commencement creditors from voting rights raises questions about the equitable treatment of all parties involved. While the court attempts to adhere to the legislative intent, it inadvertently creates an imbalance by privileging one group of creditors over another. This divergence from what could be considered fair treatment poses a significant ethical dilemma.

41. Another moral lesson emanates from the principle of legal certainty. The judgment, by interpreting the Companies Act in a manner that could be seen as restrictive, adds a layer of uncertainty to business rescue proceedings. Legal certainty is not just a juridical concern but also an ethical one. Stakeholders, including post-commencement financiers, rely on a stable legal environment to make informed decisions. Any disruption to this stability, such as excluding a category of creditors from voting, could be seen as contravening the ethical principle of predictability in law.

42. The issue of stakeholder responsibility also comes to the fore. Business rescue proceedings are not isolated events affecting only the distressed company and its creditors; they have broader societal implications, including job preservation and economic stability. Therefore, the court's decision could be criticised for adopting an approach that might discourage post-commencement financing, a crucial element for the successful turnaround of financially distressed companies. This has ethical dimensions as it potentially puts at risk the livelihoods of employees and other stakeholders who are indirectly affected by the financial health of the company.

43. Lastly, the judgment prompts reflection on the ethics of judicial discretion. While courts undoubtedly have the role of interpreting statutes, the extent to which this interpretation aligns with broader social and economic objectives is a matter of ethical concern. In this case, the court's interpretation might be viewed as inhibiting the social value of preserving businesses as going concerns, thereby impacting social welfare.

Unanswered Questions and Ambiguities in the Judgment

44. The judgment, while detailed in its exploration of the issues at hand, leaves several questions unanswered and introduces ambiguities that could have far-reaching implications for business rescue proceedings in South Africa. One of the most glaring gaps is the lack of comprehensive guidance on how post-commencement financiers should be treated in subsequent cases. While the court categorically excludes them from the voting process in section 152 meetings, it does not provide a thorough framework on how their interests should be otherwise protected or considered. This absence of guidance may lead to legal uncertainties and could deter potential post-commencement financiers from getting involved in business rescue situations, thus affecting the efficacy of the entire process.

45. Another area of ambiguity is the court's treatment of the statutory notice requirements under section 151(2) of the Companies Act. The court seems to accept that "substantial compliance" with the Act suffices without outlining the parameters of what constitutes such compliance. This lack of clarity may lead to differing interpretations and implementation in future cases, undermining the principle of legal certainty.

46. Furthermore, the judgment does not delve into the standing of prospective purchasers like Ndalamo in business rescue proceedings. While the court acknowledges Ndalamo's direct and substantial interest in the matter, it refrains from offering a conclusive view on the extent of such a party's legal standing. This omission leaves the door open for varying interpretations and poses questions that future rulings will need to address.

47. The court also sidesteps an examination of whether decisions by business rescue practitioners fall under the umbrella of "administrative action" as per the PAJA. By doing so, the court misses an opportunity to provide clarity on the level of judicial oversight applicable to business rescue practitioners' decisions, leaving this area of law ambiguous.

48. Lastly, while the judgment does reference various legal principles and precedents, it does not offer a robust discussion on how this specific case aligns with broader jurisprudential trends or international best practices in the realm of business rescue. Such a discussion could have served as a guiding light for future cases and contributed to the evolution of South African business rescue law.

49. The court's decision deviates markedly from established norms by failing to acknowledge the inherent similarity between a lender and a creditor. Even under International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS), lenders are generally treated as creditors. While both entities fall under the umbrella term of "creditor" in accounting practice, they may be treated somewhat differently based on the terms of repayment and interest. However, this distinction is not substantial enough to warrant their disparate treatment under the Companies Act. A cursory consultation with the Oxford Dictionary could dispel this confusion. If a lender is not to be classified as either a concurrent or current liability on the balance sheet, is the court then suggesting a reclassification as an equity partner, thereby considering the lender an "investor"?

Conclusion

50. The judgment in question provides a compelling case study in the complexities of business rescue proceedings under South African law. The court's decision to differentiate between pre-commencement and post-commencement creditors under the Companies Act has far-reaching implications, most notably for the practice of post-commencement financing. The ruling reinforces the primacy of the Companies Act but also raises questions about its adequacy in addressing the nuanced challenges that arise during the business rescue process.

51. From a procedural standpoint, the court's interpretation of "substantial compliance" with respect to notice under section 151(2) poses questions about the balance between strict statutory interpretation and practical considerations. This is particularly relevant in cases of urgency where strict adherence to procedural requirements may not be feasible.

52. Moreover, the court's decision to discount the votes of Mashwayi, a post-commencement creditor, underscores the need for a more comprehensive understanding of the role and rights of different types of creditors in business rescue proceedings. The judgment seems to overlook the commercial realities and the potential chilling effect it could have on future post-commencement financing, a critical element for the success of many business rescues.

53. The judgment's focus on defining a "creditor" in the context of South African business rescue laws leaves several questions unanswered when it comes to alignment with international accounting standards like IAS and IFRS. For example, it's unclear how the legal definition of a creditor for voting purposes in a business rescue plan would reconcile with accounting treatments of debts under IAS 32 and IFRS 9. The judgment also sidesteps the issue of how to account for the adoption of a business rescue plan in financial statements, particularly in light of the compromise of creditors' claims that often occurs. Additionally, while the court distinguishes between pre-commencement and post-commencement creditors for the purpose of voting rights, it does not elaborate on how this might conflict with the equitable treatment of all liabilities in accounting standards. Lastly, the lack of guidance on how the type or classification of financial instrument could impact a creditor's voting ability leaves room for future legal and accounting exploration.

54. On a broader scale, the judgment leaves unanswered questions about the categorisation of decisions made by business rescue practitioners as "administrative action" under PAJA and how such a classification might influence the scope of judicial review.

55. The moral takeaway from this case leans towards a strict, textual interpretation of statutes, potentially at the expense of commercial sensibility. The court prioritises legal formalism over the functional aspects of business rescue and, in doing so, may have set a precedent that could deter future post-commencement financing efforts.

56. Overall, while the court's judgment offers clarity on certain legal questions, it also exposes gaps and ambiguities that warrant further exploration. It serves as a reminder that the relationship between statutory law, commercial realities, and judicial interpretation often results in outcomes that are far from straightforward and can have unintended consequences on the broader legal and business landscape of South Africa.

TIAAN HERBST

THE AUTHOR AND BUSINESS RESCUE PRACTITIONER