THERE BE DRAGONS ….COMPROMISES WITH CREDITORS UNDER THE NEW COMPANIES ACT
Part E of chapter 6 of the New Companies Act 71 of 2008 (“the New Companies Act”), which will come into effect in mid or late 2010, governs compromises between a company and its creditors.
Under the existing Companies Act 61 of 1973 (“the Existing Companies Act”), compromises with creditors are dealt with under sections 311 and 312. Sections 311 and 312 of the Existing Companies Act deals govern schemes of arrangement both as between the company and its members, and as between a company and its creditors. For ease of reference we will refer to a scheme of arrangement concerning an arrangement between a company and its creditors as a scheme of compromise. Although sections 311 and 312 of the Existing Companies Act governs both schemes of arrangement between a company and its members as well as schemes of compromise between the company and its creditors, the New Companies Act separates the two. Schemes of arrangement in relation to a company and its members are dealt with in section 114 of the New Companies Act while schemes of compromise can be found in section 155 of the New Companies Act.
Whether under the Existing or the New Companies Act, schemes of compromise are controversial because they involve drastic inroads into the rights of creditors. At common law, a compromise can only be reached with those creditors who agreed to be bound by the compromise and, even if the majority of creditors agreed to the compromise, the remaining few who do not agree to the compromise are at liberty to institute proceedings against the company.
Currently, the only manner in which a compromise can be forced on dissenting creditors is by means of a scheme of compromise under the Existing Companies Act. Typically, a scheme of compromise between a company and its creditors involves creditors being requested to accept a reduced compromise of their claims on the basis that the payment that they will receive in respect of their claims under the scheme is greater than what they would receive on liquidation. Often such schemes entail a third party, the proposer, acquiring the compromised claims of creditors, as well as the shares in the company. A scheme of compromise under the Existing Companies Act is commenced when a company seeks the leave of the High Court to call meetings of creditors for purpose of explaining the scheme to the creditors and to put the scheme to their vote. At that early stage, the Court can examine the terms of the proposed scheme of compromise and refuse to order the meetings of creditors if there was a concern that the terms of the scheme are onerous or against public policy. Schemes of compromise can also be brought once a company is already in liquidation. Such schemes of compromises usually provide that third party will require all of the shares in the company once all the creditors are bound by the scheme of compromise, and, as part of the court order sanctioning the scheme of compromise, the liquidation of the company is discharged.
Schemes of compromise can take many forms, some of which involve creditors writing off a small or large portion of their claims, in others, creditors are asked to waive interest on their claims, or creditors may simply be asked to postpone the due date for payment of their claims but still be settled in full. Schemes of compromise can relate to all three classes of creditors (preferent, secured and concurrent) or only one class, leaving the other classes of creditors unaffected by the scheme. A scheme of compromise usually compares what the affected classes of creditors will be paid under the scheme with what they will get if the company went into liquidation or if the liquidation already commenced continued.
Meetings of the creditors in each affected class are chaired by an independent chairman. The creditors are required to vote for or against the scheme. Section 311 (2) (a) of the Existing Companies Act requires 75% in value of the creditors must vote in favour of the proposal in order for it to be held to have been adopted by the creditors. However, our case law has developed to hold that in schemes of compromise, unlike schemes of arrangement, 75% of the creditors in each class in value and in number must approve of the scheme. If the adoption of a 311 scheme of compromise was to be determined solely with reference to the value of creditors’ claims, there would be a danger that schemes of compromise could be pushed through by one or two creditors with large claims to the overall detriment of a far greater number of smaller creditors.
Even if the requisite 75% approval is obtained from the affected classes of creditors, a 311 scheme of compromise is still not effective and binding until such time as the High Court, by means of a court order, sanctions the scheme of compromise. It is possible that even where 75% of the creditors in number and value have agreed to the scheme of compromise, the High Court will refuse to sanction the scheme of compromise on the basis that it is inequitable or oppressive of creditors’ rights. In considering whether or not to sanction a 311 scheme of compromise, the High Court, must at common law, consider whether the scheme is bona fide in the interest of the relevant class of creditors; and whether the scheme is “fair and reasonable”.
Thus, although a section 311 scheme of compromise under the Existing Companies Act can make inroads into the rights of creditors by forcing dissenting creditors to be bound by a scheme of compromise which may reduce their claims, there are checks and balances drafted into the system, in that court intervention is required in order for leave to be obtained to propose the scheme to creditors, and again to sanction the scheme. So, what is new about compromises under the New Companies Act?
There are some marked changes in the manner in which compromises are to be handled in section 155 (part E of chapter 6) of the New Companies Act.
At first blush, the compromise chapter in the New Companies Act is similar to sections 311 and 312 of the Existing Companies Act in that it permits a company (or the liquidator of the company) to propose an arrangement of compromise of the financial obligations of a company to all creditors or to the members of any class of creditors.
However, there is no requirement that the leave of the High Court be obtained before the compromise is proposed to the creditors. Section 155 (2) of the New Companies Act simply requires that the board or the liquidator of the company propose the arrangement by delivering of the copy of the proposal, together with notice of the meeting to consider the proposal, to the company and to all creditors (or every member of the affected class of creditors) whose name or address is known to or could simply be obtained by the company.
In a departure from sections 311 and 312 of the Existing Companies Act, section 155 (3) codifies and sets out in some detail what the proposal must be contained. Under the Existing Companies Act section 312 (1) (a) (i) refers in general to the statement but the drafter of a scheme of compromise must look to what is required under our case law to be to be set out in the scheme of compromise. By contrast, section 155 (3) of the compromise chapter in the New Companies Act contains an itemised list of the information which must be contained in the proposal. One of these items is a statement as to whether or not the proposal of the compromise includes any proposals made “informally” by creditor. It is suspected that this is an attempt by the legislature to bring business rescue and compromises closer to United States and English bankruptcy law with “pre-packaged” arrangements. The use of the word “informally” is a little vague and could place a burden on the drafter of the proposal to include every single compromise of a claim by single creditor in relation to their debt, even if such compromise was as simple as “pay us when you can next month”. The wording should have referred only to proposals made by significant creditors or proposals made by creditors in relation to all creditors. Interestingly, at the common law a section 312 (1) (a) (i) statement as required under the Existing Companies Act usually requires the scheme of compromise to compare the fees of the liquidator if the scheme would be rejected and the winding up continued, against the fees of the receiver appointed to administer the scheme.
The list of information that must be contained in a proposal is quite extensive and requires, inter alia, details of all the assets and creditors of the company, the nature and extent of any proposed moratorium on claims, the treatment of ongoing contracts to which the company is a party, the order of preference in which the proceeds of the property of the company will be applied to pay creditors, any conditions precedent must be satisfied for the proposal to come into operation and be implemented, the number of employees of the company and their terms and conditions of employment, and a projected balance sheet and statement of income and expenses for the ensuing three years. A proposal must be concluded with a certificate by an authorised director or officer of the company stating that the factual information appearing therein is accurate, complete and up to date and that the projections provided are estimates made in good faith.
Section 155 (6) of the compromise chapter in the New Companies Act, provides that
“A proposal …. will have been adopted by the creditors of the company …. if it is supported by a majority in number representing at least 75% in value of the creditors or class, as a case may be, present and voting in person or by proxy at the meeting called for that purpose”.
As pointed above, although section 311 (2) (a) of the Existing Companies Act requires that scheme of compromise be adopted by 75% in value of the creditors in each affected class, the common law has required 75% of the creditors in each affected class both in value and number must approve the scheme of compromise. Thus, in drafting section 155 (6) the legislature grasped the opportunity to codify the common law requirement a scheme of compromise be approve by 75% of the creditors in number and in value in each affected class.
Notwithstanding this improvement on the provisions of the Existing Companies Act, the wording “a proposal … will have been adopted by the creditors” is ambiguous. What does “adopted” mean? Does it mean that as soon as the requisite percentage of creditor votes is obtained the proposal is binding on the dissenting creditors? For avoidance of doubt (and where there is a doubt, litigation inevitably brews), the section should have been explicit. Section 155 (7) (a) of the New Companies Act goes on to provide that a company “may” apply to court for an order approving the proposal. The use of the word “may” opens up a whole new can of worms. This suggests that it is not necessary for the company to obtain the sanction of the High Court before a compromise becomes binding on the dissenting creditors. Bearing in mind that it is no longer necessary for the company to get the leave of the High Court to propose the compromise, this means that as long as a majority in number of the creditors, representing at least 75% in value of the claims of the creditors, approve of the proposed compromise, the compromise will become binding on the dissenting minority of creditors without any court scrutiny to see whether the proposal is fair and equitable.
Although the intention of the legislature was to simply the process for a scheme of compromise by separating the requirements from scheme of arrangement as is the case under section 311 and 312 of the Existing Companies Act, the wording employed may simply have created a breeding ground for litigation.