EARLY WARNING SIGNS: ADVISING THE FINANCIALLY DISTRESSED CLIENT

The statutory trigger

Financial distress has a precise meaning in Chapter 6. A company is financially distressed if it appears reasonably unlikely that it will be able to pay all of its debts as they become due and payable within the immediately ensuing six months, or if it appears reasonably likely that the company will become insolvent within that period. Two tests, one horizon: six months forward. The enquiry is not whether the company is insolvent today — by then the useful options have usually narrowed — but whether the next six months can be navigated on the current trajectory.

Section 129(1) permits the board to resolve that the company voluntarily begin rescue proceedings if the board has reasonable grounds to believe the company is financially distressed and there appears to be a reasonable prospect of rescuing it. The Act does not let a board simply look away. Under section 129(7), a board that has reasonable grounds to believe the company is financially distressed, but elects not to adopt a rescue resolution, must deliver a written notice to affected persons setting out the applicable criteria and its reasons for not adopting a resolution. Advisers should put that subsection in front of reluctant boards early: doing nothing is itself a decision with statutory consequences.

The warning signs

No single indicator is decisive, but few genuinely distressed companies display only one. The adviser's checklist:

• Creditor pressure. Letters of demand, defaults on instalment arrangements, judgments taken or threatened, and settlement agreements rolled over more than once.
• Statutory arrears. Employee taxes, VAT or provident and pension contributions used as working capital. Arrears to the fiscus are almost always the first quiet borrowing of a distressed company.
• Payroll strain. Salaries paid late, in tranches, or funded by the shareholders personally.
• Bank behaviour. Facilities reduced or called, covenants breached, additional security demanded, or the relationship moved to a lender's workout division.
• Trading signals. The loss of a key customer or contract, sustained margin collapse, or forced sales of stock and book debts at a discount to fund the month.
• Reporting signals. Management accounts that arrive late or not at all, qualified audit opinions, and going-concern notes that grow longer each year.

Against each of these, ask the section 128 question: on what the directors know today, can the company pay everything that falls due in the next six months? If the honest answer is no, or probably not, the board is in section 129 territory.

The adviser's position

Accountants and attorneys usually see distress before boards are ready to name it. The adviser's protection — and the client's — is a written record: advise in writing, date the advice, and record the information on which it rests. Delay narrows every option. Post-commencement finance under section 135 is easier to raise while there is still a business worth funding; the moratorium that accompanies rescue protects more when assets and contracts are still intact; and a compromise with creditors under a rescue plan, with the discharge effects contemplated by section 154, requires something left to compromise.

The options ladder

• Informal workout. Before formal proceedings, a negotiated standstill or compromise with major creditors may be sufficient — and rescue proceedings remain available if it fails.
• Board resolution under section 129. The resolution is filed with the CIPC, notice goes to affected persons, and a licensed practitioner is appointed on short, strict timelines. Non-compliance is punished: the resolution lapses and is a nullity, and the company may not file again for three months without the leave of a court.
• Objection under section 130. An affected person may apply to set aside the resolution or the practitioner's appointment — a reason to commence properly, on genuine grounds, with a defensible practitioner choice.
• Court application under section 131. Where the board will not act, an affected person — a creditor, a shareholder, a trade union or employees — may apply to court to place the company under supervision.
• The clock. Section 132 designs rescue to be short. If proceedings run beyond three months without an extension granted by a court, the practitioner must report monthly on progress. Rescue is a bridge, not a residence.

Acting early is the whole game

Business rescue fails most often for one reason: it starts too late. The adviser who raises section 129 at the first cluster of warning signs — in writing, with the six-month test on the table — gives the client the full menu: workout, rescue, or an orderly winding-up on the company's own timing rather than a creditor's. Members of the Association practise across all of these disciplines. A licensed practitioner consulted early can be found through the members' directory, and an early consultation costs a fraction of a late one.