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Tuning to a common law frequency

July 2014

It is common practice to find directors of a company standing surety for the company in order to secure its debts. The consequence could be severe for the sureties, because if the company is unable to pay its debt, the creditor can take legal action against the directors or other third parties in their capacity as sureties, unless the company pays its debts and the sureties are released from liability.

In terms of section 155(9) of the Companies Act 71 of 2008, when a company (as a going concern or financially distressed, but not in business rescue) enters into a compromise with its creditors, this compromise has no effect on the rights the creditor has against the company's sureties. This section stands in contrast to section 154 of the Act where a company engaged in business rescue proceedings, represented by its business rescue practitioner, drafts a business rescue plan, which is subsequently assented to by the required majority of creditors, and provides for a discharge of the whole or part of the claims of the creditors. The contrast between these two sections raises the question of what happens to the rights of a creditor to proceed against sureties for the debts of a company in business rescue, when the adopted business rescue plan compromises that creditor's claim against the company. Without question, the distressed company's debt to the creditor is compromised and can continue on its business rescue path; however, does this mean that the sureties are freed from liability too?

On 28 May 2014 the High Court of South Africa, Western Cape Division, in the matter of Tuning Fork (Pty) Ltd T/A Balanced Audio v Greeff & Another 2014 JDR 1064 (WCC) (Tuning Fork), decided that in terms of the common law of suretyships, the release of the company from the debt meant the release of the surety as well.

This article will analyse the judgment as delivered by the Honourable Rogers J, his comparison of relevant case law and the common law relating to suretyships, and will provide a brief assessment of the impact the judgment has on the field of business rescue. The facts in this matter are as follows:

During the year 2000 "the company" (as described in the judgment) purchased audio and visual equipment from Tuning Fork. On 15 November 2011 the company's directors and defendants signed continuing and unlimited suretyships where they bound themselves as sureties and co-principal debtors for the present and future debts of the company as owed to Tuning Fork.

During July 2013 the company was placed into business rescue and a business rescue plan was subsequently adopted in October of the same year. The purpose of the business rescue plan was to allow the company to continue trading and, in doing so, a number of provisions were assented to by the creditors to facilitate the recovery of the company.

The most pertinent clause in the plan related to the remaining concurrent creditors and read as follows:

"Section 150(2)(b)(ii) - Release from debt
Should the Creditors approve the Business Rescue Plan, the payment under the Business Rescue Plan to them will be in full and final settlement of their claims against the Company ...”

Pursuant to this clause and in terms of the business rescue plan, the concurrent creditors, which included Tuning Fork, were to receive a dividend of 28.2 cents in the rand in full and final settlement of their claims against the company.

The business rescue plan was implemented on 25 November 2013 and the plaintiff received its concurrent dividend of R176 637.87 against its claim of R626 375.42. The business rescue proceedings were terminated on 5 December 2013 by the filing of a notice of substantial implementation.

Meanwhile and prior to the implementation of the plan, Tuning Fork instituted action proceedings on 1 November 2013 against the defendants in their capacities as sureties, claiming the balance of the company's debt as owing to Tuning Fork. A notice of intention to defend was served on 2 December 2013. Tuning Fork then launched an application for summary judgment.

The defendants opposed this application on two grounds, namely, that the compromise between Tuning Fork and the company, the principal debtor, released them from liability, and that they disputed the quantification of Tuning Fork's claim. For purposes of this article I will not deal with the quantum defence but rather the principles applied and conclusion reached regarding the compromise defence.

Accordingly, this matter came to Rogers J in the form of an application for summary judgment. In deciding the matter, Rogers J examined the compromise procedure as provided for in the Act, compared and referred to his own earlier judgment in the case of Investec Bank Ltd v Bruyns 2012 (5) SA 430 (WCC) (Investec), and the common law on the discharge of sureties.

The compromise procedure
In Investec Rogers (AJ as he then was) held that the section 133 statutory moratorium, which protects the company from legal proceedings once business rescue proceedings had commenced, was a so-called defence in personam for the distressed company and did not protect a surety for the company. On comparing Investec with the current case, Rogers J held that in the present case this statutory moratorium had been superseded by the release of the company against the payment to the concurrent creditors of the specified dividend in full and final settlement of their claims.

The submission made by the plaintiff in the current matter was that the legislature “could not have intended, when enacting the provisions relating to business rescue, that a surety would be discharged merely because the principal debtor… had been released from the claim by virtue of the business rescue plan”. With this the plaintiff was referring to the absence in the Act of a provision that dealt with the effect of a compromise reached during business rescue proceedings on a surety.

In terms of section 154, if a business rescue plan provides for a compromise of the creditor's (whole or partial) claim against the company, the creditor loses its right to enforce the claim or part of it once the plan has been approved by the required majority. Such compromise is, however, not the same as a compromise by a company in terms of section 155(9), which expressly does not affect the liability of a surety of the company.

These sections read together formed the basis upon which the plaintiff maintained that the legislature must have implied that the rights against the surety of the company under section 155 were the same as those of a company engaged in business rescue proceedings. The qualification found at section 155(1) (“unless it is engaged in business rescue proceedings”) implied, however, that an arrangement or compromise provided for in in a business rescue plan would affect the rights against a surety for the company.

In answering the submission made by the plaintiff, Rogers J held that “if the statute does not deal with the matter (as was the case here), the answer must be sought in the common law…”.

Rogers J further held that he did not adopt the argument that the business rescue provisions of the Act would not be workable, but for an implication to the effect that the rights against the sureties were preserved notwithstanding a compromise of the company. In saying so, however, he held that this did not mean that conversely, there was an implication that the surety would be discharged.

Rogers J held rather that since the legislature had not made its intentions clear, regard must be had to the common law principles when assessing the surety's liability.

Common law on discharge of sureties
Upon evaluating the common law relating to suretyships, Rogers J confirmed that “because the obligation of a surety is accessory in nature, the general position is that extinction of the principal obligations results in extinction of the surety”. He went on to mention the English case of Wides v Butcher & Sons (1905) 26 NLR 578. In this decision the full bench held that in adding the subscript, “subject to recourse upon third parties” when signing the deed of assignment (releasing the insolvent from all claims) resulted in a unilateral intention on the part of the creditor to reserve his right against the surety. This, however, was insufficient to allow the creditor recourse against the surety since the accessory nature of the surety's obligation had the effect of releasing the surety.

Rogers J further went on to look at the decision in Moti and Co v Cassim's Trustees. In this case the majority held that relieving the debtor of its debts meant that there was no longer any debt and thus the sureties were also discharged. The essence of the Moti judgment was that the accessory principle applies to a discharge of the principle debtor by way of a release or compromise, whether voluntary or statutory.

Application of principles
In deciding the first defence, Rogers J held that there is no provision in the Act that deals with the position of sureties of a company in business rescue and no basis for an implication into the Act preserving the creditor's rights against sureties. While this was a failure on the law maker's part, Rogers J held that the common law must be relied on presently. He further held that on application the plan itself, as reasonably interpreted provided for the discharge of the company from all claims by the concurrent creditors and thus a loss by the same creditors of their rights to enforce the claims in question. This he held, and applying the reasoning in Moti, did not change depending on whether or not the creditor in question assented to the business rescue plan or not.

Accordingly, Rogers J dismissed the application for summary judgment and granted the defendants leave to defend the main action.

Assessment
The precedent established by this judgment is that where a business rescue plan provides for a discharge/release of the distressed company (the principal debtor) from a principal debt by way of compromise in full and final settlement, the sureties for the company are as a result also discharged of their liability to the creditor. This will be the case even if the creditor voted against the plan.

What is clear from the facts is that the sureties stood not only as sureties for the company, but also as co-principal debtors to the creditor, Tuning Fork. The judgment is not explicit on whether this has any effect on the rights of the creditor against the co-principal debtors and thus whether even after settling with the principal debtor, the creditor retains his right to pursue the co-principal debtors for the balance of the debt.

Were the lawmaker in balancing the interests of the distressed company and all its stakeholders, including those who have funded the distressed company, to decide that the release of the company did not affect creditors' claims against sureties, this would mean creditors would recover the balance from the sureties and the sureties would automatically have a claim under their right of recourse against the company. This would not be ideal for a company trying to recover from financial distress as its net liabilities would not be altered. To remove the risk of such an occurrence the business rescue practitioner may include a provision in the plan having the effect that the sureties will lose their right to recover any amounts they've paid to a creditor of the company from the company.

What is also clear is that as a creditor, whether you assent or dissent to the business rescue plan, once it has been adopted without preservation of your right against a surety, that right falls away. The only way to retain your right against third parties, such as a surety, is to insist, before a vote is taken on the plan, for the inclusion of a term in the business rescue plan that your right against a surety will be preserved. Whether or not the business rescue practitioner includes this provision may well depend on how much voting (power) rights you have to sway the outcome of whether the plan is assented to and adopted or not. The larger a creditor, the more significant is its voting power and the more likely its request will be accepted by the practitioner. Another way in which a creditor can protect itself, is to insist that security be provided in the form of a guarantee rather than a suretyship.

The team

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