Insolvency Law

In South- Africa the terms bankruptcy, insolvency, sequestration and liquidation are often used interchangeably.

Though all of them refers to a central theme, there are small, but crucial, difference between them:

• Bankruptcy – The process that describes both the sequestration of individuals and the liquidation of corporate entities in the United States and United Kingdom.
• Insolvency – The process that describes both the sequestration of individuals and the liquidation of corporate entities in South-Africa.
• Sequestration – The process whereby a natural person (or registered Trust) is declared insolvent through an application to the High Court (in the Province where the individual resides). It can be done through either Voluntary Surrender or Compulsory Sequestration.
• Liquidation – The process whereby a registered entity (Close Corporation or Company) is declared insolvent through an application to a relevant court) in the province where it has its registered address or main place of business).

The insolvent’s assets (cash or proceeds after sale), are used to pay a percentage (usually 20%) to his/her concurrent (general body) of creditors. Although this might sound draconian, it allows for a person with a large amount of debt, to obtain permanent relief from such burden (by writing if off completely). Sequestration stands directly in contrast with Debt Counselling (done in terms of the National Credit Act), whereby a consumer is declared over indebted. This permits the appointed Debt Counsellor room to negotiate a repayment plan (according to income) followed by a court order, confirming such restructured payment. The debt is however never written-off, and in most instances, only increase due to the interest that keeps on accruing on the outstanding capital.

A unilateral application by an applicant for the sequestration of his estate is called the "voluntary surrender" thereof. A court may accept such application if it can be proved that the applicant’s liabilities exceed his assets. The aim in surrendering an estate is, in essence, to escape a financial position which has become an intolerable burden.

A further avenue by which a person’s estate may be declared insolvent, is through a compulsory sequestration application, made by one or more of his creditors. This is also sometimes referred to as a so called “Friendly Sequestration” (if such process is preceded by a request from a “hospitable” debtor).  To bring such application, a creditor must have a liquidated claim against the Debtor.

A Sequestration order may be granted, if the court is satisfied that the applicant creditor has proved:

• That he has indeed established a claim against the debtor’s estate;
• That the debtor has committed an "act of insolvency;" and
• That there is reason to believe that it will be to the advantage of all creditors if his estate is sequestrated.

Whereas the applicant (with a Voluntary Surrender) has to prove that sequestration will be to the advantage of all his creditors, with a Compulsory Sequestration, the creditor has to merely show that there is reason to believe that it will be the case (the onus of proof is therefore more strenuous in the case of Voluntary Surrender applications. The reason for the aforementioned is that it can be expected that an applicant will be able to provide a detailed account of his own financial position (in the case of Voluntary Surrender), whereas a sequestrating creditor (compulsory sequestration) would generally not have access to such information.

“Free residue” is defined as the part of an insolvent estate, which is not subject to any right of preference (mortgage, instalment sale agreement, legal hypothec, pledge or right of retention). It includes the balance of the proceeds of an encumbered property, after discharge of the debt.

It is of the utmost importance that an individual, who is considering sequestration must either have:

1. Immovable property, with enough equity (above the amount secured by a bond); and/or
2. Movable assets, with sufficient inherent value, which can be paid towards the body of creditors; and/or
3. Cash to the value of at least 20% of the total amount payable to Concurrent Creditors.

• If the “free residue” is insufficient to pay the basic costs and expenses (including the Master’s- and Curator’s fees and expenses, as well as the stipulated 20% to concurrent creditors, the court will unfortunately refuse the application.
• The 20% rule does not apply to the liquidation of Close Corporations or Companies.

Liquidation is the legal process by which a Close Corporation or Company is declared insolvent by a competent court, due to the fact that the business cannot pay its debt anymore (cash flow shortage), alternatively that its liabilities exceed its assets. Business Rescue is the so called ‘Debt Review’ of the business world. An external Business Practitioner is appointed, who must manage the affairs of the company until its debts has been paid and/or its financial difficulties have been resolved. Due to the high cost factor, this option is usually only a viable option for medium to large businesses, which experiences a short term cash flow problem. There must however be optimistic future financial prospects as many entities subsequently end up applying for liquidation in any event.

When can a Business Entity be Liquidated?

• If the company has by special resolution resolved that it may be liquidated by the court.
• The company is unable to pay its debts.
• It appears to the Court that it is just and equitable that the Company should be wound up.
• Any creditor of a business may approach a relevant Court, seeking the liquidation of a Company / Close Corporation, if it can be proven that it cannot pay its debt obligation. This is normally only done where there is a large certainty that the said debtor has either funds (cash) or assets, which can be sold to pay the administration costs and expenses regarding the liquidation.

Benefits of liquidation All debt is written off and the members (of a Close Corporation) or directors / shareholders (of a Company) will have the option to start a new business venture or alternatively seek employment elsewhere! It could be that the business is just not viable anymore, due to amongst various other reasons changes in the current economic climate. This allows business owners the opportunity to implement a new business strategy, without previous baggage. It is important to note that Directors / Members may only be held liable for company debt, in the event that they signed personal surety for the debt of the entity in question.

The insolvency of an individual (and all restrictions attached thereto) comes to an end when he is rehabilitated. Rehabilitation may take place automatically after 10 (ten) ten years, but most individuals apply to court for such order, at a much earlier stage.

Circumstances In Which Rehabilitation May be Sought

• If an agreement has been reached (of not less than 50 cents in the Rand) with every concurrent creditor that has proved a claim against the insolvent estate.
• Lapse of the Prescribed Period of Time after Confirmation of the First Liquidation and Distribution Account (by the Master of the High Court).
• If no claims where proved against the insolvent estate after a period of six months (from date of sequestration).
• Full payment of all proved claims.

Effect of Rehabilitation The rehabilitation of an insolvent is a matter which lies solely within the discretion of the Court. Such discretion must be exercised judicially and not arbitrarily. This means that the court must have a sound reason for arriving at its decision. In the event that such order is granted, it has the effect of discharging the debts of the insolvent (which arose before sequestration) and also relieves the insolvent of every disability that arose as a consequence of the sequestration order. It must however be noted that rehabilitation does not reinvest the insolvent with his former estate (assets).