Business rescue achieves a better result than liquidation

This 14-year old construction holding company was hit by an increase in competition and reduction in infrastructure projects after 2010. By implementing business rescue proceedings, a better result for all was achieved.

Background

The board of the company resolved to place the company under supervision in August 2012 and filed to commence business rescue proceedings at the same time. My appointment as the practitioner transpired within the required time frame and the proceedings commenced.

The company was formed in 1998 providing electrical reticulation services to the construction industry and infrastructure projects across South Africa. The group of companies comprised of a holding company and three other entities. 100% of the shareholding was held by a large BEE investment holding company with the board comprising of four directors with two of them operationally involved. The company in business rescue was the “cash cow” in the group because it was involved in the construction of the major projects.

Reasons for the financial distress

The heady days in the construction industry and country prior to the World Cup in 2010 were evidence of a “boom” across the industry. Numerous projects and infrastructure developments were awarded to a number of the industry players, turnovers were increasing and cash flows were robust. However soon after the end of the World Cup, infrastructure projects began to dwindle and competition grew exponentially with aggressive pricing cuts in some instances to win tenders at all costs became the norm.

Needless to say, the expectation from the management was that the business would continue to grow despite the increase in competition and reduction in infrastructure projects. The outcome of our investigations revealed that the impact of the financial distress became evident at least 18 months prior to the filing. The main reasons for and causes of the financial distress are listed as follows:

Acquisitions:  The company did not conduct a thorough and effective due diligence which resulted in the overpayment for the acquisition entities. The directors of the targets were employed by the business rescue company at very high monthly salaries and benefits. Perhaps it was naivety or belief that these entities would add value and everyone would benefit.

Non-payment by a developer:  The BR entity expended R12 million and commenced with the contract without checking that the necessary authorisations had been awarded to the developer. The developer owed R8 million at the time of the commencement of the proceedings. When it became evident that the developer could not meet its commitments it was revealed that they did not comply with the statutory requirements of municipal regulations and were unable to raise the necessary finance; The impact on the already constrained cash flows pushed the distress and meant commitments to the suppliers could not be settled.

Inconsistent gross profit margins: Margins were often squeezed because of increased competition and tenders were submitted at cost or below. The industry norm is about 15% to 20% which made efficiencies imperative to generate profits and cash flows. Inefficiencies in the management and administration of the projects resulted in inconsistent margins which impacted on cash flows and profits. Margins were not sufficient to meet burgeoning overhead costs.

Downtime by labour:  Materials were the largest component of the input cost and because of cash flow constraints were not procured timeously. Labour were on site and needed to be paid despite the downtime.

High overhead costs:  Top heavy and expensive management structure that emanated from the acquisitions.
The restructuring of the company had commenced prior to the business rescue proceedings.

Over gearing the balance sheet:  The belief was that the next big project would generate the required profits and cash flow to meet all the commitments. Borrowings and supplier credits were increasing to cover the cash shortfalls and were not settled within the terms of the agreements.

Insolvent Balance Sheet

The liabilities exceeded the assets in the company mainly because of the high levels of credit extended by suppliers and the bank. The assets were at a negligible value because the equipment and vehicles were owned by another within the group. The only assets of some value were the debtor’s book including the retentions and stock. Excessive holdings of redundant stock meant that cash was tied up in these items which could neither be sold nor used in projects.

First Meeting of Affected Parties – 10 days after the appointment of the Practitioner

The first meeting was very well attended by all affected parties within the regulated time frame of days after the appointment of the practitioner. The bank and a large band of the unsecured creditors were very disgruntled and at times the proceedings were very stormy. Aspersions were cast against the directors citing irregular transactions, in particular a development project, however we found that these allegations were in fact spurious. During our investigations the cession of the debtors book was signed with the main supplier in January 2000, 6 months prior to the one held by the bank. This meant the bank held a reversionary cession and was entitled to withhold the recovery of these proceeds.

Business Rescue Plan

The plan was published in September 2012 and was approved by the majority of affected parties in October 2012 at the second meeting of affected parties. The implementation of the plan and turn around process commenced immediately after approval and adoption.

The secured creditors were to be paid 100% of their claims while unsecured creditors accepted a compromise of 50% of their claims to be paid within a three year period. The balance of the retention book was at R10 million when we commenced the proceedings. This justified a better return for creditors from business rescue proceedings because in a liquidation scenario these would not be recovered because the projects would not be completed.

One of the directors initially voiced his concern about my ability to rescue the business because of my gender and lack of experience in that industry. But he changed his mind after the plan was presented to him for comments, at which point he realised the extent of my expertise. From this point onwards we were able to work together as a team – we needed each other and ultimately had the same objective in trying to save the business and save jobs.

Results of the Rescue

The company was restructured and downsized to reduce overhead and operational costs. The performance of the projects was monitored on a weekly basis which meant they were managed proactively. A turnaround in the overall performance of the company became evident when losses were negated and profits were recorded in the next financial year end. Cash flow management was instituted on a daily basis, however this remained constrained.

Early in 2014 a decision was taken to wind the company down in business rescue. We were unable to raise R5 million to repay SARS for post commencement claims and could not procure tax clearance certificates. This meant that projects and contracts would not be awarded and we could not continue as a going concern.

An amended plan was approved by the creditors where projects would be completed, performance guarantees would not be cancelled and retentions would be recovered. The business rescue of the entity could be viewed as being successful because it achieved a better result for the creditors when compared to a liquidation scenario.

Outcome

All the projects were completed, performance guarantees were not called up, retentions were preserved and employees were paid a nominal severance package. The retentions were recovered and a final distribution was remitted to the unsecured creditors albeit after an extended period.

Lessons Learnt

• Winding down a company in business rescue can provide better results for creditors than immediate liquidation, particularly in the construction industry;
• The all-important post commencement finance was provided by the major supplier allowing use of the debtors’ proceeds. The supplier continued to supply materials and did not lose future turnover and their claim of R20 million was settled.
• The bank would not have allowed the use of the proceeds which would have resulted in liquidation of the company.
• A personal surety provided by the directors was cancelled.
• The unfaltering commitment shown by the two operational directors during the proceedings was without doubt the main reason for the outcome.
• The two directors established their own company and are trading profitably, with cash in the bank and without debt. They reckon the hard lessons they learnt from being in business rescue have provided them with the necessary tools to operate in a profitable company.
• Team work is essential for a business rescue to work – the practitioner needs to establish a relationship with the key people without becoming emotionally involved.

Although we were left with no other option but to wind the company down it can be viewed as being successful because a better result was achieved for all concerned.