Law

What Should You Do If a Creditor Tries to Liquidate Your Business?

19/01/2021 14/05/2021

One of the most stressful events that a small business owner can face is having creditors breathing down their neck demanding payment for overdue debts, threatening to liquidate their company and even applying to a court to have their company liquidated.

In this article, we provide expert advice about how to fend off the liquidation of a company and ensure a firm comes out better prepared to survive the brutal economic times that South Africa finds itself in today. We also provide the options available for a small company that is struggling to survive and having to fight off aggressive creditors.

Due to the recession, there are a rising number of local companies in financial distress and facing threats or applications from creditors to liquidate their businesses.

The latest Statistics South Africa (StatsSA) figures released in November show that the total number of liquidations increased by 33.2% in the three months ended October 2020 compared with the three months ended October 2019.

Werksmans Attorneys head of insolvency, business rescue and restructuring Dr Eric Levenstein said during an interview that a company in distress faced with the possibility of liquidation needed to get advice as soon as possible.

Get professional advice as soon as possible

“My advice is do not wait if your company is struggling, or your creditors are applying pressure, go get professional advice. If you leave it too late, then your company faces one option – liquidation,” Levenstein added.

He said it was vital for small business owners to confront the situation and take drastic action to fix their battling company and ensure it survived.

Shepstone & Wylie Attorneys head of litigation Andrew Donnelly has specialist knowledge about insolvency, business restructuring and business rescue.

He said during an interview that when the owners of a small company faced a court application from a creditor to liquidate their business for alleged unpaid debts, they must first check its legality and determine if the creditor’s claims for outstanding debt were valid.

If there was a dispute about the validity of the application, then the company owners should oppose the liquidation, he added.

Stephan Venter is a Cliffe Dekker Hofmeyr lawyer who focuses on insolvency, corporate recovery, and business rescue.

He said during an interview that when reviewing a liquidation application, it was important for small business owners to determine whether their companies were commercially insolvent, since this was what a court would focus on when deciding whether or not the court should order the company liquidated.

To answer this question, the owners must consider if the company could pay its debts as and when they became due and payable, he added.

“It is expensive to go to court, so a creditor will normally only apply to the court for a company’s liquidation once they have exhausted all other informal options, and if there is a reasonable prospect to recover amounts owing to them once the company is liquidated,” Venter said.

Levenstein said that what often happened was that the board of directors anticipated the possibility of a liquidation application because of their creditors getting aggressive about unpaid bills.

“The directors then file for business rescue by a board resolution, and that puts a stop to the liquidation application for the time being. It is a defensive strategy. It doesn’t mean that the business rescue will be successful, but at least there is an opportunity to talk to your creditors. To set aside the business rescue, a creditor would have to apply to the court,” he added.

Donnelly said that only companies and close corporations could apply for business rescue. If there was already a pending application for liquidation, then the company must apply to the court for an order allowing for business rescue, he added. Donnelly said that when the owners of a distressed company applied to the court to have their company placed into business rescue, they must have a plan to save the business. The business rescue plan would require the approval from creditors holding 75 per cent of the value of the claims, Donnelly said.

“If there is no plan, then liquidation may be the only option,” he added.

Many well-known companies have gone into business rescue

Well-known local companies that have recently gone into business rescue include Comair, Edcon, Phumelela Gaming and Leisure, SAA and SA Express.

If a creditor brought a justified liquidation application and the company was insolvent with no hope of rescue, then the courts would approve the winding up, Donnelly said.

Small owner-managed or family businesses often look at their companies emotionally, and they try to save their businesses at all costs regardless of the facts.

“The best course of action often would be to make the hard decision and close the business,” he added.

Donnelly cautioned that while creditors might use the threat of liquidation to aid the payment of their debts, they had to have rational grounds for a liquidation application.

Levenstein said that tactically a creditor wanting payment could threaten the company that owed money with liquidation.

“Creditors that are owed money would apply pressure and to ensure the repayment of outstanding debt,” he added.

Creditors see liquidation as a quick way to get their money

Creditors seeking payment for their debts were increasingly applying for liquidation rather than business rescue as they saw liquidation as a quicker way to get their debts settled, Donnelly said.

“The problem with business rescue is that it can drag on. Creditors find that very frustrating because the company continues trading, but legislation prevents them from enforcing their claims,” Donnelly said.

Larger companies have a better chance of surviving than small to medium companies because business rescue was expensive, Levenstein said. It was important for company directors to consider whether they were incurring needless debt that they could not afford to pay back, he said.

In such a situation, the company directors could face accusations of reckless trading and be sued in their personal capacities, he added. Donnelly said that before a company went into business rescue, the first person the company’s directors should talk to was their banker.

If the banker heard about a business rescue of a small company through the grapevine, he or she would get a nasty surprise and go into a defensive mode where they would focus on debt recovery rather than trying to help the distressed company, he added.

Communication with a company’s bankers was even more important if the company was likely to need post-commencement finance from their bank to stay afloat, Donnelly said.

Other options for distressed businesses

A company facing the possibility of liquidation has several options other than a business rescue or a court-sanctioned liquidation.

The first was to negotiate an informal repayment plan with the creditor bringing the liquidation application, Donnelly said.

The second option was for a distressed business to pursue an informal restructuring, Levenstein said.

An informal restructuring takes place when a company changes the structure of the company, exits from non-performing entities, sells off assets, reduces staff, and cuts costs to make the company more efficient, Venter said.

“The most important thing is to have a good relationship with your creditors when proceeding with informal restructuring options,” he added.

Levenstein said that the dangers of an informal restructuring were that all of the company’s creditors needed to agree to it.

“You cannot have one creditor disagree, and then the company pays the other creditors because then you prefer certain creditors ahead of other creditors, which the law does not allow,” he said.

“The other problem is that one of those creditors could apply to the court for the company’s winding up with liquidation. This situation would come amid the company’s admission that it cannot pay its creditors and so this could invite a liquidation. So informal restructuring can work, but the problem is that there is no moratorium on creditor claims like in business rescue,” Levenstein added.

The third option for a company in distress was to pursue a voluntary liquidation, which Donnelly pointed out could offer big cost savings when compared with a court-sanctioned liquidation.

Voluntary liquidations are much more prevalent than compulsory applications as StatsSA figures show that during the ten months ending October this year, there were 162 compulsory liquidations compared to 1,448 voluntary liquidations.

Venter said that a voluntary liquidation could involve the sale of the assets and wind-down of a distressed company by an appointed liquidator.

If a company filed a special resolution with the Companies and Intellectual Property Commission in line with the relevant sections of the Companies Act, then the company would be placed under voluntary liquidation, he added.

The owners of a company could place it under voluntary liquidation even though its creditors do not agree or support the initiative, Venter said.

A fourth option is for the company directors to enter into a compromise with all of its creditors or a class of its creditors in terms of Section 155 of the Companies Act.

Venter said that a compromise was where a company comes to an arrangement with its creditors, for instance, to reduce the debt it owed them or to pay the amount owed to the creditors over an extended period. A compromise aimed to allow a company to improve its financial position, he added.

“If seventy-five per cent of the creditors in value approve the compromise, the court sanctions it and then it becomes binding on all existing shareholders. Properly used a compromise can be a very effective way of saving and restructuring a struggling company,” Donnelly said.

But Levenstein said that the problem with Section 155 was that there was no moratorium against creditor claims.

Once the court approved the liquidation application, then the Master of the High Court would select a liquidator, Levenstein said.

Liquidation was the end of the company because the liquidator would shut it down, sell all the assets and the creditors would get a final liquidation dividend, he added.

Donnelly said that liquidation would tarnish the reputations of the owners of a business and could impair their ability to win the support of clients, investors, and financial institutions for other business ventures in the future. However, a factor of liquidation was that the liquidator could probe any allegations of mismanagement by the company’s directors, he added.

A Remote Working Danger: Independent Contractor or Employee?

19/12/2020 14/05/2021

The move to a much greater level of remote working this year has reinforced the need for small businesses to ensure that they classify the people that work for them correctly. One of the biggest challenges for small businesses is to ensure that independent contractors, especially sole proprietors, do not drift into a position where the South African Revenue Service or the Department of Labour would classify such a person as an employee. The failure by a small company to manage the relationships with their independent contractors can lead to great costs for the company if the authorities find that the relationship with any of them is an employment relationship and the firm then needs to rectify the situation.

The prevalence of remote working since the start of the national lockdown in March has brought to the fore the need to distinguish between an employee and an independent contractor.

This topic has both labour and tax law implications.

Anli Bezuidenhout, a Cliffe Dekker Hofmeyr employment lawyer, said during an interview that a situation could arise where an independent contractor started working for a company, but ended up operating as an employee.

“It is important that both parties manage the relationship because the lines get blurred. Companies need to classify people correctly and manage the relationship properly,” she said.

Tertius Troost, a Mazars tax manager, said during an interview that small businesses could avoid an administrative burden if they dealt with an employee as an independent contractor.

“Small businesses battle with Pay-As-You-Earn (PAYE) tax, especially with complicated employee fringe benefits,” Troost added.

Having an employee defined as an independent contractor means that the employer would not need to pay the person either annual or sick leave or overtime pay, nor would the employer be required to make pension or medical aid scheme contributions.

In addition, an independent contractor cannot enforce a claim against the company for unfair dismissal, nor hold the employer to any of the many other employee rights provided by our labour laws.

The company would also not need to contribute on behalf of the contractor to the Skills Development Levy, Compensation Fund, and the Unemployment Insurance Fund.

Bezuidenhout said some companies like to have employees classified as independent contractors, because they then do not have to comply with the Labour Relations Act (LRA) and the Basic Conditions of Employment Act (BCEA).

Often employees agree (or pro-actively request) to be independent contractors in order to avoid PAYE and to make expense deductions against their business income.

Bezuidenhout said that individuals were often happy when companies classified them as independent contractors because that gave them flexibility.

However, the South African Revenue Service (SARS) and the Department of Labour look at the actual relationship between a company and those that work for it – it is a factual enquiry and an employer that incorrectly classified an employee as an independent contractor would be liable for the employee’s tax that the company should have deducted plus penalties and interest.

However, the employer could (at least in theory) recover the tax paid to SARS from the employee.

How tax law defines an employee versus an independent contractor

SARS requires a company to withhold employees’ tax when three elements are present, namely an employer, the payment of remuneration and an employee.

SARS also provides two tests to determine whether a person is to be regarded as an independent contractor for employees’ tax purposes.

If an employee meets both parts of the first test, then the person is an employee and any earnings paid to that employee will be subject to employees’ tax.

The first part of this test is that the employee performs over 50% of the services or duties at the client’s premises.

The second part of the test is whether any person controls the employee or his or her work hours.

The second test determines whether a contractor is trading independently.

Where an independent contractor rendered services to more than one client, then the contractor needed to apply these tests in respect of each client to assess whether the contractor was an employee at each engagement.

Another test is the common law “dominant impression test” that SARS applies to determine whether an employee is an independent contractor or an employee.

How to apply the common law “dominant impression” test

The “common law dominant impression grid” sets out 20 of the more common indicators.

These indicators take a detailed look at the relationship to determine if it is an employer and employee relationship or a client and independent contractor relationship.

There are three categories of these indicators, namely:

Near-conclusive, which relate most directly to the acquisition of productive capacity;
Persuasive, which relate to the control of the work environment;
And resonant of either an employer-employee relationship or an independent contractor or client relationship, whichever is relevant.

SARS said in an Interpretation Note that it would use the dominant impression to classify the relationship as either an employee or an independent contractor relationship.

Personal service providers, labour brokers, and expatriate employees

SARS introduced anti-avoidance measures about personal service providers or labour brokers to clamp down on those trying to avoid employees’ tax.

SARS uses common law tests to determine whether a personal service provider or labour broker is carrying on an independent business.

Mazars’ Troost said that tax law required that when a company engaged a personal service provider or a labour broker, without a SARS certificate of exemption, that company had to withhold PAYE as SARS deemed such a person an employee.

SARS would only issue an exemption certificate if the labour broker or personal service provider conducted an independent business, according to a SARS Interpretation Note.

A personal services company has to have at least three employees who were not family members in order to be considered an independent contractor, Troost added.

Expatriate employees working in South Africa may need to pay employees’ tax on local income, subject to any double tax agreements which may be in place between South Africa and the expatriate employee’s home country.

In terms of the definition of remuneration in the Fourth Schedule of the Income Tax Act, a person who is not a resident cannot qualify as an independent contractor.

A quick comparison of employee versus independent contractor

Indicative factors in determining where a person is an employee or an independent contractor, according to the South African Guild of Editors.

Employee	Independent Contractor
Works for only one employer at a time.	Provides services to more than one person or company at a time.
Works the hours set by the employer.	Sets his or her own hours.
Usually works at the employer’s place of business and uses their equipment.	Works out of his or her own office or home and uses his or her equipment.
Entitled to annual and sick leave.	Not entitled to any leave.
Often receives employment benefits, such as medical aid or bonuses.	Does not receive employment benefits from the employer.
Works under the control and direction of the employer.	Works relatively independently.
Receives a nett salary after the employer has deducted income tax and UIF.	A provisional taxpayer and responsible for paying his or her own taxes.

(Adapted from: S A Guild of Editors)

How labour law handles the distinction between employees and independent contractors

The major pieces of employment legislation, the LRA, the BCEA and the Employment Equity Act (EEA), apply to employees and not independent contractors.

The law defines an employee to mean any person, excluding an independent contractor, who works for another person or the government, receives remuneration, and conducts the business of the employer.

There is no statutory definition of the term “independent contractor”.

As a result, several tests have evolved through case law, the presumption of employment provision in the LRA and BCEA, and the Code of Good Practice on “Who is an Employee”.

To ensure that employees do not lose their labour law protections, section 200A of the LRA and section 83A of the BCEA introduced a rebuttable presumption that everyone earning under the earnings threshold of R205,433.30 a year is an employee until proven otherwise and regardless of the contract concluded, according to an article on the EE Publishers website.

An employer who disputes that an independent contractor is an employee must provide evidence about the working relationship.