But there are good reasons for arguing that it presents particular challenges for construction companies, says Brad Boertje, a construction risk management consultant and adjudicator on the Master Builders Association (MBA) North panel.
The new Companies Act (Act 71 of 2008) introduced the provisions for business rescue. When a business enters business rescue, a registered business rescue practitioner assumes responsibility for developing and executing the business rescue plan. A key provision is that once a business enters business rescue proceedings, it is immediately protected from legal action by its creditors.
“Business rescue is a highly complex process, but it can work. South African statistics indicate a success rate of around 10%, whereas the global average is half that. However, the decks are stacked against construction companies for several reasons,” he says. “Construction companies contemplating business rescue need to understand the risks.”
The first challenge identified by Boertje relates to performance guarantees. These guarantees are common in the construction industry and, mistakenly, are often seen as insurance products. In fact, though, they are quite different because they require collateral. The extent of the security required will depend on a multitude of factors, including the company’s turnover, its order book, its total guarantee exposure, its balance sheet and so on. In most cases, the shareholders (and sometimes the directors) will also be required to sign personal surety for guarantees.
If the company enters business rescue, it is protected against legal action by creditors – but individuals associated with it are not. This means that the guarantors can call in any personal sureties provided by shareholders and directors. And it is common for guarantees to be called post business rescue, as contractors flounder to maintain programme.
“These sums can be large, and certainly enough to cause an individual’s estate to be sequestrated. If you are asked to sign a personal suretyship, make sure you understand the consequences should guarantees be called in, which they inevitably will be in the case of business rescue,” he advises. “It’s particularly important to get any beneficiary to account properly for his or her losses – the guarantee is not a jackpot, but is intended to return the guaranteed party to the position they would have been in, had a contract been fully executed. This could save a lot of money.”
There is a second issue relating to guarantees. Once it is in business rescue, it’s vital that the company continues trading if it is to have any chance of exiting business rescue later on. To do so, it needs to issue performance guarantees for new contracts, which it generally can no longer obtain.
Of course, a 10% retention could be used in lieu of a guarantee but, given the paper-thin margins common in the industry at present, it’s doubtful if many construction companies could survive this dent to cashflow.
A second set of challenges relates to the supply chain of the company going into business rescue – essentially its suppliers and subcontractors. They will typically insist on being paid in advance for any goods or services. No contractor in business rescue has the cashflow to do this.
Their insistence on cash up front will also be motivated by the fact that companies in business rescue cannot obtain the normal credit risk insurance that secures the supply chain.
With no ability to procure goods and services from its supply chain, the company in business rescue simply cannot trade.
Boertje emphasises the need to manage risk adequately from the get-go, preferably using the services of a professional to ensure that the business is fulfilling its contractual obligations and, crucially, that others are fulfilling their contractual obligations to it.
For this reason, it is best to avoid “pay when paid” arrangements, and also not to condone missed payments from the main contractor. Indeed, he advises subcontractors to obtain payment guarantees from the main contractor, or payment in advance.