Company liquidations in tough economic conditions --- a last resort

Company liquidations have risen sharply this year, and are expected to increase further as rising interest rates, soaring costs of debt, higher commodity prices and reduced consumer spending put pressure on South African businesses. Albeit a 7.2% increase in company liquidations in the first five months of 2008 and the expectation for this trend to continue throughout 2008, liquidation may not always be in best interests of creditors, including banks.

Traditionally, lenders such as banks have applied for the liquidation of a failing business in order to sell off its assets and recover at least some of the money they have loaned. However, liquidating a business should be a last resort in tough economic conditions, according to Oscar Grobler, head of commercial products and financial institutions at Absa Corporate and Business Bank (ACBB).

“Liquidation is conclusive and irreversible in nature and in most instances, unnecessary,” says Grobler. “Liquidating a business that is in dire straits is destructive and a weak strategy for a lender to recover its money. It puts a lot of people out of work and destroys businesses that could potentially recover and do well in the long run.”

Four years ago ACBB adopted a different philosophy to businesses in distress. Absa believes in supporting and helping businesses through tough times, rather than destroying through liquidation of a business that could potentially survive into the next economic upturn. Since the adoption of its new philosophy four years ago, ACBB has resuscitated an average of ten to fifteen South African businesses per annum, a total of nearly 60 companies in this time period. To date, ACBB’s new approach has had a 100% success rate.

“Hard times do not necessarily call for tough measures,” says Grobler. “By offering business solutions, such as meeting short and long-term capital needs and providing employee benefit advice to businesses affected by the economic downturn, businesses can overcome the short-term bear market and thrive in the bull market later to come.”

Grobler sees a shift in the role of banks as a credit provider as well as a change in their approach to business in South Africa. Today, banks undertake a supportive and empowering role, leaving the decision to liquidate or keep a business afloat in tight and adverse market conditions largely to its shareholders and directors. After all, if a bank liquidates a company it also places its retail market customers under duress. Only in exceptional cases will banks apply for liquidation.

“Although many businesses are currently facing financial distress, the fear of the bank liquidating using a fire sale approach to recover its money is no longer on the table and neither is reckless lending by a banking institution,” says Grobler.

While ACBB believe in supporting South African businesses by providing rescue plans to sustain businesses through difficult times and keeping them afloat rather than liquidating them, the bank will also not invest more money in a seriously troubled business. They apply an “and and” strategy rather than an “either or” strategy to businesses in distress, that is to say, they support a business through providing business solutions rather considering the option of liquidating as an alternative to supporting a business. As a creditor, ACBB will not further invest in a business that is at that stage financially unsound, however it will not destroy it either. ACBB’s 100% success rate in helping failing businesses to recover and prosper attests to the success of its philosophy that liquidation by banks should be a last resort in today’s tough economic climate.