Category Legal Affairs

The Misuse of liquidation

11 October 2007 Deneys Reitz Inc

It has been said that in corporate litigation, a liquidation application is the equivalent of a powerful bomb.
The liquidation process is intended for the winding up of the affairs of an insolvent business entity or to bring an equitable end to its existence in certain prescribed circumstances.  In the case of companies, these circumstances are set out in the Companies Act, 1973.  The process is not meant to be used for enforcing payment of a debt or to enable its controllers to surreptitiously escape the consequences of their actions, such as to avoid paying creditors.

Yet, not infrequently, one finds that winding up applications being used as a tool to an ulterior motive, typically to force the debtor to pay or as an endeavour on the part of those in charge of the business to sidestep creditors.

Our courts frown upon such an abuse of the process.  There is longstanding authority for this, with case law in this regard going back more than fifty years.

However, in practice this does not seem to deter those creditors who wish to circumvent the somewhat protracted procedure prescribed for enforcing payment of debts through the normal court process, by bringing a liquidation application against the debtor company. 

This typically happens through what is called a section 345 letter of demand.  This section in the Companies Act, 1973 provides that a company is deemed to be unable to pay its debts if a creditor has delivered a written demand at the companys registered office requiring the company to pay the sum alleged to be due and the company for three weeks thereafter fails to pay the sum demanded or to enter into a settlement arrangement with the claimant.

Frequently one finds that the creditor's demand remains unmet, resulting in the institution of an application to liquidate the debtor company, in circumstances where the creditor knows full well that the debtor is disputing the debt (which of course means that the party receiving the letter may not in fact be a debtor).  Consider the following example. 

Company A enters into an agreement with company B for delivery of a computer server.  The server is duly delivered, but it turns out that there are various defects which render the server unusable and oblige company B to incur significant costs in having the defects repaired.  For this reason, company B refuses to pay company A in full.  Correspondence passes between the parties in this regard.  Company A maintains that it is not contractually liable for the defects and claims payment.  Company B refuses to pay.  Company A causes a section 345 letter of demand to be delivered, but company B refuses to pay and refers to the correspondence which passed between them.  If Company A proceeds with a liquidation application, it would probably amount to an abuse of the process of court.

Why is this so?  Winding up proceedings are not intended for the enforcement of debts or to resolve disputes as to whether or not the debt claimed exists or not.  This is sometimes referred to as the "Badenhorst Rule", after the case decided more than fifty years ago in which this rule was first stated in our law.

Given that the liquidation of a company affects the interests of all creditors and shareholders, not to mention employees, especially those with significant numbers of employees, our courts will not be inclined lightly to order the winding up of a company on the application in these circumstances.  Of course, where a creditor clearly establishes the debt, the debt is not disputed and the company is unable to pay, it would be in the interest of creditors and other stakeholders that the company is placed in liquidation.

If a winding up application is successful, it means the end of the company.  The mere bringing of a winding up application could substantially prejudice a company or even be fatal.  Other creditors may be reluctant to extend further credit or to continue doing business with the company.  Customers may be reluctant to place orders or make payment to debts owed to the company. 

Hence the analogy drawn between a winding up application and a bomb.  An applicant in liquidation proceedings should therefore not bring the proceedings to achieve an ulterior motive.  If it does and the court finds the application to be an abuse of the process of the court, the unscrupulous applicant may well find itself mulct with a punitive costs order.  Therefore, before you drop the bomb, ensure your aim is true.

Andre Vos, Director, Deneys Reitz Inc.

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