Do Suretyship Obligations Survive a Business Rescue

Since the new Companies Act came into force, there have been challenges in ascertaining the meaning, effect and application of many of the provisions of the new Act.

In the recent decision of the Western Cape High Court in the matter of Tuning Fork (Pty) Ltd t/a Balanced Audio v Greeff & Another 2014 (4) (SA) 521 (WCC), the Court had cause to consider one such challenge. The matter was brought against two sureties for payment to the plaintiff of the principal indebtedness owed by the Company (in business rescue), for which the sureties had bound themselves jointly and severally to pay.  The defendants, who were directors of the Company, defended the action and were represented by Assheton-Smith Incorporated on the basis that the principal debt had been extinguished by the adoption and implementation of a business rescue plan for the Company, which provided for a compromise between the Company and its creditors and for the full and final settlement of the principal indebtedness of the Company to the plaintiff.  The Company had been placed in business rescue, a business rescue practitioner had been appointed and a business rescue plan submitted to affected persons (shareholders, creditors and employees) for consideration and approval at a meeting held in terms of Section 151 of the Companies Act.

The business rescue plan included a compromise on creditors’ claims in full and final settlement of R0,282 cents in the Rand.  It did not stipulate that claims against sureties be preserved.   The business rescue provisions of the Companies Act do not stipulate that claims against sureties be preserved, notwithstanding the compromise of a claim as part of the business rescue plan.

The business rescue plan was adopted at a meeting held in terms of Section 151 of the Companies Act.   Section 152 of the Companies Act requires that at least 75% of all creditors vote (50% of which must be independent i.e. unrelated parties to the Company) on the adoption of the business rescue plan.  In terms of Section 152(4) of the Companies Act, an adopted business rescue is binding on the Company, each of the creditors of the Company, and on every holder of the Company’s securities, whether or not such person was present at the meeting or voted in favour of the adoption of the plan.

Subsequently the creditors were paid out their compromised claims and the business rescue plan was implemented. The effect of this was that the Company’s principal indebtedness to creditors of the Company, including the plaintiff were paid by the Company and the principal indebtedness to such creditors, including the plaintiff, was extinguished.

The defence that was raised on behalf of the sureties was based upon the well-established general principles of our law of suretyship;  that if a principal debt is discharged by a compromise with or without a release of the principal debtor, the surety is also released, as the principal debt no longer exists.  As the Company’s debt had been compromised with the plaintiff and paid in terms of the business rescue plan, no principal debt exists for which the sureties are liable.

The defence was contested on the basis that the preservation of the claim against the surety ought to be implied in the provisions of the Companies Act to the effect that such claims remain unaffected by the adoption of the business rescue plan.

The determination of this issue, although referred to in a few previous cases, had not previously required determination because usually suretyship agreements expressly provide for the rights against a surety by a creditor to survive any compromise concluded with the principal debtor.

Rogers J handed down Judgment in the above matter in the Western Cape High Court and, it is submitted, correctly held that the principal indebtedness had been extinguished by the implementation and adoption of the business rescue plan.

By applying the well-established test for implying a term in a statute, one cannot imply that rights against sureties “are or are not affected by the adoption of a business rescue plan. The matter is simply not addressed”.  The learned judge went on to state “if the statute does not deal with the matter, the answer must be found in the common law, even though the character of the answer might be influenced by the statutory event”.

The learned judge then applied the general principles of our law of suretyship;  that if the principal debt is extinguished, the surety is released, unless the suretyship provides otherwise. The decision was made in the context of summary judgement and the learned judge remarked that if there was evidence before him that the plaintiff had voted against the adoption of the business rescue plan, his decision might have been different.

Craig Assheton-Smith of Assheton-Smith Incorporated stated, “it is my opinion that this would not have made a difference to the principles that are to be applied.    As reasoned by the learned judge, the legislature appears to leave it up to the parties to regulate this either through terms of the business rescue plan itself, the terms of the suretyship or by way of a compromise with the surety in which he or she abandons his or her right of recourse against the Company.    If not dealt with, the latter could be the undoing of the very objective of the business rescue plan, which is to permit a Company to continue to trade in solvent circumstances. The unregulated approach however does not accord with the balance of the provisions of the Companies Act, the majority of which are very prescriptive in their provisions.  One is left to wonder thus whether the legislature simply overlooked the common law when formulating the business rescue provisions of the Companies Act.”

In light of this judgment, it is critical that the terms of a suretyship agreement preserve the right of a creditor to proceed against a surety regardless of the compromise of the principal debt pursuant to a business rescue or otherwise.