Defaulting debtors have been around for as long as debt arrangements have existed. As such, creditors and lawmakers have spent centuries trying to find effective debt enforcement strategies. A creditor in Medieval Venice could keep a defaulting debtor under house arrest in the creditor’s home, while the French frequently excommunicated debtors or paraded them in the town square. Fortunately, the laws around debt enforcement have since changed drastically, and debtors no longer have to worry about being pelted in the town square or being kept prisoner in creditors’ houses. That, however, does not mean that debtors now have free rein to ignore their debts. For companies specifically, failure to settle debts may result in significant consequences, such as those contemplated in the Companies Act 61 of 1973 (the ‘old Companies Act’). One such consequence is commercial insolvency and the risks associated with it.

Commercial insolvency – distinct from factual or technical insolvency – is not a novel or particularly complex concept. It is, however, a key risk that companies should always be mindful of, in that creditors may still apply for the winding up of a debtor company even if that company’s assets exceed its liabilities. In terms of section 345(1)(a) of the old Companies Act, a company is deemed unable to pay its debts – and thus, commercially insolvent – if:

(a) a creditor, by cession or otherwise, to whom the company is indebted in a sum not less than one hundred rand then due—

• (i) has served on the company, by leaving the same at its registered office, a demand requiring the company to pay the sum so due;
• (ii) in the case of any body corporate not incorporated under this Act, has served such demand by leaving it at its main office or delivering it to the secretary or some director, manager or principal officer of such body corporate or in such other manner as the Court may direct,

and the company or body corporate has for three weeks thereafter neglected to pay the sum, or to secure or compound for it to the reasonable satisfaction of the creditor.

(b) any process issued on a judgment, decree or order of any court in favour of a creditor of the company is returned by the sheriff or the messenger with an endorsement that he has not found sufficient disposable property to satisfy the judgment, decree or order or that any disposable property found did not upon sale satisfy such process; or

(c) it is proved to the satisfaction of the Court that the company is unable to pay its debts.

Section 344(f) empowers a court to liquidate a company if it is unable to pay its debts as described in section 345. The justification for the winding up of a company, despite even the genuine possibility that it may have assets in excess of its liabilities, is found in Boschpoort Ondernemings v Absa Bank, where the SCA held that:

‘…the valuation of assets, other than cash, is a notoriously elastic and often highly subjective one: the liquidity of assets is often more viscous than recalcitrant debtors would have a court believe; more often than not, creditors do not have knowledge of the assets of a company who owes them money – and cannot be expected to have...’

Simply, creditors need not to concern themselves with whether or not a debtor company may have assets somewhere, or with the value of such alleged assets. Rather, to the creditor, it is a simple matter of whether or not you can settle your debts as they become due and payable. If not, then a creditor may approach the court for a liquidation order in terms of section 344.

A debtor may defend the application by evidencing that it is not unable to pay its debts as contemplated in section 345(1). A court will also not grant an application for winding up if the application is intended to enforce payment of a debt which is disputed. However, where there is prima facie evidence that the debt exists, the onus is on the debtor to show that the debt is bona fide disputed on reasonable grounds. In the recent case of Jaltech Structuring v Impact Empowerment Ventures, the applicant – a creditor of the respondents – brought an application for the winding up of the respondents in terms of section 344(f) read with section 345(1)(a) and/or (c). The respondents raised several defences, the most relevant for present purposes being the respondents’ claim that the debt was in dispute.

In 2021, the applicant and the respondents (‘parties’) entered into a settlement agreement for the payment of fees owed by the respondents for services rendered by the applicant. The parties agreed that the respondents would repay two capital amounts owed to the applicant in instalments over a period of time set out in the settlement agreement. The respondents paid off the first capital amount, in accordance with the settlement agreement. The respondents paid 3 of the 8 instalments for the second capital amount and failed to pay the rest. In a letter to the applicant, marked ‘without prejudice’, the respondents did not dispute the debt of R2,707,171.85 due to the applicant. The applicant delivered a letter of demand in terms of section 345(1)(a)(i) of the Companies Act. The respondents replied, and for the first time, denied the existence of the debt in respect of the second capital amount. The applicant deemed the respondents unable to pay their debts, and brought an application in terms of 344(f) for the winding up of the respondents.

The respondents first challenged the admissibility of this letter, on the grounds that the letter was made without prejudice and as part of settlement negotiations. The court rejected this argument, ruling that it contained an admission of insolvency on the part of the respondents, and for that reason, could not be privileged. This is in line with the principle established in Absa v Chopda, where the court stated:

'As a matter of public policy, an act of insolvency should not always be afforded the same protection which the common law privilege accords to settlement negotiations.’ and that ‘Public policy would require that such admission should not be precluded from these proceedings, even if made on a privileged occasion’.

In relation to the respondents disputing the debt, the court applied the rule established in Prudential Shippers, where it was held that a dispute debt does not constitute a valid defence where a portion of the amount of the debt is disputed by the debtor. The respondents had already paid three out of the eight instalments in relation to the debt, which amounted to prima facie evidence that the debt exists. To succeed in their defence, and in line with the Badenhorst rule, the respondents were required to prove that a bona fide dispute exists and on reasonable grounds. The court agreed with the applicant’s submission that the respondents could not legitimately dispute their indebtedness due to the fact that the parties had entered into a settlement agreement for the payment of this very debt. The court found that the respondents had failed to prove that the debt was in dispute, or that it had the means to pay the debt. Accordingly, the court found that the requirements of section 344(f) and 345 had been met, and ordered the liquidation of the respondents.

This ruling is a reaffirmation of the principle that the winding up of a commercially insolvent debtor is justified if a debt has been prima facie established and such debt remains unpaid. It is also a reminder that a court will not be easily swayed towards exercising its discretion in favour of a debtor that has not discharged its debts. A creditor that is able to prove to the satisfaction of the court that the debtor is unable to pay its debts is entitled to succeed in its liquidation application.

Written by Siyabonga Nyezi, Associate and Keamogetswe Spooner, Candidate Attorney, and reviewed by David Hoffe, Counsel at Fasken