Emerging Market Restructuring Series

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South Africa: Restructuring in 2021

Sub-Saharan AfricaEmerging Markets
Khurshid Fazel Khurshid Fazel Partner, Head of Restructuring and Insolvency, Webber Wentzel

During 2021 there is likely to be an increase in company restructurings in South Africa.

Prior to Covid-19, South Africa was grappling with economic challenges and Covid-19 and the accompanying lockdowns put further pressure on businesses, particularly in the hotel and leisure, retail, property and construction sectors. Many businesses have had to face difficult decisions with the only possible salvation being restructuring.

There is no rulebook for when a business should consider restructuring but there are certain indicators that a company is in distress which, unless tempered, will ultimately lead to dire consequences. Sime of these indicators include breach of financial covenants, cash flow pressures and loss of key customers and suppliers.

It is natural for most businesses to respond to cashflow pressures by cutting costs but cost cutting is most likely not a long term solution and will negatively impact the recovery of the business

There are a myriad of other options that may be available for alleviating liquidity concerns including disposal of non-core or non cash generative assets, capital raises through rights issues, restructuring of debt facilities, arranging working capital lines.

The lender of last resort to a company in distress is usually the biggest creditor bank, which by then probably holds all the security, leaving no security for other potential lenders. If the incumbent lender is reluctant to take on further exposure they may be inclined to yield some security to other lenders.

Aside from creditor banks, a distressed company can also look to new equity providers, existing shareholders and special situations funds or lenders. Distressed or special situations funds play an increasingly important role in financial restructuring in larger economies, but are uncommon in South Africa. The strength of the secondary distressed debt market is an important component of successful restructurings, since distressed funding has advantages, such as providing alternative sources of liquidity, a clear exit route for existing financial institutions and helping with restructuring expertise for an operational turnaround.

In some situations, global special situations funds buy debt from South African financial institutions. However, this usually occurs only when there is a loan syndicate which includes foreign lenders, which implies bigger events stretching across multiple jurisdictions. South African banks are not usually eager to sell debt as they tend to prefer to manage and restructure, although they may be more prepared to sell after a long period of holding a non-performing loan.

The key is to act swiftly. For example, attempting to sell assets into a market that is aware that the seller is distressed will drive prices down or raising capital from shareholders is more likely to be successful if shareholders believe that they are not throwing good money after bad money.

It is often difficult for management to continue operating the day to day business whilst also working on a strategy to increase liquidity. In the international market, Chief Restructuring Officers (CROs) are commonly appointed to assist with distress and develop a turnaround plan. There has been less traction in South Africa with the appointment of CRO's but independent corporate finance teams can also play an important role in assisting a company with its turnaround strategy.

In South Africa, the Companies Act makes provision for a more formal restructuring process, namely business rescue.

Although the Companies Act sets out a six-month forward-looking test that requires the board of a company to make the decision put it into business rescue, the decision to place a company in business rescue is often made later than it should be which a successful turnaround more difficult to achieve.

Post-Commencement Financing (PCF), which is lent to a company once it has entered into business rescue, for various reasons including the fact that incumbent lenders may have security over all the assets and PCF lenders rank behind secured lenders in a business rescue.

Whether formal or informal restructuring is the correct option differs for all businesses and situations.

Lenders may retain more control over their exposure when there’s informal restructuring but the formal structure of business rescue benefits the company by providing moratoriums on repayments and legal action.

In many instances, business rescue may in itself exacerbate the challenges faced by the company as customers and suppliers become skittish about continuing to trade with a company in business rescue. This will make it difficult for the company to achieve a successful turnaround.

Ultimately there is no playbook for businesses to decide which course of action to follow, however, the principles that will have universal application is to monitor early warning signs of distress and to act swiftly to alter the trajectory by bringing in the necessary experts to assist management with a turnaround strategy.