When not to institute Liquidation proceedings when a debt is due…

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Liquidation proceedings are usually, and should as rule be, instituted when a debtor company is unable to pay its debts as they become due. However, liquidation proceedings should be carefully considered, as opposed to action proceeding (Summons), for the collection of a debt.

The law differentiates between two types of insolvency, namely factual and commercial insolvency.  A debtor is factually insolvent when its liabilities exceed its assets.  Commercial insolvency is entered when, despite a companies’ assets exceeding its liabilities, it is nonetheless unable to pay its debts.  As a rule, a company finding itself in any of these situations stares down the barrel of the proverbial gun, and is likely to find itself at the wrong end of an application for liquidation.  Similarly, the directors of companies who trade under insolvent circumstances can be held personally liable for the debt of the company incurred under such insolvent circumstances.

In spite of this, a creditor must take great caution in deciding on instituting liquidation proceedings when the debt in question is being disputed by the debtor company.  In this regard the Court has held in the matter of Badenhorst v Northern Construction Enterprises (Pty) Ltd 1956 (2) SA 346 (T) that :

“ It is trite that winding-up proceedings are not to be used to enforce payment of a that is disputed on bona fide and reasonable grounds.” (my underlining)

This statement has become known as the “Badenhorst Rule”.  This rule has also been widely accepted by legal authorities such as P M Meskin et al; Henochsberg on the Companies Act 5 ed Vol 1 at 693-694, where they state that: “

“Winding-up proceedings ought not to be resorted to in order by means thereof to enforce payment of a debt, the existence of which is bona fide disputed by the company on reasonable grounds; the procedure for winding-up is not designed for the resolution of disputes as to the existence or non-existence of a debt.’   

It must be noted that once the respondent’s indebtedness has been established on prima facie (on face value) grounds, the onus is on the debtor to show that this indebtedness is disputed on bona fide and reasonable grounds.  Furthermore, the discretion of a court not to grant a winding-up order upon the application of an unpaid creditor is narrow and not wide.  Even the existence of a counterclaim by the debtor company, which if proved, might discharge the creditor’s claim by reason of set off, is not in itself a reason for a court not to grant a liquidation order.  It will however be one of the factors that a court considers when deciding whether to grant the order or not.

Creditors should proceed with caution

When a creditor is, or has been made aware of the debtor company’s defence to its claim, and such a defence, on the face of it, constitutes a) a bona fide defence, on (b) reasonable grounds, great caution must be taken when deciding on which route to follow in order to collect the debt in question.  Under these circumstances a creditor will be well advised to utilise action proceedings and to issue Summons for payment of the debt.  To proceed with an application for liquidation, which will ultimately be decided on the papers filed (as opposed to oral evidence) might very well end up in the application being dismissed and the creditor being required to pay the legal costs of the debtor company.

Should you have any queries or require any advice regarding liquidations or the collection of debt in general, please contact our offices for formal advice.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Fred Visagie
C & A Friedlander Inc.- Insolvency & Business Rescue

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