ERIC LEVENSTEIN: Beware the walking dead of zombie companies – Financial Mail

As SAs economy remains under great strain, we need to consider the number of financially distressed companies that continue to operate on the cusp of insolvency and potential collapse.

Recently published statistics by Stats SA (December 2020) show that liquidations increased by 20.5 % in the fourth quarter of 2020, against the fourth quarter of 2019.

SA has seen 153 filings for liquidations, with the catering and accommodation sector leading the way, followed by real estate and business services and then by manufacturing.

In the current downturn, directors of companies (and this is an international phenomenon) have to continuously and critically assess their financial position.

They will have to consider if they should be trading at all; if their businesses continue to be sustainable; or if they should possibly consider filing for some kind of rescue process or liquidation.

If directors kick the can down the road, they may be opening themselves up to the possibility of attracting personal liability for reckless trading, or trading in insolvent circumstances.

If directors are aware that there is very little prospect of creditors getting paid, the companys continuing to incur credit (for example, as the recipient of goods and services on credit) might in fact turn out to be a fraud on creditors.

It means that such directors could be held civilly and criminally liable in terms of the Companies Act. In terms of the act, the onus would be on the directors to prove that they acted honestly and reasonably in these circumstances.

The pandemic has affected companies ability to pay debts, as lockdowns have effectively curbed entities ability to generate enough revenue.

In recent months we have seen more zombie companies rear their heads. They continue to trade in insolvent circumstances where they are doing nothing more than rolling over debt, often at the expense of the companys creditors.

Zombie companies, as the name suggests, are firms that are no longer competitive and which require frequent bailouts to continue to operate.

Many of these companies survive only because of their reliance on bank facilities, which are often stretched to the maximum.

These companies generate only enough cash to cover operating costs, overhead (fixed) costs (salaries, utility bills and rental obligations) and possibly interest due on loans.

Thats where it ends. Repaying burdensome debt is beyond their ability.

Zombie companies are seen as a barrier to productive and meaningful growth and are, as argued by many economists, detrimental to the economy. These companies could lock up scarce skills and valuable resources, which should rather become available and be used more effectively by more successful and dynamic companies.

It is argued that these companies need to be put out of their misery, where liquidation is the only option.

But there is another way out.

In recent years, various companies in SA have filed for business rescue, with positive outcomes for creditors.

South Gold Exploration, Basil Read, Group Five, Comair, Edcon, Phumelela and House of Busby have all gone through the business rescue process and have delivered better returns to creditors than would have been achieved had they been placed in liquidation.

In all of these instances, the directors of these companies made a timely call, realising that their companies were financially distressed and that they could reasonably be rescued through application of chapter 6 of the Companies Act.

These companies filed for rescue at an early enough stage in the distressed debt cycle, which resulted in the delivery of some value to stakeholders. Whether SAA can be placed in the same category, only time will tell

The problem is that zombie companies are well beyond this stage.

They survive from hand to mouth and boards of directors often refuse to see the wood for the trees. They need to realise that their companies are trading on borrowed time.

For many of these companies, it is already too late, with the prospect of rescue no longer being available, as there is no sustainable business or value left to rescue.

As Covid relief funding comes to an end (from the government and financial institutions), and following a grim December trading period, many companies are now facing a reckoning with their debt.

At this point, an intervention, and some hard decision-making, are whats required.

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ERIC LEVENSTEIN: Beware the walking dead of zombie companies - Financial Mail