Creditors who do not have security are called unsecured creditors, and they are the ones who lose the most when companies are liquidated. The effect of giving security is to reduce the amount which will be available in the free residue.

Because security protects a creditor against loss, there is an incentive on creditors to get as much security as possible from debtors who may be liquidated. Some creditors are tempted, for selfish reasons, to bend the rules or even commit irregularities to try to protect their position.

When a company is liquidated the directors lose their jobs and the shareholders lose their investment. Because these people are insiders with knowledge of the business and affairs of the company, they are in the best position to know in advance if business is bad and if the company might be liquidated.

Many shareholders and directors abuse their advance knowledge by taking company assets for themselves or giving them to friends. This is called asset stripping. The company then has fewer assets and is even worse off.

The combined effect of security and asset stripping is that there is usually very little money left in the free residue for unsecured creditors

The insolvency law tries to combat these evils and there are many rules which are designed to expose and undo these dishonest schemes. These rules deal with investigation and “clawback”, which is the process of undoing improper security schemes and getting back assets which were stripped out of the company or otherwise paid to in a manner unfair to creditors.

The liquidator has a very important job. He must find the assets, do the investigations, claw back assets which were wrongfully removed, sell the assets for the best price, and distribute the money in the proper way.

Creditors and insiders who may have committed irregularities have good reason to fear an independent competent liquidator, because he has strong posers to investigate what they did. An experienced liquidator can often uncover these irregularities. His duty is to take back any ill-gotten and to report any criminal conduct. For these reason there is often an incentive on insiders and certain creditors to try to get a “friendly liquidator” who will turn a blind eye.

The liquidator earns a commission on the assets which he sells, and there is fierce competition for appointments as liquidator.

The wishes of creditors are, in theory at least, an important factor in deciding which person to appoint as liquidator.

It is obviously very important to ensure that only competent and independent liquidators are appointed and the insolvency law tries to ensure this. However, those provisions are evaded almost every day. There are various kinds of irregularities in the appointment of liquidators, including some liquidators who” buy” support by sharing their fee with an official in the creditor organization who gives the support.

There are also “cosy relationships”, for example where a creditor supports a liquidator on the unspoken understanding that the liquidator will try to protect the creditor who supported him. The unspoken threat is that if the liquidator challenges the creditor’s suspect security or claim, the creditor will not support that liquidator in future.

Such irregularities result in too many unsuitable appointments, with the result that too many irregularities never get investigated or exposed. This helps the dishonest persons get away with what they did and undermines the insolvency laws which were designed to protect unsecured creditors against such irregularities.

Some people must first get paid from the free residue “pot” before the balance can be divided among the general creditors. So, for instance, the liquidator’s fee and thee costs of administering the estate must be paid. That reduces the balance for creditors.

Next in line are certain privileged creditors who are called preferent creditors. They have preference for payment from the free residue pot. Only after the preferent creditors have been paid can the ordinary creditors share what is left. The major preferent creditor is SARS – who has wide powers to claim estimated amounts, leaving unsecured creditors with little or nothing.

There is more bad news for the unsecured creditor. The insolvency law, as applied in practice, is slanting in favour of dishonest people who so easily get away with asset stripping and other collusion.

In practice it is very difficult even for an independent competent liquidator to undo the asset stripping. The legal obstacles are large and the chances of succeeding in court are poor. This part of our law is mainly inherited from England, where the courts traditionally took a soft lien of asset strippers and gave them the benefit of the doubt too easily. Asset strippers are sometimes banks, and perhaps the financial establishment had too much influence with the judges of the time.

The sad consequence is that liquidators seldom succeed in winning a case against an asset stripper.

In addition, the estate must give security for costs, to guarantee that if the liquidator loses the case the defendant will recover his legal costs.

Unsecured creditors have further problems. Their chances of having a meaningful input in the appointment of a suitable liquidator are slim.

It should be noted that in recent years there have been more and more allegations of a major creditor (e.g. a bank) setting up estates in advance, shifting exposure away from themselves before liquidation, and organizing the appointment of liquidators whose main job is to protect the creditor in question against investigation.

The combined effect of institutionalized asset stripping and the tactic of setting up estates and having protection from a friendly liquidator represent a serious threat to unsecured creditors.

Risk Control Measures

It would be naïve to believe in any quick solution to the above fundamental realities which underlie and magnify the extent of insolvency risk. However, creditors who cannot avoid the liquidation route should be aware of these risks and could consider implementing some of the suggestion below.

Early Warning Systems

The question of early warning systems and risk avoidance measures is a major topic which cannot be dealt with in this article, other than to say that early warning systems must be implemented to identify high-risk debtors so that appropriate steps can be taken in good time to ensure adequate recovery.

An early warning is not a way of finding out about an estate that has already been liquidated. It is a flag to warn the creditor in advance, well before liquidation.

If a creditor has such warning, it can take steps to improve its position. The main object is to reduce exposure as much as possible. Whatever is lawfully collected in the ordinary course of business before liquidation is safe.

An effective early warning system would require a reliable method of regularly obtaining relevant facts, capturing and analyzing them, and reporting any danger flags for remedial action. 

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