The Badenhorst Rule: Why Liquidation Is Not Always the Answer to Unpaid Debt

Few things are more frustrating in business than providing goods or services to a customer who simply refuses to pay. You have fulfilled your obligations, issued your invoices, sent countless reminders and perhaps even threatened legal action. Yet, your bank account remains unaffected by your efforts.

At this point, many creditors consider taking more drastic measures. Why bother with lengthy court proceedings when you can threaten to liquidate the debtor's company instead?

After all, the prospect of liquidation should be enough to convince anyone to settle their debts. Unfortunately, the law is not quite that simple.

Liquidation versus summons: What is the difference?

Although both procedures may arise from a company's failure to pay its debts, they serve different purposes.

When a creditor issues summons, it asks the court to determine whether the debtor is legally obliged to pay the amount claimed. If successful, the creditor obtains a judgment which can be enforced through various mechanisms, including the attachment and sale of the debtor's assets.

Liquidation proceedings, on the other hand, are aimed at winding up a company's affairs, realising its assets and distributing the proceeds among creditors according to their respective legal rights.

In other words, summons is generally aimed at recovering your money, while liquidation is aimed at winding up the debtor company. Importantly, even if you successfully liquidate a company, there is no guarantee that you will recover your money.

When can liquidation be effective?

Liquidation can be an effective remedy where a company owes an established debt and is unable to meet its financial obligations due to insolvency.

Section 345 of the Companies Act 61 of 1973 provides that a company may be deemed unable to pay its debts if a creditor serves a statutory demand at its registered office and the company fails to pay, secure or compound the debt to the creditor's reasonable satisfaction within three weeks.

The prospect of liquidation may encourage a debtor to settle an outstanding debt, particularly where the company is still trading and wishes to avoid liquidation.

However, there is an important limitation which creditors sometimes overlook.

The Badenhorst rule

In Badenhorst v Northern Construction Enterprises (Pty) Ltd 1956 (2) SA 346 (T), the court established a principle which remains relevant approximately 70 years later. Simply put, liquidation proceedings should not be used to enforce payment of a debt where the debtor genuinely disputes its existence on reasonable grounds.

This principle, commonly referred to as the Badenhorst rule, has repeatedly been reaffirmed by our courts, including the Supreme Court of Appeal.

Does this mean that a debtor can avoid liquidation merely by disputing an outstanding invoice? Certainly not.

The dispute must be bona fide, meaning genuine, and based on reasonable grounds. A debtor cannot simply deny liability or manufacture an unsubstantiated defence to prevent liquidation.

The distinction is between a debtor who genuinely disputes liability and one who simply refuses to pay.

In Grenco Projects and Construction CC v Hermanus Esplanade Dev Co (Pty) Ltd [2024] ZAWCHC 172, the Western Cape High Court considered an application for liquidation involving disputed construction payment certificates. Although the creditor had established grounds for liquidation, the court considered the genuine underlying disputes and pending arbitration proceedings. Rather than granting liquidation, it exercised its discretion to postpone the application pending the outcome of arbitration. Interestingly, the debtor was ordered to pay the costs of the liquidation application, illustrating that the consequences of invoking the Badenhorst rule are not always straightforward.

The lesson is simple: A statutory demand is not a shortcut to proving a disputed debt.

When should a creditor rather issue summons?

Where a debtor genuinely disputes the indebtedness, summons will often be the more appropriate course of action. Ordinary action proceedings allow the parties to present evidence, discover documents and have disputed factual issues determined through a trial.

However, there is another consideration which creditors frequently overlook. Winning your case and recovering your money are two entirely different things.

You may spend considerable time and money obtaining judgment against a company, only to discover that it owns no meaningful assets and has no funds available to satisfy the judgment.

In legal circles, this is sometimes referred to as obtaining judgment against a man of straw. You may have won the legal battle, but your victory is hollow if there is nothing to recover.

Choosing the correct strategy

Before deciding whether to issue summons or institute liquidation proceedings, creditors should consider more than whether money is owed.

Does the company own assets? Is it still trading? Can it satisfy the debt? Are there other creditors? Has anyone provided personal suretyship?

These questions may materially influence the appropriate recovery strategy.

A creditor with a strong contractual claim against an insolvent company with no assets may ultimately recover very little, regardless of the remedy pursued. Conversely, a creditor dealing with a financially sound company that genuinely disputes liability may be better served by issuing summons.

Liquidation remains an important remedy, but it is not necessarily the correct one.

The objective should not merely be to win a court case. It should be to recover your money.

Before spending substantial amounts on litigation, careful consideration of the merits of your claim and the debtor's financial circumstances may save you from an expensive and ultimately hollow victory.

Need assistance recovering outstanding debts?

At Van Zyl Scheepers Attorneys, we assist businesses with commercial debt recovery, litigation and liquidation proceedings. Whether you are considering legal action against a defaulting debtor or need advice on the most appropriate recovery strategy, our team can help you assess your options and pursue a commercially sensible outcome.

Contact us to discuss your matter and how we can assist.