When “Getting Paid” Comes Back to Bite

By Wessel Robertson | Director

Settlement Agreements in Insolvency Contexts

There is a certain relief in reaching a settlement. The dispute is resolved, terms are agreed and payment is on the horizon.

But where the counterparty is financially distressed, that sense of closure can be misleading. A settlement reached at the wrong time, or structured in the wrong way, may later be challenged by a liquidator. In some cases, the very act of “getting paid” can create exposure rather than eliminate it.

When a settlement is not the end of the matter

South African insolvency law allows a liquidator to revisit transactions concluded before liquidation. The purpose is to ensure fairness between creditors and to prevent one party from being preferred over others in the period leading up to insolvency.

In terms of the Insolvency Act 24 of 1936, a liquidator is empowered to set aside certain transactions concluded before liquidation, including dispositions without value under section 26, voidable preferences under section 29, and undue preferences under section 30.

A settlement agreement, even one that appears commercially sensible, may fall within this scrutiny. Depending on the circumstances, it could be characterised as a voidable disposition, an undue preference to a creditor or a disposition made without value.

If successfully challenged, the effect is that the transaction may be set aside. Funds received may need to be repaid to the insolvent estate, often long after they have been applied or distributed.

Structure carries more weight than intention

It is a common assumption that a negotiated settlement is inherently fair and therefore insulated from attack. That is not necessarily the case.

Courts do not assess these agreements based on commercial intention alone. They consider how the transaction operates in substance, particularly in the context of the debtor’s financial position at the time.

Points that often come under scrutiny include:

• Timing – Transactions concluded shortly before liquidation attract closer attention, especially where the debtor was already under financial strain.
• Value – Whether the creditor gave proper value in return for what was received. A compromised or reduced claim may still raise questions depending on how the arrangement is structured.
• Effect on other creditors – Whether the settlement had the effect of placing one creditor in a better position than others in a similar class.
• Security and payment mechanisms – The way in which payment is made or secured can influence how the transaction is characterised.

The label attached to the agreement, whether it is an acknowledgment of debt or a settlement agreement, is not decisive. The underlying mechanics and impact are far more important.

Warning signs that should not be overlooked

Not every settlement with a distressed counterparty is problematic. However, certain indicators should prompt a more careful approach:

• Increasing urgency to conclude and implement the agreement
• Inconsistent or selective payments to particular creditors
• Ongoing restructuring discussions or informal arrangements with other stakeholders
• A pattern of missed or delayed payments before the settlement

These factors do not, in themselves, invalidate a transaction. They do, however, increase the likelihood that the agreement may later be examined in a liquidation scenario.

Practical Implications

A settlement agreement should not be viewed in isolation where there is any risk of insolvency. It forms part of a broader factual matrix that may be assessed after the event, often with the benefit of hindsight.

Creditors, lenders, and businesses dealing with distressed counterparties should consider whether the proposed structure will withstand scrutiny if liquidation follows. This may involve reassessing how value is recorded, how payments are staged and whether additional protections are required.

Early input at the structuring stage is far more effective than attempting to defend a transaction after it has been implemented.

Next steps

If you are negotiating a settlement in circumstances where the other party may be financially unstable, it is prudent to have the agreement reviewed before signature.

The Corporate Disputes team at Fairbridges can assist in assessing the risk, refining the structure of the arrangement, and ensuring that the agreement is aligned with both your commercial objectives and the realities of insolvency law.