By Monique Sharland
Noticeably different to the previous Companies Act, under the new Act directors and “prescribed officers” are personally accountable for a great deal more and may be held individually liable and even criminally sanctioned under certain circumstances.
Under the new South African Companies Act of 2008, directors’ functions and duties are spelt out in detail. Besides this and a number of other critical legislations, directors must be fully compliant with the company’s provisions contained in its Memorandum of Incorporation (MOI).
In the financial services magazine, Cover, an article by Terrance M Booysen, Lucien Caron and Robert Davies had this to say:
“In the increasingly litigious environment we live in today, the courts will use the business judgement rule to establish whether the directors have fulfilled their duties. If not, in certain circumstances they can be held personally liable. Moreover, with new legislation being passed, these circumstances of personal liability are increasing and therefore it is critical that directors have an acute understanding of the organisation’s affairs, as well as the consequences the law will have upon a director should they default in their legal duties owed to the organisation. Having regard to the matters of director’s and their increased liabilities; one really does need to think twice about entering (or maintaining) a directorship position, particularly if the person is averse to the potential risks and reputational damage. It’s one thing if a director can mitigate their risks, but when matters are taken completely out of the director’s hands and they are still held liable, that is something altogether different and this begs the question of why a person would want to be a director at all”.
STANDARD OF DIRECTORS’CONDUCT
A director includes an alternate director, a person who is a member of a committee of a board of a company or of the audit committee of that company and a “prescribed officer”. Despite not being a director, a “prescribed officer” is a person who, within the company, exercises and participates in the general executive control over management of the business.
In the new Act where it does not deal with a director’s specific duty, or the consequences thereof, the common law will apply. Attempting to produce a full list of directors’ fiduciary duties in this article would be arduous and pointless at best due to its far reaching and complex immensity of various laws.
In terms of the new Company’s Act and common law, a director is required to act:
- In good faith and for a proper purpose in the best interests of the company and;
- With the degree of care, skill and diligence that may reasonably be expected of a person carrying out the same functions in relation to the company as those carried out by that director; and
- Having the general knowledge, skill and experience of that director.
This means that more is expected from directors to require above average skills. However, directors with below average skills will not be subject to a lower test as they will still be tested against the reasonable average person. This duty is derived from the common law.
Section 22(1) of the Act states that a company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. Section 77 (3)(b) of the Act states that a director of the company is liable for any loss, damage or costs sustained by the company as a direct or indirect consequence of the director:
- having carried on the company’s business despite knowing that it was conducted in a manner that was reckless, negligent or to defraud any person, and
- being party to an act or omission by the company despite knowing that the act or omission was calculated to defraud a creditor, employee or shareholder of the company, or had another fraudulent purpose;
- signed, consented to, or authorized the publication of any financial statements that were false or misleading in a material respect.
Therefore, if a company continues to incur debts, where, in the opinion of a reasonable business person standing in the shoes of the company director(s), there would be no reasonable prospect of the creditors receiving payment when it becomes due, it can be inferred that the business of the company is being carried on recklessly or negligently.
Consequently, a director would have a duty to pass a resolution for a company’s business rescue or alternatively resolve to wind up or liquidate it as soon as he or she becomes knowingly aware that the company is either financially distressed or is trading in insolvent circumstances (both factually, in that its liabilities exceed its assets, or commercially, in that it cannot pay its debts to creditors as and when they fall due).
If the company is financially distressed and the director decides not to place it under business rescue, the director is under a legal obligation, in terms of section 129(7), to deliver a written notice to each affected person (creditors, trade union, employees if not represented by a trade union, shareholders) confirming that the company is financially distressed and its reasons for not placing the company under business rescue.
On the other hand, if the company is trading insolvently and or it cannot pay its debts to creditors as and when they fall due and there is no prospect for business rescue to succeed, the director is obligated to file for liquidation.
Should a director not follow the procedures in this manner, he or she may be held personally liable for the company’s debts save for the courts discretion to relieve the director from liability in terms of section 77(9).
CIVIL CLAIMS BY THE COMPANY AGAINST DIRECTOR(S)
Section 77(3) holds directors liable to the company for any loss, damages or costs sustained by the company for knowingly carrying on business recklessly, with gross negligence or with intent to defraud any person.
Any director, who allows his company to receive goods or services on credit from a creditor, knowing full well that the company is not in a position to make payment for such goods, opens himself/herself up to a personal liability claim. Such conduct would constitute reckless behaviour on the part of the director and may also include an intent to defraud the creditor who had supplied goods to the company on credit.
CIVIL CLAIMS BY CREDITORS AGAINST DIRECTOR(S)
As is evident from the above, the company itself has a claim for loss or damage caused by the director to the company itself. The Act does not specifically mention the basis upon which a creditor can pursue a claim against the director who contravened the various sections referred to above.
Section 218(2) of the Act, however, states that any person who contravenes any provision of the Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention. Therefore, this would allow a creditor to claim against the company as well as against a director(s) or any person who caused loss or damage to the creditor as a result of a contravention of the Act. For instance, this section would allow a creditor to institute an action against the directors for the cost of the goods or services supplied on credit to the company which ultimately remained unpaid, if the business of the company was carried on recklessly or negligently at the time the goods were procured or the services rendered by the company.
LIABILITY OF DIRECTOR(S) FOR APPROVING DIVIDEND DISTRIBUTIONS
A director(s) of a company may be held personally liable if he or she was present at a meeting or participated in the making of a decision to approve a dividend distribution, despite knowing that the distribution was contrary to satisfying the solvency and liquidity test immediately after completing the proposed distribution and failed to vote against the resolution.
When one considers the fact that directors are appointed in a fiduciary position, it is criminal when they abuse their position for selfish motivation and personal gain.
Creditors are often faced with supplying services and goods to companies who refuse to pay or cannot pay. Ordinarily, creditors would issue summons to recover monies owed, but this is costly and can affect the creditors profits. Instead, creditors could consider whether the director(s) have been negligent or reckless in trading (and has evidence of this), the creditor could institute action or summons for loss and or damage caused to the creditor unders section 218(2).
In the event that the creditor does not have sufficient evidence to institute action against the customer company, the creditor can approach our recommended specialised liquidation attorneys and Business Accounting Network’s alliance partners, Robyn Hey Attorneys Inc. to apply to the High Court to liquidate or wind up the company on the basis that the company is commercially insolvent (it’s current liabilities exceed its current assets) and is unable to pay its debts as and when they become due, even though the company may be solvent in that all of its assets exceed its liabilities.
Thereafter, Robyn Hey Attorneys Inc. can proceed with a liquidation enquiry and interrogate the director(s) in respect of the trading of the company where they would seek to establish the knowledge on the part of the director(s) on the negative liquidity of the company while dealing with its suppliers and creditors and to obtain factual evidence on behalf of the creditor to pursue personal liability claims.
In conclusion, creditors can be relieved in knowing that they remain able, under the Act, to institute legal proceedings against delinquent directors of companies civilly for amounts owed to them by the company for products or services unpaid, and also to bring criminal charges against directors in the appropriate circumstances.
Monique Sharland, founder and CEO of Business Accounting Network, is a professional accountant, small business tax law expert and franchising specialist
DISCLAIMER: This publication is provided by BAN Business Accounting Network cc for information only, and does not constitute the provision of professional advice of any kind. The information provided herein should not be used as a substitute for consultation with professional advisers. Before making any decision or taking any action, you should consult a professional advisor who has been provided with the pertinent facts relevant to your particular situation. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the author, copyright owner or publisher.
COPYRIGHT: ©BAN Business Accounting Network cc. All rights reserved.