Under the new Companies Act 2008, can a defendant demand security for its legal costs when sued by a financially shaky company?
A company is a legal persona in its own right, separate
from its shareholders and directors. This is the most fundamental
principle of modern company law.
It follows that anyone who does business with a company needs to be cautious, particularly when lending money or extending credit to the company. If the company is unable to pay what it owes (or is unable to do what it promised to do) there will be no recourse against its shareholders and directors, save in the exceptional circumstances in which the Companies Act or the common law provides for a piercing of the corporate veil to impose liability for the company's debts on those who were in control of the company at the relevant time.
A defendant's concern as to its legal costs where the plaintiff is a financially suspect company
A particular problem arises where a company or close corporation is the plaintiff in legal proceedings. If judgment is eventually given against the company or close corporation, the court will usually order it to pay the legal costs of the defendant. If the company or close corporation has insufficient cash or assets, it will be unable to satisfy such a costs order, in full or at all.
Consequently, where a company or close corporation institutes legal proceedings, the defendant may, from the outset, have a legitimate concern that if its defence to the claim is successful, it will be unable to recover its legal costs from the company and may suffer severe financial prejudice from having to pay those costs from its own pocket.
The old Companies Act of 1973 made explicit provision in this regard
The now-repealed Companies Act of 1973 addressed this specific issue in section 13 which provided that–
"Where a company ... is plaintiff or applicant ... in any legal proceedings, the Court may at any stage, if it appears by credible testimony that there is reason to believe that the company ... will be unable to pay the costs of the defendant or respondent... if successful in his defence, require sufficient security to be given for those costs and may stay all proceedings till the security is given."
The Close Corporations Act had – and still has – an
almost identical provision in section 7 of that Act.
These provisions empower the court to call a halt to the legal proceedings until the plaintiff company or close cooperation has paid into court an amount sufficient to cover the defendant's estimated legal costs, or provided other acceptable security for those costs.
It was for the court to decide, on the basis of evidence placed before it by the defendant, whether there was reason to believe that the plaintiff company or close corporation would be unable to satisfy an adverse costs order.
For some reason, never explained, the new Companies Act of 2008 contains no provision for a plaintiff company to be required to give security for the legal costs of a defendant. As Daffue J remarked in Build On Construction (Pty) Ltd v Rasdi CC  ZAFSHC 25, when handing down judgment on 8 March 2013 –
"Section 13 of the 1973 [Companies] Act dealing with security for costs does not have a corollary [by which the judge meant a counterpart] in the new Act."
The relevant provision of the Close Corporations Act, however,
remains in place. The lacuna in the new Companies Act is a
matter of grave concern to defendants who are being sued by a
company whose financial resources may be too thin to satisfy an
adverse costs order.
Is there any alternative provision in the new Companies Act?
Does the new Companies Act contain any other provision in terms of which a worried defendant can demand security for legal costs when sued by a company with suspect financial resources?
There is indeed a novel and very broad provision in the new Companies Act 2008 which provides in section 20(9) that –
"If, on application by any interested person or in any
proceedings in which a company is involved, a court finds that the
incorporation of the company, any use of the company, or any act by
or on behalf of the company, constitutes an unconscionable
abuse of the juristic personality of the company as a separate
entity, the court may
(a) declare that the company is to be deemed not to be a juristic person in respect of any right, obligation or liability of the company or of a shareholder of the company ...; and
(b) make any further order the court considers appropriate to give effect to a declaration contemplated in paragraph (a)."
It remains to be seen whether a court will interpret this
provision widely enough to be the basis of an order in terms of
sub-section (b), quoted above, that a plaintiff company, whose
financial resources are suspect, must provide security for the
legal costs of the defendant.
An affirmative answer to this question would require the court to find that the institution of legal proceedings by a company, in circumstances where it has insufficient financial resources to satisfy an adverse costs order and has not voluntarily offered security for costs, constitutes an unconscionable abuse of the juristic personality of the company as a separate entity'.
It is by no means clear that the admittedly elastic language of section 20(9), quoted above, can be stretched far enough to cover this situation.
Even if the High Court finds a legal basis on which to order that security for costs be furnished, it seems certain that the court would nonetheless place the onus on the defendant to lay before the court evidence on which the court could conclude – as with the now-repealed section 13 of the old Companies Act – that there is a credible basis to reasonably conclude that the plaintiff company would be unable to satisfy an adverse costs order.
In other words, there would be no onus on the plaintiff company to show, affirmatively, that it would be able to satisfy an adverse costs order; the onus would be on the defendant to show the contrary.
However, it has hitherto been generally accepted that, in response to an application for security for costs, a plaintiff company should produce its financial statements in support of its averment that it would be able to pay the defendant's costs. See the remarks of Daffue J at para  of his judgment in Build On Construction (Pty) Ltd v Rasdi CC, noted above.
A weakness in the drafting of the new Companies Act
It is highly regrettable that the drafters of the new Companies Act 2008 did not incorporate the satisfactory (and tried and tested) provisions of section 13 of the old Companies Act 1973 into the new Act, but chose instead to leave this very important matter – an almost everyday concern of litigation attorneys – unaddressed.
It has been suggested (see the article by van Loggerenberg and Malan in (2012) 75 THRHR 609) that this was "a pure oversight" by the drafters of the new Companies Act, and that it can only be cured by legislative intervention.
The first tranche of amendments to the new Companies Act in Act 3 of 2011 did not address this issue, with the result that the law in this regard remains in uncertainty and it will take several High Court judgments (more, if the various judges take different views) or a further amendment to the Act before the law in this regard is clarified.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.