It was previously thought that shareholders had a right to claim directly against directors for contraventions of the Companies Act, 2008. However, the Supreme Court of Appeal (“SCA”) has ruled in Investment Holdings (RF) Ltd and Another v Kirkinis and Others that this is not the case. The claim is the company's claim and the shareholder's loss is addressed by this claim.
African Bank Limited (the “Bank”) is a wholly-owned subsidiary of JSE-listed African Bank Investments Limited (“ABIL”). From April 2013 to August 2014, the share price of ABIL dropped from ZAR28.15 per share to ZAR0.31 per share, resulting in its shareholders incurring considerable losses.
Two of the shareholders sued the directors of ABIL for recovery of these losses on the basis that the directors had failed to exercise their powers in good faith and in the best interests of ABIL and the Bank, which resulted in the business of ABIL and the Bank being carried out recklessly or with gross negligence in contravention of sections of the Companies Act. The shareholders based their claim on section 218(2) of the Companies Act which provides that:
“Any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention.”
One would think that with the section cast in the widest of terms – “any person”, “any other person”, “any loss or damages” – the liability of a guilty director for losses incurred by a shareholder would easily follow. However, as the SCA found, it is not that simple.
No reflective loss
The rule at play is that that there can be no reflective loss in relation to companies and their shareholders. The underlying principles are, first, that a company has a distinct legal personality. Secondly, holding shares in a company merely gives shareholders the right to participate in the company on the terms of the memorandum of incorporation. This right remains unaffected by a wrong done to the company and, as such, a personal claim by a shareholder against a wrongdoer who caused loss to the company is misconceived.
The court referred to English law authority, which found that a shareholder cannot recover damages merely because the company in which they are interested in has suffered damage. They cannot recover a sum equal to the diminution in the market value of their shares, or equal to the likely diminution in dividend, because this “loss” is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. Their only “loss” is through the company, in the diminution in the value of the net assets of the company, in which they have shareholding.
The court referred to a recent English case in which it was held that there are four considerations against reflective loss:
- the need to avoid double recovery by the claimant and the company from the defendant
- causation, in the sense that if the company chooses not to claim against the wrongdoer, the loss to the claimant is caused by the company's decision not by the defendant's wrongdoing
- the public policy of avoiding conflicts of interest, particularly that if the claimant had a separate right to claim it would discourage the company from making settlements
- the need to preserve company autonomy and avoid prejudice to minority shareholders and other creditors
The court added that the law gives the right of action to the company instead of the shareholders because were it not to do so, the company and its creditors would be prejudiced. In addition, each shareholder would have a claim resulting in a multiplicity of actions based on the same cause. If, instead, the claim is given to the company, then the company would suffer no loss and that will ensure that the shareholders suffer no loss. The company's claim is an asset that compensates the company and the shareholders for their losses. If both were to have a claim, the wrongdoer would suffer double jeopardy and the shareholder would be compensated twice – once when their claim is successful and once when the company's claim is successful.
The court held that when the Companies Act became operative, the rule against claims for reflective loss was part of South African law. Accordingly, the appellants' claims, being quintessentially reflective loss claims, were misconceived, unless saved by section 218(2) of the Companies Act.
The court noted the definition of a company in the Companies Act as a distinct juristic person and held that this is foundational to company law and is the basis of the rule against claims for reflective loss. The court also examined a policy paper published by the Department of Trade and Industry in relation to the Companies Bill, in which it was said that:
“It is not the aim of the [Department of Trade and Industry] simply to write a new Act by unreasonably jettisoning the body of jurisprudence built up over more than a century. The objective of the review is to ensure that the new legislation is appropriate to the legal, economic and social context of South Africa as a constitutional democracy and an open economy. Where the current law meets these objectives, it should remain as part of company law.”
The court referred to the presumption that statutory provisions are not intended to alter or exclude the common law unless they do so expressly or by necessary implication, and that where possible, statutes must be read in conformity with the common law.
The court then analysed the various sections of the Companies Act that provide for director's duties and held that directors owe duties to the company and not the shareholders. In addition, the Companies Act designates, in certain specific instances, that it is the company that enjoys the claim. The court held that the words “as a result of the contravention” in section 218(2) must be given their conventional meaning such that the person who can sue to recover loss is the one to whom harm was caused. There must be a link between the contravention and the loss allegedly suffered. The court held that the loss was occasioned to the company and the company is the entity with the right of action.
Accordingly, the court held that the rule against claims for reflective loss has not been expressly abolished by section 218(2) or abolished by necessary implication and it disallowed the shareholders' claims.
Originally published 07 July, 2020
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