South Africa: The New Companies Act, No. 71 Of 2008 – Reckless Trading And The Personal Liability Of Directors

Last Updated: 29 July 2011
Article by Eric Levenstein

Originally published May 2011

The personal liability of South African directors is an emotive and important issue. The topic has gained momentum with the coming into effect of the new Companies Act, and general concerns about incurring personal liability.

Directors need to be aware of the circumstances in which they can be held personally liable for the debts of a company should it be placed into liquidation. It is incumbent upon directors to ensure that when the warning signs become evident, they immediately take legal and financial advice and, if necessary, place their companies either into business rescue or liquidation or to cease trading.

The question to be considered is whether or not insolvency is in fact a real possibility and whether the telltale signs of trading in insolvent circumstances are evident to directors. It is at this stage that directors are obligated to place their companies into business rescue or liquidation.

The Companies Act, No. 71 of 2008

The new Companies Act No. 71 of 2008 (the Act) was signed into law on 8 April 2009 and became effective on 1 May 2011. The Act has a significant impact on directors' liability in corporate South Africa.

Section 424(1) of the old Companies Act has been replaced by section 77 which, while worded differently, retains the essence of the old section 424. Section 77, as read with section 22 of the Act, penalises and holds directors personally liable for any loss incurred through knowingly carrying on the business of the company recklessly or with the intent to defraud creditors and other stakeholders. Section 214 creates criminal liability for those directors trading a company in a manner which is calculated to defraud a creditor.

Standard of director's conduct

Section 76 addresses the standard of conduct expected from directors. Section 76(3) states that a director of a company, when acting in that capacity, must exercise the powers and perform the functions of a director:

  • 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.

Section 76(4) states that in respect of any particular matter arising in the exercise of the powers or the performance of the functions of a director, a particular company director will have satisfied the obligations set out in section 76(3), if the director has taken reasonably diligent steps to become informed about the matter.

What would constitute "reasonably diligent steps?" In these circumstances, a director would be entitled to rely on the performance and information provided by persons who have received delegated powers or authority to perform one or more of the board's functions that are capable of delegation under applicable law. This includes the ability to rely on the veracity of the information provided, including financial statements and other financial data prepared by the employees of the company, accountants or any other professional person retained by the company, the board, or any committee constituted by the company.

Also included would be matters involving skills or expertise that the director could reasonably believe a particular person to have or to be within that person's professional competence. For instance, if a director receives financial information from departmental managers, he or she would be entitled to rely on the veracity of such information provided such reliance is "reasonable" in the circumstances and when one considers the specific expertise of that particular manager. For example, the marketing director would not have the same level of insight into a set of management accounts as would the financial director.

Furthermore, in terms of section 76(4) of the Act, a director would have satisfied the obligations of section 76(3), if the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company.

In terms of section 77(2)(a), a director of a company may be held liable in accordance with the principles of the common law relating to the breach of a fiduciary duty, for any loss, damages or costs sustained by the company as a consequence of any breach by the director of duties contemplated, inter alia, in section 76.

Reckless trading: when does one place a company into business rescue or apply for the company's liquidation due to trading in insolvent circumstances?

Reckless trading and conducting the company's business with the intention of defrauding a creditor are also covered by the new Act.

Section 77(3)(b) states that any director of a company is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director:

  • having acquiesced to the carrying on of the company's business despite knowing that it was being conducted in a manner prohibited by section 22(1) of the Act; or
  • being party to an act or omission by the company despite knowing that the act or omission was calculated to defraud a company creditor, employee or shareholder, or had another fraudulent purpose.

Section 22(1) 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.

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 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).

The definition of financial distress in reference to a particular company at any particular time, means that:

  • it appears to be reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuring six months; or
  • it appears to be reasonably likely that the company will become insolvent within the immediately ensuring six months.

If a company is financially distressed and directors decide not to place it into business rescue, directors will be under a statutory obligation, in terms of section 129(7), to deliver a written notice to each affected person, confirming that the company is financially distressed and is not being placed into business rescue and providing reasons for this.

The decision by a board to pass a resolution for business rescue needs to be done urgently to enable the business rescue practitioner to take control for the purposes of having a business rescue plan approved and thereafter implemented.

If a company is trading in insolvent circumstances and there is no prospect for business rescue, the directors are obligated to file for liquidation on an urgent basis. In South African law, a company need not be placed in liquidation merely on the basis that it has an "insolvent" balance sheet (i.e. it is factually insolvent). Many start-up companies commence trading on this basis and might remain "insolvent" for a substantial period of time. It is only when the company becomes commercially insolvent (i.e. it cannot pay its debts to creditors as and when they fall due) that directors face an obligation to apply for liquidation. This is not the case where the company is not currently trading and is not incurring credit with creditors. Any insolvent liquidation would still have to be dealt with in terms of the old Act (the new Act only deals with the winding up of solvent companies).

If a company continues to incur debts, where, in the opinion of reasonable businessmen standing in the shoes of the company directors, there would be no reasonable prospect of the creditors receiving payment when due, it can be inferred that the business of the company is being carried on recklessly or negligently as contemplated by section 22(1) of the Act.

The timing of such a liquidation filing depends on the factual circumstances of each case, and in particular the extent of the financial information available to such director at the relevant time. But, should a director not proceed in this manner, he or she might be held personally liable in terms of section 77(3)(b) as read with section 22(1) of the Act.

The test will always be that there will come a point in time when reasonable businessmen would wind up his or her company and pay creditors in full, unless he or she has access to further capital which can revitalise the company with some appropriate form of capital reconstruction.

Incurring credit when a director knows that the company will not be able to meet its liabilities when they fall due, will be tested by the court in order to substantiate the argument that the director should have placed the company into business rescue or liquidation, at that time, and should not have continued to do business knowing full well that such company would never be able to satisfy its creditors.

The detail of financial information available to a director, together with the veracity of such information, will be taken into account when the personal liability of such director is examined in terms of section 77 of the Act. Obviously if a director is in charge of operations, he or she will not be expected to be privy to the same level of financial information as the financial director.

Section 214 now renders a director (or any person) guilty of a criminal offence if such director or person was knowingly a party to an act or omission by a company calculated to defraud a creditor, employee, or a holder of the company's securities (shareholder), or with another fraudulent purpose.

Thus carrying out the business of the company knowing full well that such company is not able to pay its creditors, now constitutes a criminal offence.

Defences available to directors

The Act does make provision for directors to raise "honest or reasonable" behaviour on their part to be a defence in these circumstances. Section 77(9) states that in any proceedings against a director, other than for wilful misconduct or wilful breach of trust, the court may relieve the director, either wholly or in part, from any liability set out in this section, or on any terms the court considers just, if it appears to the court that the director has acted honestly and reasonably, or having regard to all the circumstances of the case, including those connected with the appointment of the director, it would be fair to excuse the director. This is the equivalent of the Business Judgment test.

It is important to note that the Act does not limit the application of section 77 only to directors as such. It applies to a director, an alternate director, a prescribed officer (as designated by the Minister), a person who is a member of a committee of a board of a company, or a member of the audit committee of a company irrespective of whether or not the person is also a member of the company's board.

Knowingly a party to prohibited conduct?

Furthermore the Act defines what is meant by a person "knowing" of such prohibited conduct.

"Knowing" is defined as a person either having actual knowledge, a person who has investigated the matter to an extent that would have provided the person with actual knowledge; or a person who has taken other measures which, if taken, would reasonably be expected to have provided the person with actual knowledge of the matter.

The intended effect of sections 76 and 77 in the Act is to protect directors who, in carrying on the business of the company, have shown a genuine concern for the prosperity of the company and whose decisions have been made in the company's interests. Directors should note that any enquiry into the conduct of the affairs of a company will always involve an evidential investigation. To the extent that a director has fulfilled his or her fiduciary duties and conducted the affairs of the company in accordance with sound business practices that fall within the parameters of these expectations, the evidence should speak for itself. Compliance with what can be reasonably expected of a director when faced with similar circumstances will therefore, in appropriate and objective circumstances, constitute a defence to any action launched in terms of section 77. "Reasonable behaviour" will differ from case to case and will be considered having regard to the peculiar circumstances of the issues facing a particular director.

As in all cases involving negligence, the test in South African law is essentially an objective one, in that it postulates the standard of conduct of the notionally reasonable director. It is subjective insofar as the said notional director is envisaged as conducting himself or herself with the same knowledge and access to financial information as the relevant director would have had in the circumstances. In this regard the court will have regard to, inter alia, the scope of operations of the company; the role, functions and powers of the directors; the amount of the corporate debt; the extent of the company's financial difficulties; and the prospect, if any, of recovery.

Delinquent directors

Section 162 of the Act states that a director may be declared "delinquent" if such director grossly abuses the position of director or intentionally or by gross negligence, inflicts harm upon the company or a subsidiary of the company contrary to section 76 or acts in a manner that amounts to gross negligence, wilful misconduct or breach of trust in relation to the performance of the director's functions within, and duties to, the company or as contemplated in section 77 of the Act.

Summary

Directors will have to "up their game". They need to be aware of the increased obligations in the Act, particularly in regard to the potential exposure to directors' liability whilst sitting on boards of companies in South Africa.

The new provisions of the Act require South African directors to make important decisions on company issues at board level.

Directors who allow companies to continue to trade in situations of financial distress or insolvent circumstances must recognise that such trading may be the subject of examination either by the business rescue practitioner or, if the company is placed into liquidation, at insolvency enquiries in the post liquidation period.

In current local and world financial markets, a frank and realistic review by directors of the manner in which their companies trade will be essential for survival and to avoid personal liability.

Worldwide, there is an expectation that directors' duties to their companies be elevated to ensure that the correct decisions are made for the financial benefit of the companies at all times. Failure to maintain a particular level of knowledge of these issues can result in directors being severely criticised or being held liable for company debts as a result of reckless and negligent behaviour.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions