South Africa: Delinquent Directors: Courts Adopt A Zero Tolerance Approach

Last Updated: 29 November 2016
Article by Thipa Denenga

Summary:

Directors of companies will have to carefully consider the manner in which they conduct the affairs of companies. Recent case law proves that courts will not hesitate to grant orders of delinquency against directors.

The Companies Act together with case law significantly increase the expected level of directors' duties to companies in South Africa and the standard of conduct required. Coupled with the soon to be implemented provisions of King IV, directors must always consider whether they are adhering to the stringent duties imposed upon them.

Introduction

South African directors are to take heed of the implications of section 162 of the Companies Act 71 of 2008 ("the Act"), dealing with delinquent directors, in light of the courts unforgiving approach as adopted in recent case law.

The provisions of the Act intend to raise the standards of behaviour and integrity expected of directors by holding them accountable not only to the company, shareholders and fellow directors but also to the employees of the company.

The Law

Section 162 provides that a company, a shareholder, a director, company secretary or prescribed officer of the company, a registered trade union that represents employees of the company, or any other representative of the employees of the company, may apply to court for an order declaring a person (a director) delinquent or under probation if:

  1. the person is a director of that company, or within 24 months immediately preceding the application, was a director of that company; and
  2. such director has:

    1. consented to serve as a director whilst ineligible or disqualified under the Act or whilst under a probation order in terms of the Act or the Close Corporations Act and acted in a manner that contravened that order;
    2. grossly abused the position of a director;
    3. intentionally, or by gross negligence, inflicted harm upon the company or a subsidiary of the company, contrary to the provisions of the Act; or
    4. acted in any manner that amounts to negligence, wilful misconduct or breach of trust in relation to the performance of such director's duties.

Furthermore, the Act provides that a director may be declared delinquent where such director uses his or her position or any information obtained while acting in the capacity of a director to:

  • gain an advantage for him- or herself or for another person other than the company or a wholly owned subsidiary of the company; or
  • knowingly cause harm to the company or a subsidiary of the company.

Any declaration of delinquency would have dire consequences for the person concerned. For the most serious misconduct, the order of delinquency made in terms of section 162(6)(a) is unconditional and lasts for the lifetime of the person concerned.

For less serious contraventions, the court may impose conditions upon the order as it deems appropriate. Even in the circumstance where the court is more lenient in its order, one can only imagine the significant reputational damage the director in question may face.

The rationale of this remedy is that a director who is guilty of serious abuse of his position and infringements of his fiduciary duties should not be allowed to continue to hold a directorship or should only be allowed to do so under strict conditions imposed by a court.

Case Law

In the case of Kukama vs Lobelo and Others (38587/2011) [2012] ZAGPJHC 60 (12 April 2012), the South Gauteng High Court found that the director concerned had contravened section 22 (reckless trading) and section 76 (standards of directors conduct) of the Act.

The director had, inter alia: allowed funds (some R2.2 million) intended for the company to be paid into an alternative account to the detriment of the company; failed to detect a fraud on SARS in the sum of R39 million; and had further failed to alert his co-director and co-shareholder of such fraudulent transactions.

The court found that the conduct of such director did "not measure up to the standard required and expected of a director" and as a result found that he was in breach of the fiduciary duties he owed to the company. Further, section 76(2) (b) of the Act created a duty on the part of a director to communicate at "the earliest practicable opportunity any information that comes to his attention to the board", which he failed to do.

The court found that the director's conduct was grossly negligent, constituted wilful misconduct, a breach of trust and a gross abuse of his position as a director. As a result, the court ruled that the director should be declared delinquent in terms of section 162 of the Act, which order resulted in the automatic removal of the director from the board. The court further granted leave to the company that had suffered damages as a result of the director's conduct, to institute legal proceedings for such losses against the director personally.

In the most recent case of Gihwala and Others v Grancy Property Ltd and Others (20760/14) [2016] ZASCA 35, the court confirmed that an order of delinquency made against directors of a company is not regarded as unconstitutional.

The brief and somewhat complicated fats in this case were as follows: In 2005 an overseas investor, Mawji, accepted an invitation from Gihwala to invest in a joint venture with the Dines Gihwala Family Trust and Manala, using Seena Marena Investments (Pty) Ltd (SMI) (of which Gihwala and Manala were the directors and shareholders) as the front company.

In terms of this 2005 agreement, Grancy Property Ltd, Grancy, a company controlled by Mawji, acquired one-third of the shares in SMI. Grancy also made a loan to Manala to pay half of the amount he needed for his one-third contribution to SMI. SMI used the funds provided by the three investors (Grancy, Manala and the Trust) to acquire a 58% shareholding in Ngatana Property Investments (Pty) Ltd (Ngatana), the company registered for purposes of a BEE scheme enabling black investors to obtain shares in a listed company – Spearhead Property Holdings Ltd – at a reduced price. Eventually these were exchanged for shares in Redefine Income Fund Ltd after a takeover by the latter.

After a payment was made by Ngatana to SMI of R6 657 673, a total of R 4 million was paid to the Trust, Gihwala and Manala but nothing to Grancy. R 2 million was invested in a company in which Gihwala's wife had an interest, but this company was liquidated and the money was lost. Ngatana also paid R 750 000 each to Gihwala and Manala as 'directors' fees' because of SMI's assistance in setting up the original BEE scheme. SMI also made two loans to Manala without the knowledge of Grancy.

Ngatana eventually sold all its shares in Redefine and SMI received a dividend of R5 572 727. This amount was paid in equal shares to the Trust and Manala. The relationship between Mawji and Gihwala became acrimonious and several High Court actions followed.

A number of issues arose for determination on appeal, the most important of which are as follows:

  • Whether the 2005 agreement was breached and, if so, in what respects?
  • Whether the High Court was correct to make orders of delinquency in relation to Gihwala and Manal?

Wallis JA held that the 2005 agreement contained various tacit terms, inter alia, that Grancy was to become holder of one-third of the shares in SMI. Although it was not a partnership agreement, it was similar to one in many respects. Gihwala and Manala stood in a fiduciary relationship to Grancy to protect its interest as a shareholder.

There were clear breaches of the agreement, inter alia, by Gihwala and Manala refusing to acknowledge Grancy as a shareholder; and by refusing the latter to exercise certain rights of a shareholder.

Finally, the court upheld the orders of delinquency in relation to Gihwala and Manala. It held that they had acted with gross negligence and in breach of their fiduciary duties to SMI by appropriating benefits received from Ngatana for themselves while it should have gone to the company and then to its three shareholders. Their actions, therefore, fell squarely within the grounds for a delinquency order as described in s 162(5)(c) of the Companies Act 71 of 2008 as they grossly abused their position as directors and intentionally or, at the very least, through gross negligence, caused harm to SMI.

The court further held that s 162(5) was not a penal provision but intended to protect the investing public against directors who engage in serious misconduct and act in breach of the trust that shareholders place in them. This is not an arbitrary or capricious provision limiting their right to choose a profession but is in the public interest.

The appeal was dismissed and Gihwala, Manala and the Trust were declared liable, jointly and severally to Grancy.

What does this mean?

The case law above illustrates that the courts will not hesitate to grant orders of delinquency against directors where the circumstances warrant such.

There is no doubt that directors of companies will have to carefully consider the manner in which they conduct the affairs of companies, particularly where there is the possibility of being declared delinquent. Directors who find themselves on the receiving end of such an order are highly unlikely to be nominated (never mind actually appointed) to any other boards of companies.

In the initial draft of the Act, it was proposed that a "register of delinquent directors" be available to the general public. This appears to have fallen away. This means that although a person may have been declared a delinquent director, those who deal with him may not know of that fact unless it is disclosed.

We therefore recommend that companies who are appointing directors must, in addition to vetting persons to be appointed, require undertakings from each prospective director that she or he has never been declared a delinquent director and he or she is not aware, after having made an enquiry, of any proceedings where his or her declaration as delinquent director is sought.

Furthermore, directors will need to understand whether or not they are complying with the provisions of the Act. In particular, a director is obliged to ensure that he or she is not trading his or her company in a position of financial distress which might push the company into a situation where it becomes insolvent and unable to pay its creditors.

Clearly these provisions significantly increase the expected level of directors' duties to companies in South Africa and the standard of conduct required. Coupled with the soon to be implemented provisions of King IV, directors must always consider whether they are adhering to their duties.

It is therefore important that directors should thoroughly examine whether or not they are complying with the provisions as set out in Section 162 and carefully consider the manner in which they conduct the affairs of companies. If they are in doubt, directors should promptly seek legal advice so as to avoid and/or mitigate the consequences of an order of delinquency together with its adverse and severe consequences.

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.

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