UK: Directors Owe A Duty To The Company, Not To Shareholders

Recently Justice Molopa-Sethosa handed down judgment in the Pretoria High Court in an important exposition of the law in relation to the liability of directors for claims by shareholders.

The plaintiffs were two shareholders of African Bank Investment limited ("ABIL") (collectively "the plaintiffs") and the first to tenth defendants were directors of ABIL and African Bank Limited ("African Bank") (collectively "the defendants").  The eleventh defendant was an auditing firm which performed professional services to ABIL and African bank.   African Bank was a wholly owned subsidiary of ABIL.

The Plaintiffs issued summons against the defendants on the basis that during December 2012 to December 2014, the defendants, in their capacities as directors, conducted the business of ABIL and African Bank recklessly in contravention of s 22(1) (which states that a company must not carry on its business recklessly, with gross negligence, with the intent to defraud any person or for any fraudulent purpose) and s 76(3) (which states, in part, that when a director exercises his or her power, he or she must do so in good faith, in the best interest of the company and with the degree of care, skill and diligence that may be reasonably expected of a person) of the Companies Act 71 of 2008 (the Companies Act").   The plaintiffs alleged that the breach of these provisions resulted in significant loss on the part of ABIL and African Bank which resulted in the share price of ABIL to drop by R27.84.

The Plaintiffs essentially claimed that they had suffered a diminution in the value of their ABIL shares and, in terms of s 218 (2) of the Companies Act, the defendants were liable to compensate the plaintiffs for the loss suffered as a result of the conduct of the directors.

The Plaintiff's plead that the former directors are liable to compensate them for damages they suffered by virtue of the provisions of s218(2) of the Companies Act by contending that their claim is based on a statutory cause of action rooted in s 218(2) of the Companies Act, which states:

The Plaintiff's claim against the directors is not "delictual" in nature, but rather is, according to what has been pleaded, a remedy as provided for by the provisions of s 218(2), which, according to the Plaintiffs, provides for a new remedy which did not exist under common law.   The Plaintiffs contend that they need not do more than to frame their cause of action within the four corners of s 218.  They took it one step further and say that they do not need to plead that the directors owed them, as opposed to the company, a duty of care and that no other elements (such as fault or wrongfulness) are required.

The defendants took exception to the plaintiffs' amended particulars of claim on three grounds as follows:

• firstly, that the plaintiffs' particulars of claim lacked the averments necessary to sustain a cause of action as a claim for reflective loss is not sustainable in SA law;
• secondly, the amended particulars of claim did not contain allegations to rely on s 218(2) of the Companies Act in that the Plaintiffs did not claim that they suffered loss as a result of the defendants' alleged contraventions but as a result in the diminution in the value of their shares; and
• thirdly, the plaintiffs' particulars of claim did not contain sufficient averments to sustain a cause of action based on the representations allegedly made by the defendants in that they did not allege that they suffered damages as a result of the defendants' representations.

The court said that the plaintiffs' suggested interpretation of s 218(2) will result in a situation where a director of a company is potentially liable to parties who, "he, or she, has not met, has not heard of, and is entirely unaware of."  The court took the view that this is, "an enormous departure from the clearly established legal principles".  The court said that if this had been intended, then the statute would have said something along the following lines "notwithstanding anything in the common law", or words to that effect.

The court found that in order for the Plaintiffs to succeed, they needed to show that their reliance on s 218(2) and a breach of s 76(3) of the Companies Act gives the plaintiffs' a claim against the  defendants and secondly that section 218(2) has extinguished the common law which does not allow a claim for reflective loss.

The court, in deciding the aforementioned questions, held that it is a trite principle of statutory interpretation that a statute does not alter the existing common law more than necessary and that legislation is to be interpreted in light of the common law as far as possible.

Upon considering s 218(2) of the Companies Act, the court held that s 218(2) is worded widely in respect of individuals who fall within its ambit, however, the court said it is restricted in its application and applies only to "damage suffered by that person as a result of that contravention."  The court said that this restriction requires a particular person to have suffered damage as a result of a particular contravention.  What this means is that the particular person who has suffered damage must be a person who is able to invoke a claim for damage as a result of a particular contravention of the Companies Act.  The court said that even if the plaintiffs could advance a claim for a breach of s 76(3) under s 218(2), they must show that s 218(2) has altered the common law to allow a reflective loss. This would, according to the court, be a drastic departure from a core principle of company law.

The court held that there was nothing to indicate that the legislature intended to alter the common law and allow reflective loss claims to be brought in terms of this section.  The court further noted that where a breach of s 76(3) of the Companies Act is relied upon by a plaintiff to establish defendant's liability to compensate for damages under s 218(2), the provisions of s 77(2) must be considered. The court said that s 77(2) expressly requires a claim for a breach of s 76(3) to be brought, "in accordance with the principles of common law".

The court accordingly found that the Plaintiffs' claim for a reflective loss was not available in our law. Further, the court found that there was an insufficient causal link between the harm suffered by the company as result of a breach of duty owed to it, and any loss suffered by its shareholders in consequence of a fall in share price.

The court held that, on the facts, it was African Bank who suffered a loss for which it could claim against the eleventh defendant.   The court held that it is established law that shareholders have no personal claim for damages where the company has suffered loss against from a third party and said that in these circumstances the company itself must claim damages and not the shareholders.   The court concluded that it was African Bank who suffered the loss and it is thus African Bank who is the proper plaintiff in the claim against the defendants.

The court found that the Plaintiffs as shareholders merely have a right to participate in the company which right remains unaffected by any wrong done to the company.  The rationale behind this is that a shareholder benefits from limited liability, thus since a shareholder is normally not exposed to liability of a company, it is also normally not the beneficiary of claims which may accrue to a company.   The court reiterated the common law position in a delictual claim for pure economic loss stating that where a wrong committed by a director against a company, not a shareholder, a shareholder is not entitled to recover loss from the alleged wrongdoer.

In arriving at her conclusion, Justice Molopa-Sethosa referred to the discussion of the reflective loss doctrine in Itzikowitz v ABSA 2016 (4) SA 432(SCA) by saying that in law a company has a legal personality distinct from its shareholders and that accordingly a loss to the company which causes a fall in its share price is not a loss to the shareholder.   Justice Molopa-Sethosa further said that the shareholder cannot be said to have suffered a loss as a result of a breach of duties owed to the company simply because "as a result" its share price has fallen.  Justice Molopa-Sethosa said that our courts have determined that there is an insufficient causal link between harm suffered by a company as a result of a breach of a duty owed to it and any loss suffered by its shareholders in consequence of a fall in the company's share price.   The honourable judge said that there is no reason to suppose that the legislature intended, by enacting s 218, to depart from that judicially sanctioned approach.

Justice Molopa-Sethosa said that the plaintiffs' reliance on s 218(2) to found a reflective loss claim does not establish a claim that can be sustained in law, and does not avoid the exception that the defendants have taken.   Justice Molopa-Sethosa therefore found that a proper case had been made out by the defendants and ordered that the exceptions raised by the first to tenth defendant and eleventh defendant be upheld with costs.

This judgment is ground-breaking as is confirmed the position that:

• directors do not owe a duty to shareholders but to the company itself;
• shareholders cannot claim from directors for their reflective loss suffered; and
• finally, that s 218 of the Companies Act did not intend to change the common law position that a shareholder cannot claim reflective loss from a director.

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.