Prescription And Constructive Knowledge: Key Principles From A Recent Supreme Court Of Appeal Decision

Introduction

A recent judgment from the Supreme Court of Appeal has provided important clarification on the application of prescription in the context of misappropriation of funds within a close corporation. The case revolved around whether a debt owed to a close corporation had prescribed, particularly in circumstances where one member was alleged to have misappropriated funds over an extended period, and the other member claimed ignorance of the wrongdoing until after the former's death.

Legal Framework: Prescription and Knowledge

The Prescription Act 68 of 1969 governs the period within which a creditor must institute action to recover a debt. Section 12(1) of the Act provides that prescription commences as soon as a debt is due. However, section 12(3) introduces an important exception: a debt is not deemed due until the creditor has knowledge of the identity of the debtor and the facts from which the debt arises. Furthermore, the section deems a creditor to have such knowledge if it could have been acquired by exercising reasonable care.

The onus lies on the party raising prescription to prove not only the passage of time but also that the creditor had, or could reasonably have acquired, the requisite knowledge to institute action.

Court's Analysis and Findings

In the case at hand, the appellant (the executrix of a deceased member's estate) contended that the respondent (the surviving member of the close corporation) had constructive knowledge of the misappropriation of funds by the deceased during his lifetime. The appellant argued that, by virtue of his fiduciary duties and statutory rights as a member, the respondent could have discovered the misappropriation had he exercised reasonable care.

The court, however, was not persuaded by this argument. It emphasised that the mere existence of fiduciary duties and statutory entitlements does not automatically impute constructive knowledge of wrongdoing to a member. The court held that, for constructive knowledge to be established, there must be specific facts pleaded and proved to show that it would have been reasonable to expect the member to exercise his powers, and that such exercise would have revealed the wrongdoing.

The appellant relied on two alleged "red flags": statements by the respondent suggesting he was unaware of how the deceased acquired significant assets, and evidence that the respondent had queried discrepancies in his loan account. The court found these insufficient. The respondent's role in the corporation was limited to operational and technical matters, with no involvement in financial management, which was exclusively handled by the deceased and his family. There was no evidence of distrust or dysfunction during the deceased's lifetime, and the business remained financially healthy, masking the misappropriation.

The court further noted that, even if the respondent had exercised his statutory rights, the complexity and concealment of the misappropriation meant that only a detailed forensic investigation—such as that conducted after the deceased's death—would have uncovered the wrongdoing. The court rejected the notion that hindsight could be used to impose a higher standard of vigilance on the respondent than was reasonable in the circumstances.

Conclusion

The Supreme Court of Appeal reaffirmed that the test for constructive knowledge under the Prescription Act is fact-specific and context-dependent. The party alleging prescription must prove that the creditor could, with reasonable care, have acquired the knowledge necessary to institute action. In this case, the appellant failed to discharge this onus, and the court dismissed the appeal, holding that the debt had not prescribed.

This judgment underscores the importance of a nuanced, evidence-based approach to constructive knowledge in prescription matters, particularly where internal corporate relationships and the division of responsibilities are at play.