Attacking directors (or officers) of companies in business rescue

Author :   By Ravie Govender & Alex Eliott

Business rescue provisions clearly state that a company in business rescue enjoys freedom against prosecution of claims against it. These provisions are silent when it comes to instituting civil recovery actions against directors who have conducted the business fraudulently, recklessly or both.

Could a creditor of a company in business rescue hold the directors (or even its officers) liable for fraudulent and/or reckless trading?

Currently it is possible for a creditor to bring a civil claim against directors for the fraudulent and reckless carrying on of the business, but only when a company is liquidated, through the mechanism of section 424 of the 1973 Companies Act. However the winding-up provisions in the 1973 Act do not, by definition, apply to a company in business rescue.

The 2008 Companies Act, on the other hand, does not provide a workable mechanism by which a creditor of a company in business rescue can sue a director personally for reckless or fraudulent trading.

There are a host of statutory duties imposed on directors by section 76 of the 2008 Companies Act. However, a breach of these duties only gives rise to a claim, in terms of section 77(3), against the director, by or on behalf of the company,for losses sustained by the company. It does not afford any right of recovery to creditors of the company.

Section 218(2) of the Act provides that any person who contravenes any provision of the Act is liable to any other person for any damages suffered by the aggrieved party in consequence of the contravention. This seemingly wide provision unfortunately narrows the scope for establishing personal liability.

  • First, most of the obligations that are imposed by the Act are imposed not on individuals but on the company itself. For example, the prohibition in section 22(1) on reckless or fraudulent trading is clearly a peremptory requirement imposed on the company – without any mention of its directors or officers.
  • Second, there must be a "contravention" of the Act, which requires proof that the company breached a peremptory requirement of the Act (not just a directory requirement). There are very few peremptory requirements in the Act.
  •  Third, it will in most cases be extremely difficult for the creditor to prove that the cause of its loss was the particular contravention complained of.

From both these Acts the legislative framework does not provide a workable situation for holding directors personally liable for the debts of the company in business rescue. Another point is that when a creditor accepts a business plan and such plan through implementation discharges the whole or part of the debt as approved, a creditor will lose the right to enforce the relevant debt or part of it (in this instance also against directors).

However, company law is not based solely on legislation but on common law principles also. This was clearly emphasised in the matter of Ex Parte Lebowa Development Corporation Ltd [1989] 4 All SA 492 (T). In this matter the court was asked in terms of section 311 of the Companies Act 61 of 1973, by the applicant (a creditor and also the major shareholder of Discreto (Pty) Ltd, under judicial management), for an order authorising the calling of meetings of the creditors of Discreto to consider and decide upon a proposal of a compromise or arrangement between Discreto and its creditors that had been put forward by the applicant.

Judge Stegmann in his judgment, after a close analysis and questioning of the applicant's proposal, dismissed the application by concluding it was clear that the applicant had no intention to provide the insolvent company with capital that could be realised to pay future creditors in full. As such the court could not knowingly expose creditors to further risk by this insolvent company and refused the application. Before reaching his decision, however, the learned judge commented that a line of enquiry into the possibility of fraud and recklessness must be pursued because enough was already apparent to him to suggest a prospect of establishing personal liability on the part of the directors or other officers of Discreto for at least some of Discreto's debts.

Stegmann J went on to draw comparisons between English law and South African law with regard to common law principles of fraud and recklessness. The conclusion reached by him was that the two jurisdictions shared similar common law principles when determining fraud and/or recklessness (gross negligence).

He pointed out that anyone (specifically referring to directors and other company officers) who injures another by fraud ( dolus)or negligence ( culpa) is of course personally liable to the victim in terms of the common law remedies respectively deriving from the actio doliand the actio legis Aquiliaefor patrimonial loss resulting from the fraud or negligence.

To give substance to these principles the judge made example of the following three cases, two of which were English and one South African:

English cases

  • In R v Sinclair and Others [1968] 3 All ER 241 (CA),a director of a company who dishonestly (ie knowing that he is not entitled to do so) exposed the company's funds to a risk to which he was not entitled to expose them (the potential prejudice), and who honestly believed that the funds would be repaid, nevertheless had the intention to defraud and committed a fraud on the company by so doing.
  • Similarly in R v Grantham [1984] 3 All ER 166 (CA),a director who dishonestly exposed his company's creditor to the risk that the company might not pay him, or might not pay him in full, on due date or soon after, had an intention to defraud the creditor, even if he honestly believed that the creditor would ultimately be paid.

Stegmann J analyses these two English cases and stated that to obtain credit for a company without disclosing a known risk that the terms of payment may not be honoured is fraud, even if the representor may not have intended to cause a loss and may honestly have believed that the debt would probably be paid, provides no sufficient excuse.

South African case

The judge then emphasised that these English cases were fully in accord with the principles of our law as reflected in, for example, Orkin Bros Ltd v Bell and Others 1921 TPD 92. The facts of that case were such that the fraud could be found to have been committed on the basis that the defendants obtained goods on credit for a company, while knowing that there was no likelihood that the company would be able to pay, since it had no means of payment. As indicated, however, it is not necessary to go so far as to prove that the representor knew that there was no likelihood of payment. It is sufficient to prove that the representor was aware of a risk that the company might not be able to pay in full on due date, even if the representor honestly believed it more likely that the company would be able to pay.

In conclusion and to answer the question posed at the start, whether a creditor of a company in business rescue could hold the directors (or even its officers) liable for fraudulent and/or reckless trading: A creditor could do so under common law as was clearly pointed out above in Ex Parte Lebowa Development Corporation Ltd. However, creditors should be cognisant that if they approve a business plan that discharges the whole debt or a part thereof and such plan is implemented, then they would lose the right to proceed against the directors or officers of the company altogether under the common law. The loss of this right to enforcement, however, can be overcome in the plan.

For further enquiries on the content of this article and to find out how a creditor could protect their enforcement rights against directors (or even officers), kindly contact the authors.

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