The delinquent director: no tolerance for errant directors?

ERRANT COMPANY DIRECTORS WHO FAIL TO COMPLY WITH THE OBLIGATIONS SET OUT IN THE COMPANIES ACT, 2008, FACE THE PROSPECT OF BEING DECLARED “DELINQUENT” UNDER CERTAIN CIRCUMSTANCES.

Our courts have declared directors, who have failed to discharge their duties under the Companies Act 71 of 2008 (Companies Act), to be delinquent, and have granted leave to the companies involved to claim damages from such director for losses incurred as a result of such director’s conduct.

It is therefore incumbent on South African directors to take cognisance of the impact of section 162 of the Companies Act (declaration of delinquent directors) and to take steps to ensure that they do not open themselves up to the possibility of being declared delinquent.

SECTION 162

In terms of section 162 of the Companies Act, 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 delinquent. Such a declaration will be made if the person is a director or, within 24 months immediately preceding the application was a director, and:

• had acted as a director or prescribed officer, while ineligible or disqualified in terms of section 69 (save where certain limited exceptions apply);
• whilst under a probation order in terms of the Companies Act or the Close Corporations Act, acted in a manner that contravened that order;
• grossly abused the position of a director;
• intentionally, or by gross negligence, inflicted harm upon the company or a subsidiary of the company, contrary to the provisions of the Companies Act;
• acted in any manner that amounts to gross negligence, wilful misconduct or breach of trust in relation to the performance of such director’s duties; or
• allowed the business of the company to be conducted in a manner prohibited by section 22(1) (i.e. recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose).

Furthermore, the Companies Act provides that a director who 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, may be declared delinquent.

Any organ of state responsible for the administration of any legislation may also apply to court for an order declaring a director delinquent, if such director has repeatedly been personally subjected to a compliance notice or similar enforcement mechanism for substantially similar conduct in terms of any legislation.

As alluded to above, a court will be obligated to declare a person to be a delinquent director if the person consented to serve as a director while ineligible or disqualified. Such disqualifications are set out in section 69 of the Companies Act and include that such person:

• was an unrehabilitated insolvent; or
• is prohibited in terms of any public regulation to be a director; or
• has been removed from an office of trust on the grounds of misconduct involving dishonesty; or
• has been convicted in the Republic or elsewhere for theft, fraud, forgery or any conduct involving fraud, misrepresentation or dishonesty or offences involving various statutes such as the Insolvency Act, the Close Corporation Act, the Competition Act, the Financial Intelligence Centre Act (FICA), the Securities Services Act or the Prevention and Combating of Corrupt Activities Act.

Any person who has at least twice been personally convicted of an offence or subjected to an administrative fine or similar penalty in terms of any legislation could also be subject to an application for a declaration of delinquency.

Any declaration of delinquency will subsist for the lifetime of the person declared delinquent on account of having consented to serve as a director whilst ineligible or disqualified under the Companies Act, or whilst under a probation order in terms of the Companies Act, that person acted in a manner that contravened the probation order.

Any declaration made by the court may be made subject to any conditions that the court considers appropriate, including a limitation of the application of such a declaration to one or more particular categories of companies.

As an alternative to a declaration of delinquency, a court may make an order placing a person under probation instead. This would occur under circumstances where the court is satisfied that the declaration is justified, having regard to the circumstances of the company’s conduct and the person’s conduct in relation to the management, business or property of the company at the time. Such order for probation (similar to a suspended sentence) will be made subject to conditions that the court considers appropriate and may subsist for a period not exceeding five years.

It is important to note that an order for probation applies to directors who were present at meetings of companies and failed to vote against a resolution despite the inability of the company to satisfy the solvency and liquidity test as set out in section 4 of the Companies Act. The solvency and liquidity test would apply to directors and any person who is obligated to consider whether, having regard to the reasonably foreseeable financial circumstances of the company at a particular point in time that the assets of the company are fairly valued, are equal to or exceed the liabilities of the company, and it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months thereafter.

Furthermore, any person may be placed under probation if he or she:

• acts in a manner materially inconsistent with the duties of a director; or
• acts in or supports a decision of a company to act in a manner which results in oppressive or prejudicial conduct; or
• on some basis acted in a manner which constituted an abuse of the separate juristic personality of such company.

The court may further make an order placing a person under probation if, at any period of ten years after the effective date of the Companies Act, the person has been a director of more than one company (irrespective whether concurrently, sequentially or at unrelated times) and during the time that the person was a director of each of such companies, two or more of those companies each failed to fully pay all of its creditors or meet all of its obligations, except in terms of a business rescue plan as contemplated in Chapter 6 of the Companies Act or a compromise with creditors in terms of section 155 of the Companies Act.

Without limiting the powers of the court, a court may order as conditions applicable or ancillary to a declaration of delinquency or probation that the person concerned:

• undertakes a designated programme of remedial education relevant to the nature of the person’s conduct as director;
• carries out a designated programme of community service; or
• pays compensation to any person adversely affected by the person’s conduct as a director to the extent that such a victim does not otherwise have a legal basis to claim compensation.

If a person is placed under probation, he or she is to be supervised by a mentor in any future participation as a director while the order remains in force or be limited to serving as a director of a private company or of a company of which that person is the sole shareholder.

Any person who has been declared delinquent or subject to an order of probation may apply to court to suspend the order of delinquency and substitute an order of probation, with or without conditions, at any time more than three years after the order of delinquency was made, or to set aside an order of delinquency at any time more than two years after it was suspended, or an order of probation at any time after such order was made. This will not be available to a person declared delinquent on account of having consented to serve as a director whilst ineligible or disqualified under the Companies Act or whilst under probation in terms of the Companies Act or the Close Corporations Act and acted in a manner that contravened that order.

CASE LAW

In the case of Kukama vs Lobelo, Peolwane Properties (Proprietary) Limited, Diphuka Construction (Proprietary) Limited and CIPC, South Gauteng High Court, Johannesburg, 12 April 2012, the Presiding Judge ruled that the director concerned had contravened section 22 (reckless trading) and section 76 (standards of director’s conduct, including the duty to communicate to the board at the earliest practicable opportunity any information that comes to the director’s attention) of the Companies Act. The court found that the director’s conduct did “not measure up to the standard required and expected of a director” and as a result found that he was in breach of his fiduciary duties to the company.

The court held 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. The court did not order the director’s removal, as such would occur automatically as a result of such declaration. 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.

Following the aforementioned decision in Kukama, in the case of Cook v Hesber Impala (Pty) Limited and others [2016] JOL 36194 (GJ), the High Court warned that a declaration of delinquency can only be made in relation to one of the legislated grounds stipulated in section 162 of the Companies Act, and that there must be clear “evidence” of any conduct that warrants a director being declared delinquent.

With this in mind, if such “evidence” is available, then the directors can also be held personally liable under section 218 of the Companies Act for the losses incurred by any person as a result of the directors’ delinquent conduct.

In the case of Companies and Intellectual Property Commission v Cresswell and Others 921092/2015) [2017] ZAWCHC 38, the Western Cape High Court expanded upon the meaning to be ascribed to the words “gross negligence” or “wilful misconduct” within the prescripts of section 165(5)(c)(iv)(aa). In this case, a director of a company allowed the company to carry on trading while knowing that the company was insolvent. The director inter alia made withdrawals from the company’s bank account and also received payments from the company’s bank account into his personal account.

In finding that the director’s conduct constituted gross negligence or wilful misconduct, the court referred to the case of S v Dhlamini 1998 (2) SA 302 (A), where the Appellate Division indicated that gross negligence is characterised by an attitude of reckless consideration of the consequences of one’s actions.

The Western Cape High Court further indicated that the concept of gross negligence was developed in a number of cases such as Transnet Ltd t/a Portnet v Owners of the MV “Stella Tingas” and another 2003 (2) SA 473 (SCA). In this case, the Supreme Court of Appeal (“SCA”) indicated that for conduct to qualify as gross negligence, “… it must demonstrate, where there is found to be conscious risk taking, a complete obtuseness of mind or, where there is no conscious risk taking, a total failure to take care”.

SUPREME COURT OF APPEAL – GIHWALA CASE

In the more recent judgment of the SCA in the case of Gihwala v Grancy Property Limited 2017 (2) SA 337 (SCA), the constitutionality of section 162 of the Companies Act was called into question. The constitutional challenge was brought on appeal by Mr Gihwala and Mr Manala (who were the directors of Grancy Property Limited (“the company”)) following from a decision of the Western Cape High Court (“the court a quo“), to reject the constitutional attack on section 162 and to further declare the directors to be delinquent.

The directors challenged the constitutionality of section 162 of the Companies Act on the following grounds:

• that the provisions of section 162(5) applies retrospectively. In support of this argument, the directors indicated that the events relied upon by the court a quo to justify the order of delinquency occurred before the commencement of the Companies Act on 1 May 2011;
• that after consideration of the provisions of section 162(5)(c) as read with section 162(6)(b)(ii), the aforementioned provisions vested no discretion on the courts to make an order of delinquency, which subsist for a period less than 7 years; and
• that the provisions of section 162(5) infringes upon their right to choose a trade and occupation or profession, their right to access courts and their right to dignity.

The SCA took the view that in assessing the directors’ arguments, it is the purpose and intent of section 162 which had to be examined. The court found that the purpose of section 162 is to protect the investing public against the type of conduct that leads to an order of delinquency, and also to protect those who deal with companies against the misconduct of delinquent directors.

In rejecting the argument of retrospectivity, the SCA relied on a principle established in the case of R v St Mary, Whitechapel (Inhabitants) 116 E.R. 811 (1848) 12 QB 120 that a statute is not retrospective merely “because a part of the requisites for its action is drawn from time antecedent to its passing”.

Insofar as the duration of delinquency is concerned, the SCA found that the courts’ discretion to reduce the subsistence of a delinquency period was catered for in terms of section 162(11)(a), which confers upon the courts the power to relax the full effect of the delinquency once the delinquent has demonstrated that it is appropriate to do so.

Further, and in relation to the right to trade occupation, the SCA found that it was never suggested by the directors that section 162(5) is capricious or arbitrary and, on that ground alone, that constitutional challenge had to fail.

With regard to the directors’ challenge relating to the alleged infringement of their right to access to court, the SCA dismissed this contention and found that before an order of delinquency is made, the errant directors had been given a fair hearing before a court.

Lastly, the court found that in order to challenge the constitutionality of section 162 on the basis that it infringes their dignity, the SCA found that an attack on this ground can only be pursued by attacking the rationality of the provision. The SCA noted that the attack on section 162 was not on the ground that the particular provision was irrational. The court held that it is a constitutional requirement that all legislation must serve a rational purpose – and section 162 passes this test. The directors’ appeal therefore had to fail.

LESSON LEARNED?

There is no doubt that the 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 and incurring personal liability. Directors who find themselves on the receiving end of such an order will not be nominated and, in fact, cannot be appointed to any other boards of companies.

Furthermore, the word “delinquency” carries criminal connotations. The various dictionary definitions refer to “offender”, “guilty of a crime or misdeed”, “failing in one’s duties” or “failing to perform an obligation”, the most telling and damning being “a person guilty of serious antisocial or criminal conduct”. In this regard, directors who are declared to be delinquent may also be held criminally liable under section 214 of the Companies Act.

Directors will need to understand whether or not they are complying with the provisions of the Companies Act. In particular, a director is obligated to ensure that he or she is not trading his or her company recklessly, i.e. 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 provisions of King IV, directors need to carefully consider whether they are adhering to their duties as set out in section 75 and 76 of the Companies Act, or face an order of delinquency with all of its negative and unfortunate consequences. Once an order declaring a person to be a delinquent director is made, that person may also be held liable towards the company under section 77(5) or to any person under section 218 of the Companies Act, for any loss or damage suffered as a result of that person’s conduct.

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