The Companies Act:
Section 22(1) of the Companies Act 71 of 2008 (“the Act”) read together with sections 218(2) and 77, set the stage for directors of a company being held personally liable for the company’s debts.
Prohibition of Reckless Trading: section 22(1) records that ”a company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose”.
Civil Actions Against Directors: under section 218(2) of the Act, “any person who contravenes any provision of the Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention”. As such, any person who has suffered a loss of damage and can show a causal link to a breach of another section (such as section 22) by a director, can sue the director in his/her personal capacity.
Directors’ Liability: section 77(3)(b) of the Act states that “a director is liable for any loss, damage or costs sustained by the company as a direct or indirect consequence of the director having”…”acquiesced in the carrying on of the company’s business despite knowing that it was being conducted in a manner prohibited by section 22(1)”.
The sections mentioned above have been enforced by the South African courts, who have, in a number of court cases, held directors personally liable based on them.
Any Change under the COVID -19 Pandemic?
The question is, does anything change in respect of directors’ personal liability under the Covid-19 pandemic and following the declaration of a national state of disaster under the Disaster Management Act 57 of 2002? With the wildly changing and unstable business landscape, can directors be held to the same standards as before? How can directors accurately forecast a company’s solvency and liquidity? How can they predict the company’s likelihood of surviving in order to be able to fulfil its delivery, payment and other obligations?
Under section 22 of the Act, the Companies and Intellectual Property Commission (“CIPC”) has the power to issue the company with a notice, or compliance notice if necessary, if it has reasonable grounds to believe that a company is (i) trading or carrying on business recklessly, with gross negligence or for a fraudulent purpose, or (ii) unable to pay its debts as they become due and payable in the normal course of business.
On 24 March 2020, the Companies and Intellectual Property Commission (“CIPC”) issued a Practice Note No. 1 of 2020 (“the Practice Note”) in which it recorded that, in light of the Covid-19 pandemic and national state of disaster, it would “not invoke its powers under section 22 of the Act” to issue notices or compliance notices to a “company which is temporarily insolvent and still carrying on business or trading”, but only where CIPC “has reason to believe that the insolvency is due to business conditions which were caused by the Covid-19 pandemic”.
The Practice Note however records that it lapses within 60 days after the declaration of a national disaster has been lifted.
Directors are not Absolved during the Covid-19 Pandemic: although the Practice Note allows companies to temporarily trade under insolvent circumstances, it does not absolve companies and boards from the requirements of section 22 not to carry on business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose (even in the present circumstances). Directors remain liable to the company under section 77(3)(b), and liable to any person under section 218 of the Act, as mentioned above.
Relief by a Court: Section 77(9) of the Act provides some relief for directors because it enables a court to relieve a director from personal liability where it appears to the court that the director has acted honestly and reasonably, or having regard to all the circumstances of the case, it would be fair to excuse the director from liability.
Some Measure of Relief from the Practice Note: We however believe that the Practice Note will provide some relief to directors if they acted honestly and reasonably in their actions to try and bring the company back out of commercial insolvent circumstances. The Practice Note would have no value if it did not provide an additional defense to a director in that regard. It was, after all, issued by CIPC, which is tasked with enforcing the Act.
Directors need to continue to act honestly and reasonably and uphold all their fiduciary duties during the Covid-19 pandemic and national state of disaster. They should take advice from professionals where they require that input to make an informed decision, ensure they have as much information to hand as possible, and keep accurate records (including as required by the Act of notices and agendas for meetings, minutes of meetings and resolutions passed), all so they can be relieved by a court if a claim against them in their personal capacity is lodged. In addition, directors should investigate getting a directors liability insurance policy in place.