Now Creditors Can Apply for Directors to be Declared Delinquent – Why is That Important?

Now Creditors Can Apply for Directors to be Declared Delinquent – Why is That Important?

“He who is quick to borrow is slow to pay” (Old proverb)

A recent High Court decision means that, for the first time, creditors of debtor companies are specifically cleared to apply for the company’s directors to be declared “delinquent” in certain circumstances. And that has significant implications for both directors and creditors.

For directors – major long-term career risks

Company directors need to manage a whole range of duties, responsibilities and risks, including being declared “delinquent” in terms of the Companies Act. For more serious categories of misconduct a director risks disqualification from holding any directorship or senior management position for a period ranging from 7 years to a lifetime.

A wide range of less serious categories of misconduct can lead to “probation” orders, with possible disqualification for up to 5 years, supervision by a mentor, remedial education, community service and payment of compensation.

The fact that creditors can now make delinquency applications adds a new level of director risk, the reality being that of all the stakeholders out for blood after a corporate failure, unpaid creditors may well be the fiercest. Your best defence against any personal attack is to always be aware of, and to scrupulously comply with, all your many fiduciary duties.

For creditors – a new door opens

As a creditor on the other hand, your chances of recovering a company debt from a director personally will depend on a range of factors – whether you hold personal suretyships, whether you can prove personal liability for breach of statutory duties and so on (this is a complex topic – specific legal advice is essential).

Now another door has opened to you, and although as we shall see below you will have to convince the court that you are acting in the public interest, it will certainly make directors think twice about defrauding you or exposing you (and creditors and the public generally) to loss through corporate misconduct.

  • The case in question stems from the creditors of a company in liquidation failing to recover their debt from it, and consequently taking action against the directors in their personal capacities for over R370m.
  • They also asked the High Court to declare the directors delinquent, and one of the directors objected on the basis that creditors have no power to bring such an application. Indeed, the Companies Act gives this right only to a specific list of stakeholders – namely a shareholder, director, company director, secretary or prescribed officer, registered trade union, employee representative, Takeover Regulation Panel, some organs of state and the CIPC (Companies and Intellectual Property Commission).
  • The Court however agreed with the creditors that they could apply under another provision of the Companies Act which allows anyone to apply “acting in the public interest, with leave of the court”. On the facts of this particular matter, the creditors were cleared to proceed under that provision.
  • In reaching this decision, the Court took account of the (as yet unproven) serious allegations levelled against the directors – extreme breaches of fiduciary duty over a long period of time and involving substantial amounts of money, “a full panoply of misdemeanours” including gross abuse of position and gross negligence, the large number of directorships held by the directors, the (indirect) involvement of public entities – the list goes on.
  • Importantly, the Court rejected the director’s argument that “the danger of giving the creditor such standing was that it could use the threat of a delinquency declaration to squeeze the proverbial few extra bob out of the directors.” Every case, said the Court, must be decided on its own facts, and the fact that creditors are suing directors personally does not automatically mean that they are acting cynically and opportunistically.
  • But clearly, to succeed you will have to prove that you are acting in the public interest and not just in your own interest as a creditor. It will help to be able to argue, as the creditors in this case did, that “the general public and creditors deserve and require to be protected in their dealings, engagements and transactions with the companies and close corporations of which the defendants are respectively directors and/or members; and … the relief will protect the public from the defendants repeating or replicating their delinquent conduct in other entities.”

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Why You Need a Shareholders’ Agreement, and How to Structure It

Why You Need a Shareholders’ Agreement, and How to Structure It

Whether you are forming a new company or buying shares in an existing one, a formal shareholders’ agreement, tailored to suit your particular situation and needs, is essential.

What is a shareholders’ agreement?

It’s a contract between shareholders outlining the rights, responsibilities, and obligations of each shareholder, it provides a framework for the governance of the company, and it ensures a clear understanding between the shareholders about its management, operation and control. It’s not a legal requirement, but not having one is a recipe for uncertainty and dispute.

Which brings us to…

Why you need one

Here are some of the reasons why it’s a “must-have” and not a “nice-to-have” –

  • The Memorandum of Incorporation (MOI) is not enough: Every company must have a memorandum of incorporation (MOI) setting out amongst other things the “rights, duties and responsibilities of shareholders, directors and others within and in relation to a company” but you should always complement its provisions to suit your particular needs and circumstances. Be careful here, the MOI will override any conflicting provisions in your shareholder’s agreement.
  • Dispute avoidance and management: By setting out the agreed shareholder relationships and responsibilities, a shareholders’ agreement will greatly reduce the risk of bitter, disruptive and expensive disputes arising. Where disagreements do arise, reference to the agreement should help diffuse them before they become a major issue. Agree processes for dispute resolution.
  • Avoidance of deadlock: Deadlocks can occur when shareholders are unable to reach a decision on important matters such as the direction of the company or the appointment of new directors. Deadlocks will inevitably hurt the company and could even result in failure and liquidation. A formal shareholders’ agreement reduces the risk of deadlocks by providing a clear set of rules for decision-making and resolving disputes.
  • Clarity of roles and responsibilities: Your agreement should define the roles and responsibilities of each shareholder, which can be especially important in companies where the shareholders are also involved in the day-to-day management of the company. This will help to ensure that each shareholder is clear about their obligations and the consequences of not complying with them, and it will help to prevent misunderstandings that may arise from overlapping responsibilities.
  • Flexibility: Make sure that your agreement is tailored to the specific needs of the company and shareholders. This allows it to be flexible enough to accommodate changes in the company’s structure and operations, while still providing the necessary protection and clarity to shareholders.
  • Protection of minority shareholders: Sometimes, majority shareholders have different goals and objectives than the minority shareholders. A formal shareholders’ agreement can provide protection to the minority shareholders by ensuring that the company operates in a fair and equitable manner. In doing so it reduces the risk of dispute by setting out the voting rights and decision-making powers of each shareholder.
What should be in it?

As we said above, your agreement should be tailored to your particular needs, so professional advice is essential to ensure that your agreement is legally binding and protects the interests of all parties involved. You will likely to be advised to address at the very least the following aspects –

  • How loan accounts, profit sharing, payment of dividends, salary and fringe benefit structures and the like will work
  • Who will manage the company and its business activities, and how
  • Decision-making processes, with reference to meeting requirements and voting
  • Roles and responsibilities, powers to make executive decisions and to bind the company
  • Confidentiality requirements, conflict of interest rules, restraints of trade and the like
  • Conflict resolution procedures
  • Valuation and sale of shares, rights of first refusal etc
  • The list goes on – every company and every set of circumstances will be different, so brainstorm other issues to be included with your fellow shareholders, other stakeholders, and your legal advisors.

Keep everything as short, simple and practical as possible!

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Directors – When Are They Personally Liable?

Directors – When Are They Personally Liable?

“… for the benefit of immunity from liability for its debts, those running the corporation may not use its formal identity to incur obligations recklessly, grossly negligently or fraudulently. If they do, they risk being made personally liable.” (Quoted in the judgment below)

Particularly in hard times, it is not at all uncommon to find yourself unable to recover a debt from a company in financial straits whilst at the same time you know that its directors hold assets in their own names. Can you attack them personally?

The answer is founded in the centuries-old concept of companies as separate legal entities or “juristic persons”. They trade in their own names and have their own assets and liabilities, so as a rule directors will not be personally liable for a company’s debts unless either –

  1. They signed personal suretyship for them, or
  2. They fall foul of one of our law’s provisions entitling a court to declare them personally liable.

So, in the absence of personal suretyships, when in practice can you recover a company debt from its director/s? And when are you as director at risk of being sued personally?

Let’s look at the facts and outcome of a recent High Court case for some insights –

The fraudulent car auction, the disappearing company and the director’s defence
  • The buyer of a car on auction subsequently discovered that it was a 2010 model despite being sold to her as a 2012 model.
  • She cancelled the sale, returned the car to the auction company that had sold it to her, and, when her demand for a refund of the purchase price was refused, took a default judgment against the company.  
  • What followed was a saga of unsuccessful attempts to recover her money from the company, its address having changed and the director claiming to have resigned and sold the company, which he said had ceased trading and was awaiting deregistration.  
  • The buyer eventually sued the director personally, asking the Court to “pierce the corporate veil”. The director’s defence boiled down to saying that he had not used the company “as a front”.
Piercing the corporate veil

“Piercing the corporate veil” in this context is, simply put, a court holding directors personally liable for a company’s debts by declaring that the company is to be “deemed not to be a juristic person” in respect of particular debt/s.

On what grounds will a court make such a declaration? Per the High Court in this matter:

  • Where there is “fraud and the improper use of a company or conduct of the affairs of a company” or  
  • “[W]here its incorporation, use or an act performed by or on its behalf [the Court’s underlining] constitutes an unconscionable abuse of the juristic personality of the company as a separate entity.”  
The director’s misrepresentation and “cavalier disregard” for the company’s interests
  • On the facts, the Court found that the director had misrepresented the details of the motor vehicle to the buyer, that this misrepresentation was material and induced her to purchase the vehicle, and that it “was deliberate such that it amounted to fraud, alternatively dishonesty, further alternatively improper conduct.”  
  • “Additionally, as the director and owner, he acted with cavalier disregard for the interests of the company … Such conduct is manifestly not in the best interest of the company and may be considered reckless and dishonest. This conduct was indubitably with callous disregard for its effect on the company as a separate legal entity and at a time when he describes its financial situation as being parlous.Therefore, whilst a director is entitled to resign at any time, his resignation cannot be used as a means of evading his fiduciary duties as a director.”   
  • Concluding that “the conduct of the director adversely affected the [buyer] in a way that reasonably should not be countenanced and which constitutes an unconscionable abuse of the company’s juristic personality”, the Court declared him personally liable to repay her the purchase price, interest, and costs.

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Directors at War: Terminating Email Access

Directors at War: Terminating Email Access

“All is fair in love and war…and business is war.” (Jasmine Kundra)

When company directors are locked in dispute, one of them may be tempted to cut off the other’s access to emails and to the business server – a tactic likely to have immediate and serious consequences for the director thus cut off.

Its appeal as a tactic to force the other director to the negotiating table is obvious, but the question is whether the director thus deprived has any legal remedy available to force immediate restoration of access.

A recent Supreme Court of Appeal matter saw a director in that exact position trying to get his access back urgently with a “spoliation order” application.

“Cut off his email and server access”

When the two directors fell out, one (let’s call him ‘A’) applied for liquidation of the company on the grounds of deadlock. Director B opposed this application, and, alleging that A had resigned his directorship, instructed the web hosting entity hosting the company’s server and email addresses to cut off A’s ‘email and company network/server access’ with immediate effect.

A, denying hotly that he had resigned, immediately applied to court for a “spoliation order” restoring his email and server access to him.

Spoliation – a quick and effective way to get back possession, but only if…
  • The spoliation process is designed to stop disputing parties from taking the law into their own hands and provides a quick and effective way of regaining possession of something if you have been wrongfully deprived of it. It’s a quick and effective remedy because “[T]he injustice of the possession of the person despoiled is irrelevant as he is entitled to a spoliation order even if he is a thief or a robber. The fundamental principle of the remedy is that no one is allowed to take the law into his own hands”. In other words, you can get an immediate spoliation order without having to prove your right to possession of the thing – all you have to prove is the wrongful dispossession.
  • So that would have been an ideal outcome for A, giving him immediate restoration of his access to his emails rather than having to fight his way slowly through a full trial proving his rights to email and server access. But it was not to be. His problem was that, in order get a spoliation order, one of the first things you must prove is that you were in “peaceful and undisturbed possession” of something.
  • Now A would have been able to prove such possession if he had for example been wrongfully deprived of use of a company car or even of an “incorporeal” right to use property (such as “quasi-possession” of a right of access under a servitude). But he was unable to convince the Court that his email/server access fell into any such category.
  • As the Court put it: “Thus only rights to use property, or incidents of occupation, will warrant a spoliation order.” A’s prior use of the email address and server was not an “incident of possession of movable or immovable property”, it is purely “a personal right enforceable, if at all, against [the company].”
  • In a nutshell, A must now prove his legal right to email and server access – perhaps he will be advised to apply for an ordinary interdict, perhaps he will sue for damages and/or re-instatement, but whichever course he chooses he will need to accept the inevitable delays. In other words, if B’s tactic was to put immediate and substantial pressure on A in the short term it worked – at least for now.

Don’t however take any action like this without professional advice – it could come back to bite you badly if it misfires.

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

© LawDotNews

Directors, Creditors – Do Personal Suretyships Survive Business Rescue?

Directors, Creditors – Do Personal Suretyships Survive Business Rescue?

“Creditors have better memories than debtors” (Benjamin Franklin)

In these hard times of pandemic and economically destructive unrest, an unfortunate number of businesses face collapse, and many will opt for the “first aid for companies” option of business rescue.   

Creditors coming out of that process with a shortfall (only the luckiest creditors are likely to emerge with full settlement) will naturally look to any personal suretyships they hold to cover that shortfall.

A recent SCA (Supreme Court of Appeal) decision has brought welcome clarity to the question of whether – and in what circumstances – such personal suretyships will survive the business rescue process.

Both directors and creditors need to understand the outcome, and to act accordingly.

Sued for R6m, a CEO’s defence crumbles
  • A company CEO (Chief Executive Officer) signed a personal suretyship in favour of a creditor supplying the company with petroleum products.
  • When the company fell upon hard times it was placed into business rescue. Eventually a business rescue plan was adopted, the rescue process was terminated, and the creditor sued the CEO for the shortfall on its claim of just over R6m.
  • The CEO’s main defence was that his liability as surety was an “accessory obligation” – in other words, if the creditor’s claim against the principal debtor (the company) fell away, he should be released from his liability as surety.
  • But, held the Court, although a principal debtor’s discharge from liability does indeed ordinarily release the surety, our law allows the creditor and the surety to agree otherwise.
  • And the suretyship agreement in this case did just that. It contained “unobjectionable” and “standard” terms which included a specific agreement by the surety that he would remain liable even if the creditor “compounded with” the company by accepting a reduced amount in settlement of its claim. Nor was there any mention in the business rescue plan of its effect on creditor claims against sureties (it could, for example, have provided specifically for sureties to remain on the hook, or to be released). But the deciding factor remained that the wording of the suretyship was such that the creditor did not abandon its claim against the surety by supporting the business rescue plan.
  • Bottom line – the CEO goes down over R6m, and the creditor has another shot at emerging unscathed from the mess.

Heed these lessons from the judgment!

The SCA in its judgment undertook a comprehensive interpretation of the terms of the deed of suretyship, of the business rescue plan, and of the relevant legislation. Although the detail will be of more interest to lawyers and academics than it will be to the average director or creditor, it did bring welcome clarity to an issue of great practical importance, and the valuable lessons therein should be heeded –

Directors: As always, think twice before signing any personal suretyship, and if you absolutely have no alternative, at least understand fully what you are letting yourself in for both legally and practically. Equally, ensure that the business rescue plan lets you fully off the hook as regards any possible personal liability; you may be advised to go further and have a separate release agreement with any creditor/s holding your surety. Although not directly relevant to this article, think also of managing any risk of personal liability beyond suretyship, such as allegations of reckless trading and the like.

Creditors: You on the other hand should always try for watertight and upfront suretyships from directors and others with attachable assets (again not directly relevant to this article, but also take whatever security you can over company assets such as debtors, fixed property etc). And when it comes to the business rescue plan, make sure that it leaves your claim against sureties unaffected.

Upfront professional advice and assistance is a real no-brainer here!

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

© LawDotNews

Companies: Are Restraints of Trade Valid in a Time of Covid?

Companies: Are Restraints of Trade Valid in a Time of Covid?

“For him to be forced out of a career of choice to start working in a different field at a time when many businesses are closing down, retrenchments and lay-offs being commonplace and individual[s] doing everything possible to survive and cope with the health and economic devastating effects of the covid 19 pandemic, is plainly unreasonable and contrary to public policy and constitutional values” (extract from judgment below)

Consider this unhappy (but not unlikely) scenario: For whatever reason, you part ways with your fellow director/shareholder (or perhaps a key employee), who goes off immediately to join (or found) the opposition. 

Now you have a major problem – he/she was privy to all your trade secrets and confidential information and they are now being used to compete against you. Your business could be crippled.

Using the time-tested restraint of trade clause

An effective and time-tested way of protecting your business from such a risk is to insist on all directors, shareholders and key employees signing restraint of trade agreements from the start. Such restraints are usually included as clauses in employment contracts and/or (less commonly) in shareholder agreements. 

However, it is vital to word the restraint clause correctly if it is to stand up to legal scrutiny.  Although our law has long recognised the right of businesses to enforce this type of contract so as to protect their “proprietary and protectable interests”, and although in general we are held by the law to the agreements that we conclude, there is always a balance struck with the employee’s constitutional rights to be economically active and to earn a living.

As the High Court put it recently: “It is settled law that restraints of trade are valid and binding and, as a matter of principle, enforceable unless, and to the extent that, they are contrary to public policy because they impose an unreasonable restriction on the former employee’s freedom to trade or to work. It is also settled that the onus of establishing that the restraint of trade is unreasonable falls on the former employee.”

A common mistake – going “too wide”

The most common mistake businesses make is to word the restraint of trade too widely (in one or more of type of activity, geographical area or time period). No matter how tempting it may be to do so, that is courting disaster. The wider the clause is, the greater the chances of a court holding it either totally invalid or only partially enforceable. Rather word your clauses tightly and defensibly.

Two recent High Court decisions illustrate both this principle, and the potential impact of the Covid-19 pandemic on our courts’ approach to the questions of reasonableness and time periods.

The impact of the pandemic on the “reasonableness” test
  • A director, shareholder and employee of a company specialising in media and advertising solutions resigned as both director and employee after a breakdown in relations, the company owing him R1.2m in short-paid salary. He however retained his shareholding. 
  • He was subject to restraints of trade (in both his employment and shareholder agreements) which prohibited him from working for a competitor, and from sharing confidential information and trade secrets with them, for 18 months in any of 29 African countries.
  • He nevertheless joined a direct competitor (active in 2 of the 29 African countries) and acted in breach of the restraint by contacting customers and business associates. When sued in the High Court for enforcement of the restraint clauses, his main defence was that they were unreasonable and prevented him from earning a living.
  • The Court confirmed the need to consider all the relevant circumstances, not only at the time a restraint is entered into, but also at the time that the business tries to enforce its restraint. In this case, the company’s attempts at enforcement encompassed the period March to July 2020 – a time of strict lockdowns and economic turmoil.
  • The upshot – the Court rejected the company’s suggestion that the ex-director could remain economically active in another field for which he was qualified, commenting: “For him to be forced out of a career of choice to start working in a different field at a time when many businesses are closing down, retrenchments and lay-offs being commonplace and individual[s] doing everything possible to survive and cope with the health and economic devastating effects of the Covid-19 pandemic, is plainly unreasonable and contrary to public policy and constitutional values”. The restraints were rejected as unenforceable.
The impact of the pandemic on time periods 

Another recent High Court decision saw the Court reducing a 2-year restraint, on sales employees who resigned in March and April 2020 respectively, to 14 months. 

In doing so the Court took what it considered to be a reasonable base period in the circumstances of 12 months and added 2 months “to compensate for the lockdown period”, also commenting that “…I am aware that our society is living in strange times. The COVID-19 pandemic has played havoc with, inter alia, our economy. Businesses have been prevented from operating and the ability of the applicants to appoint and train new salespersons will undoubtedly have been blunted by the state of the economy. This is of some relevance when considering the length of the period of restraint…”.  

So – are restraints of trade valid in times of pandemic and upheaval?

Neither decision means that restraints are necessarily unenforceable or only partially enforceable during times of economic turmoil and high unemployment. Each case will be decided on its own merits, but in assessing whether your own restraint clauses will be considered reasonable and enforceable, they are clearly factors to be borne in mind.

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