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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The Trouble with Family Loans: A R540,000 Lesson

The Trouble with Family Loans: A R540,000 Lesson

“How sharper than a serpent’s tooth it is to have a thankless child!” (Shakespeare)

“Family helps family in times of need” – that’s been part of human culture since long before the dawn of history but be sure to observe all legal formalities. A recent High Court decision provides an excellent example of the risks of not doing so.

Parents lose R540,000
  • A daughter in the middle of a divorce borrowed R540,000 from her parents so that she could buy out her spouse’s 50% share in her house.
  • As far as her parents were concerned it was a repayable loan, but when they had to sue their daughter for repayment they were in for a rude shock.
  • Although their daughter had admitted asking to “borrow” the money, the Court held that the parents had failed to prove (the onus being on them to do so) “the existence of a loan agreement, its terms and consequent breach thereof on a balance of probabilities”. Nor had they proved “the material terms and conditions agreed upon including the amount of the loan and the date of repayment”. Another nail in their coffin – they had failed to prove animus contrahendi (lawyer speak for “a serious intention to contract”).  
  • Their claim was dismissed with costs, so it’s goodbye to their R540k.
5 reasons why you need a contract, no matter how strong your family

One wonders how many families have rued their attitude of “We have a very close and strong family, and we trust each other with everything. No way do we need a contract. Forget it.”

But it’s not just a matter of trust. Consider these scenarios –

  1. Without a written contract, who is to say for certain that you are all on the same page as to whether it is a gift or a loan, and if so when and how it is repayable? You could in all innocence have two totally different visions of what you have agreed on. It’s only fair to everyone to put everything on record.
  2. Even the strongest families go through rough patches – it may be highly unlikely, but it happens, and our law reports are full of unforeseen and bitter family fights.   
  3. What if (horrible thought, but we must all be realistic) one of you dies before the debt is repaid? Now you are dealing not with a parent, a grandparent, or a child, but with the executor of their estate, an executor who will need proof of the loan and its terms.
  4. If a divorce should intervene, a family loan is as much an asset (or liability) as any other, and solid proof of it will be essential. 
  5. The same applies to an attack by a third party such as the taxman or a creditor.

Bottom line: Have a clear, written contract recording at the very least the amount of the loan and the agreed date and terms of repayment. For significant amounts of money, professional advice is essential.

A final thought – ask about the National Credit Act

It may seem strange in the context of a family, but your loan agreement will be unenforceable if you didn’t register as a “credit provider” in terms of the National Credit Act (NCA) in circumstances where you should have registered. In many cases it won’t be necessary, in that it doesn’t apply where family members are dependent on each other. Plus, only “arm’s length” transactions will as a general rule fall under the NCA. But there are grey areas here, so specific advice is again essential.

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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Debtor Not Paying? Consider a Liquidation Application

Debtor Not Paying? Consider a Liquidation Application

“When debtors once have borrowed all we have to lend, they are very apt to grow shy of their creditors’ company” (John Vanbrugh)

Bad debt is a major issue for many businesses in these hard economic times – not taking robust steps to collect it could be fatal to your own financial position.

So if you are being given the run-around by a recalcitrant corporate debtor, take advice on whether an appropriate and cost-effective remedy for you might be an application for the company’s liquidation (“winding-up”).

Cynical misuse of the liquidation process as a debt collection tool or to avoid any genuine disputes over liability is likely to end badly for you (you risk a heavy costs order for “abuse of process”). Be aware also that if your application is successful and a liquidation order is granted, you might be in for more than your own legal costs (ask for advice on the “danger of contribution” in winding-up matters).

But properly used, a liquidation application will certainly get your debtor’s attention very effectively. It’s often the only strategy that has any effect on a “dodging debtor”. The threat of a liquidator knocking at the door to take over control of the company is a great motivator to actually do something – pay up, or make a genuine settlement offer, or at least disclose whether something is in dispute so you can deal with it.

The practical challenge can however be in proving that the debtor is actually financially unable to pay its debts. That’s often not easy, and mere failure by the debtor to pay the debt is not sufficient. 

The “section 345 demand” shortcut

However there is a shortcut – serve on the company’s registered office a demand for the debt. You may hear it referred to as a “section 345 letter”, that being the section of the Companies Act which makes this all possible. If the debt is not paid (or secured or resolved by agreement) within three weeks, the company is deemed to be unable to pay its debts, making a liquidation application much easier to support.

The 2021 High Court case of a municipality struggling to recover debts due to it by two property companies provides a good example of this letter of demand process in action…

Letters of demand sink two property companies
  • Two related companies, one a property-owner and the other a tenant, owed the local municipality for unpaid rates, service charges, and electricity accounts.
  • The municipality served the appropriate letters of demand on the companies’ registered offices, but still they failed to pay up. Their attempts to settle with the municipality having failed, the municipality applied to the High Court for liquidation.
  • The High Court duly granted provisional liquidation orders against both companies, finding on the facts that they had failed to rebut the presumption that they were unable to pay the debts. Nor were they able to convince the Court to exercise its discretion to refuse the liquidation orders.

As an end note, it is essential that your letter of demand is correctly drawn and correctly served.  If it isn’t, your application is headed for failure – and that can be a very expensive exercise.

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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Bodies Corporate: Before You Sequestrate to Recover Arrears…

Bodies Corporate: Before You Sequestrate to Recover Arrears…

“Bankruptcy – a fate worse than debt” (Anon)

One of a Body Corporate’s fundamental duties is to collect monthly levies from the scheme’s members, and to take robust action to recover any arrears. As with any other creditor/debtor relationship however, trying to recover debt can be an exercise in frustration and delay, and the more recalcitrant the debtor, the greater the temptation to “go straight for the jugular” by applying to sequestrate the debtor’s estate.

You will have to show that the sequestration is to the advantage of creditors as a whole – not just to you – but that isn’t the only consideration. You will be throwing good money after bad if you end up having to pay a “contribution to the costs of sequestration”.

The recent case of a sectional title Body Corporate, which perhaps thought that it was protected from this particular danger because of its statutory preferences for recovery of arrear levies prior to transfer, illustrates the danger.

But before we get to the facts and the outcome of that case let’s have a quick look at the general principles involved.    

What is a “contribution to costs” and who has to pay it?

If you want to share in the net proceeds of an insolvent estate, you must formally prove your claim at a meeting of creditors convened by the trustee of the insolvent estate. If you don’t do that, you wave goodbye to any possible dividend and will be writing off the debt.

On the other hand, if you decide to prove your claim you may be at risk of having to pay into the estate as well as writing off the debt – talk about adding insult to injury! That danger arises if the costs of sequestrating the estate exceed the funds in the estate available to pay them. In that event the trustee of the insolvent estate will recover a “contribution to costs” from proved creditors – including you if your claim was proved as above.

The special danger of being the “petitioning creditor”

The creditor who applies for the debtor’s sequestration is – as “the petitioning creditor” – liable to contribute to the shortfall even without proving a claim. In other words, unlike other creditors, you cannot protect yourself from contributing to costs by holding back the claim – you are “deemed” to have proved it. That’s why, although applying for sequestration can be an excellent way of recovering debt from a recalcitrant debtor, it is essential to first consider the danger of contribution.

How “secured creditors” can protect themselves

Also relevant to our story is that a creditor holding security (such as a bond over the insolvent’s property) must prove its secured claim in order to be paid out the net proceeds of its security. A secured creditor can, if it suffers a shortfall after being paid out those net proceeds of its security, also share in the “free residue” of the estate. The “free residue” is the net proceeds of all unencumbered assets available for distribution to creditors. The secured creditor’s share in this event will be based on the “concurrent” portion of its claim, in other words it is now a concurrent creditor.

This is where the danger comes in because any contribution payable is payable in the free residue by concurrent creditors. A secured creditor can largely protect itself from this danger by “relying on the proceeds of its security” to satisfy its claim. By doing so it waives its concurrent claim for the shortfall, but equally it no longer has to contribute along with the other proved (or petitioning) concurrent creditors. It will now only have to contribute when there are no other such creditors, or when other contributors are unable to pay their share.   

The case of the Body Corporate that sequestrated to recover arrears – and paid the price

Let’s see how those principles were applied in a recent Supreme Court of Appeal (SCA) case –

  • The owner of two sectional title units, bonded to separate banks, was unable to pay his levies. The Body Corporate sequestrated his estate, and his two units were sold. Only the two banks proved claims.
  • This was where the Body Corporate’s statutory protection for arrear levies came in. No transfer can be registered in the Deeds Office until all rates and taxes (and levies in the case of Bodies Corporate and Homeowners Associations) have been paid in full. Thus the arrear levies were paid in full to the Body Corporate by the transferring attorneys. “Done and dusted” thought the Body Corporate, but it was not to be.
  • There was a shortfall in the insolvent estate, and the trustee tried to recover the resultant contribution from the two banks (the bondholders) who had proved their claims in the estate.
  • The banks objected, arguing that because they had relied on their security in proving their claims, they were not liable to contribute (as above). The Body Corporate, they argued, was as the petitioning creditor liable for the contribution despite not having proved its claim.
  • The Body Corporate on the other hand argued that it could never be liable for a contribution. Although it was indeed the petitioning creditor, it had never proved a claim against the estate and the arrear levies had been paid to it in full, as required by law, before transfer of the properties.
  • To cut a long story short, the dispute wound its way through our courts and ended up in the SCA, which, after a detailed examination of the relevant law, held the Body Corporate as petitioning creditor to be solely liable for the full amount of the contribution to costs (R46 663.16).
Bodies Corporate beware!

The Court’s reasoning in reaching this conclusion will be of great interest to the lawyers amongst us, but the bottom line for Bodies Corporate is this – if you sequestrate to recover arrears, you could well end up carrying the full brunt of any contribution to costs.

So perhaps take advice on whether you can/should rather use other debt collection processes, including perhaps applying to the CSOS (Community Schemes Ombud Service) to order and enforce payment of the arrears.

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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Suing a Debtor – Make Sure Your Victory Isn’t a Hollow One

Suing a Debtor – Make Sure Your Victory Isn’t a Hollow One

“Pyrrhic victory”, n. A very costly victory, wherein the considerable losses outweigh the gain, so as to render the struggle not worth the cost (Wiktionary)

With our economic woes unlikely to abate any time soon, expect an increasing number of your debtors to find themselves in financial difficulty. If you end up litigating against any of them the last thing you will want to do is to throw good money after bad.

And whilst fighting a court case and winning against a recalcitrant debtor is all very well, it’s a hollow victory if by the time you come to enforce your judgment the debtor has no assets left to execute against. You may have won the battle, but you’ll have lost the war. You’ll be left with nothing but a large legal bill and a very sour taste in your mouth.

So what can you do if, during the litigation, you realise that the court case is nothing but a delaying tactic to give the debtor time to dispose of or hide assets? Or perhaps the debtor genuinely thinks it has a valid defence to your claim but decides to get rid of assets just in case it loses. Either way, you risk having no assets left to execute against if you eventually win.

Fortunately our law has an effective remedy for you in the form of an “anti-dissipation interdict” (sometimes referred to as a “Mareva Injunction” which is a similar English remedy). Its effect is to freeze, until your case is finalised, enough of your debtor’s assets to satisfy any judgment in your favour.

A R230m case illustrates what you must prove
  • A plaintiff suing in the High Court for R230m plus interest and costs became aware through media reports of a potential dissipation of the defendant’s assets in the form of a corporate unbundling exercise.
  • It obtained an order that the defendant provide security of R430m and when this security was not forthcoming the plaintiff applied for an anti-dissipation interdict.
  • The Court set out what you must prove thus –
    • That the defendant “is dissipating assets or hiding assets”.
    • That “there is reason to believe that such dissipation or hiding of assets is taking place mala fide [in bad faith] with the intention of defeating [your] claims”.
    • In addition you “must satisfy the Court that all the other requirements for the granting of an interim interdict have been established.” These other requirements, as set out in many other cases, are proof of –
    • A prima facie (“at first view”) right, even if it is subject to some doubt,
    • A reasonable apprehension of irreparable and imminent harm to the right if an interdict is not granted,
    • The balance of convenience must favour the granting of the interdict, and
    • You must have no other remedy.
  • Finding on the facts that the defendant (a company) was indeed disposing of its assets and would be left as only an empty shell after doing so, and that it was acting in bad faith and “with the view to frustrate the [plaintiff’s] claims and to render its victory in the pending action pyrrhic”, the Court granted the interdict.

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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Can Your Bank Take Your Money Without Permission?

Can Your Bank Take Your Money Without Permission?

“A bank is a place that will lend you money if you can prove that you don’t need it” (Bob Hope)

A recent High Court decision has settled the knotty question of whether your bank can take money it holds for you in one account to cover your debt to it in another, without your permission and without notice to you.

Firstly, what is “set-off”?

To understand how important this new decision is, we need to go back to our common law (unwritten law) principle of set-off. In simple terms, common law set-off allows one debt to be cancelled out by another. So if for example I owe you R1,000 and you owe me R900, I am both your creditor and your debtor, and vice-versa. If we come to blows, I can then set the one debt off against the other with the net effect that I owe you R100.

Credit-lenders, and in particular banks, used to make extensive use of this to collect debt. If for instance you fell behind in your mortgage bond or credit card payments, your bank could, if it was so inclined, take the arrears out of your current account as soon as your salary was paid into it – without your consent and without notice to you. 

Banks have always argued that this ability has made it easier for them to lend money to us when we ask for it, as it reduces their risk by giving them more security if things go wrong. Giving notice or asking for consent would, they argue, allow a recalcitrant debtor to quickly withdraw the funds and frustrate the debt collection. But the other side of the coin of course is that you could suddenly find yourself without money to live, let alone to service your other debt payments – a situation particularly hard on lower earners and those struggling with mountains of debt.

Enter the NCA (National Credit Act) in 2005…

How the NCA changed things

In broad terms, the NCA (when it applies – see next paragraph) restricts set-off in such a way as to give the consumer the right to choose whether or not to consent to set-off, which accounts it may be applied to, in respect of which amounts, when it is to be applied, and in respect of which debts. 

But does the NCA apply to your particular debt? In most cases, yes. In a nutshell (there are some “ifs” and “buts” here so ask your lawyer for specific advice) the NCA applies to most personal loans, home loans, overdrafts, credit card debt, asset finance agreements, lease agreements and so on. It covers consumers who are individuals and some – not all – “juristic persons” (companies and the like – take advice for details).

Which brings us to the High Court…

Nevertheless at least one bank (which is unlikely to be alone in this practice) has continued until now to apply common law set-off without consent, in other words they would take money from a customer’s account to cover the customer’s debt on a separate credit agreement. The bank argued that the NCA’s set-off restrictions did not apply on its interpretation of the NCA, in its circumstances and to its credit agreements. Importantly, its agreements omitted any mention of set-off (where an agreement does mention set-off, there is no argument – the NCA restrictions definitely apply). 

Having received complaints from consumers to this effect, the National Credit Regulator asked the High Court to interpret the NCA’s provisions and to rule on the legality of the bank’s practice.

The High Court’s decision 

Common law set-off without your consent as above cannot happen if the NCA applies to your credit agreement. 

In a nutshell – you have the choice! Banks and other credit-lenders must ask you before taking money from one account to cover your debts in another.  

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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