Directors at War and the Liquidation Option – A Tale of Sibling Rivalry

Directors at War and the Liquidation Option – A Tale of Sibling Rivalry

“Family quarrels are bitter things. They don’t go according to any rules” (F. Scott Fitzgerald)

A company’s directors have both the power and the duty to manage the company’s affairs for its benefit.

When two or more directors are in place, it’s perhaps natural for the occasional disagreement to arise between them. Indeed, regular expression of a variety of different viewpoints and ideas can make for a strong, dynamic board and business. Provided, that is, that the directors are in the end result still able to agree on the decisions vital to their company’s continued operations. 

What happens though when disagreements and disputes escalate and make it impossible to continue running the business? Typically, communications break down to the extent that decision-making is paralysed. First prize will of course always be an amicable settlement – through formal mediation perhaps, or negotiation to buy out a dissenting director’s shareholding. But if these attempts fail, the company is in big trouble. 

Fortunately our law offers you an effective remedy in the form of the “just and equitable” liquidation. It comes with its own risks and can be costly, so it’s often regarded as a last-resort option (ask your lawyer for advice on the various other remedies that may be available to you), but it works. A recent High Court decision illustrates…

Sister v brothers in a deadlocked development company 
  • A sister and her two brothers owned, through their trusts, equal shares in a farm (partially inherited from their father and partially purchased from their uncle’s deceased estate). 
  • They were also the three directors (and, again through trusts, the equal shareholders) of a company formed to subdivide, develop and sell residential plots on parts of the farm.  
  • The company operated successfully and profitably for many years, paying substantial dividends to the shareholders, and has always been and remains solvent. 
  • Trouble began brewing it seems several years ago, primarily between the sister and the brother in charge of the day-to-day running of the company’s business.  Serious disagreements arose around an unhappy saga of sibling fallout – including the disputed existence of a partnership, alleged fraudulent stripping of over R6m by the brothers, and a litany of purported personal and familial abuse. 
  • All these allegations were hotly denied, although an undertaking by the brothers to not “emotionally abuse” their sister in a settlement agreement at one point clearly indicated to the Court that the relationship breakdown was not confined to the siblings’ professional affairs. The relationship between the directors and shareholders was, said the Court, “that of partners in a family context”. 
  • The sister applied for the liquidation of the company on the grounds that it was “just and equitable”. This is a procedure provided in the Companies Act for a court to have the discretion – even though a company is solvent – to liquidate it in order that an independent liquidator can take over. 
  • The brothers opposed the application, claiming that there was no deadlock in the functioning of the company or between the directors and shareholders, but the Court disagreed. Its order liquidating the company, and its reasons for doing so, provide a useful summary of how this particular law works in practice…
3 grounds on which to wind up a solvent company

The Companies Act allows a court to liquidate a solvent company on application by director/s or shareholder/s on any of three grounds –   

  1. “The directors are deadlocked in the management of the company, and the shareholders are unable to break the deadlock, and 
    • Irreparable injury to the company is resulting, or may result, from the deadlock; or 
    • The company’s business cannot be conducted to the advantage of shareholders generally, as a result of the deadlock;
  2. The shareholders are deadlocked in voting power, and have failed for a period that includes at least two consecutive annual general meeting dates, to elect successors to directors whose terms have expired; or
  3. It is otherwise just and equitable for the company to be wound up.”

That last “just and equitable” ground gives courts a wide discretion to reach a decision based on all the facts of each particular case. The Court in this matter found that the involvement of all the directors in the business had effectively come to a standstill and took into account the facts that there had not been a directors’ meeting since 2014 plus the sister had refused to sign the latest financial statements. 

It concluded that “the directors do not communicate and there is clearly immense personal animosity between them, and a lack of trust and confidence”, making it difficult to see how the company could continue its business. The lack of substantiation provided by the sister to back up some of her disputed allegations did not, said the Court, detract “from the fact of the breakdown in their relationship, and the lack of trust and confidence”.

It was therefore just and equitable that the company be wound up. 

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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Business Rescue: Are Your Suretyships Enforceable? A R5.5m Lesson for Directors and Creditors

Business Rescue: Are Your Suretyships Enforceable? A R5.5m Lesson for Directors and Creditors

“Some people use one-half their ingenuity to get into debt, and the other half to avoid paying it” (George Prentice, newspaper editor and author)

You are owed a lot of money by a company that goes into business rescue. The business rescue plan provides for creditors like you to accept a dividend of only a few cents in the Rand in settlement of your debt. You stand to lose heavily.

But perhaps there’s hope yet – a director with assets has signed personal suretyship. Can the director now say “sorry, you adopted the business rescue plan so your claim no longer exists”, and refuse to pay you? 

The directors’ defence
  • A creditor was owed R6.5m for the lease of mining equipment to a company which was placed under business rescue. In terms of a business rescue plan approved by the creditor it was paid only a portion of its claim, losing its right to claim anything further from the debtor company.
  • The two directors of the debtor had signed a deed of suretyship in terms of which they stood as co-sureties and co-principal debtors with their company for all amounts owing.
  • The creditor duly sued the directors for its shortfall of some R5.5m The directors’ defence was that they were not liable because – 
    • The suretyship entitled the creditor to go after them only for “any sum which after the receipt of such dividend/s or payment/s may remain owing by the Debtor.” (Own underlining). 
    • Nothing remained owing by the debtor which had been released from its debt by the business rescue plan.
  • In other words, argued the directors, nothing was owed by the debtor company, so they were liable for nothing. 

  • Not so, said the Court. That “would render the terms of the deed of suretyship nonsensical and militates against the very reason for a creditor obtaining security against the indebtedness of a debtor i.e. to mitigate the risk of the debtor being unable to fulfil its obligations due to inter alia business rescue.” The business rescue plan made no provision for the position of sureties and therefore “the liability of the sureties is in my view preserved.  And while the debt may not be enforceable against [the company], it does not detract from the obligation of the sureties to pay in the circumstances of this case.” In other words, a surety’s liability is unaffected by the business rescue unless the plan itself makes specific provision for the situation of sureties.
  • Bottom line – the directors must personally cough up the R5.5m (plus interest and costs).
Lessons for directors and creditors

The outcome here could have been very different had the wording of either this particular suretyship or the business rescue plan supported the directors’ defence.

Creditors – when securing your claim with a director’s suretyship check that you are fully covered in any form of business failure situation.  And ensure that a business rescue plan specifically provides that its adoption does not release sureties. 

Directors – when you sign personal surety understand exactly what you are letting yourself in for. And if you are unlucky enough to find yourself in the middle of a business rescue, actively manage your personal liability danger – particularly when it comes to the wording of the rescue plan.

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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Proving Your Claim in a Liquidation or Sequestration – When You Should, and When You Shouldn’t

Proving Your Claim in a Liquidation or Sequestration – When You Should, and When You Shouldn’t

“A small debt produces a debtor; a large one, an enemy” (Publilius Syrus, Roman writer)

You are owed money by a debtor, whose “insolvent estate” is “sequestrated” (in the case of an individual or trust) or “liquidated” (in the case of a company or other corporate). 

The Master of the High Court appoints a “trustee” (in the case of a sequestration), or a “liquidator” (in the case of a liquidation) to sell all the debtor’s assets and to distribute the sale proceeds between proved creditors. 

When you learn of your debtor’s sequestration/liquidation, ensure firstly that the trustee/liquidator knows that you are a creditor so that you receive reports on the financial position of the estate and on progress towards its finalisation.

You will have an opportunity to lodge and prove your claim in the sequestration/liquidation, which you do by completing a formal “claim form” for proof at a meeting of creditors. 

The question is – should you prove your claim or shouldn’t you? 

Adding insult to injury – contributing to costs

Note: For simplicity we’ll refer below only to “insolvent estate”, “sequestration” and “trustee”, but the principles apply equally to corporate liquidations.

If you don’t prove your claim as above, you won’t receive any dividend and will effectively have to write off your debt entirely. 

But the other side of the coin is that by proving your claim you may be exposing yourself to an even worse fate –

  1. When the costs of sequestration of an insolvent estate exceed the funds in the estate available to pay them, the trustee of the estate recovers a “contribution” from proved creditors to cover those costs. 
  2. In that case you as a proved creditor risk adding insult (having to pay a contribution into the estate) to injury (having to write off your original debt). That’s why, as a creditor, you should be very wary of formally proving your claim against an estate until you are satisfied that no danger of contribution exists. 
The special case of the “petitioning creditor”

Now the rub here for the “petitioning creditor” (the creditor who applied for the debtor’s sequestration in the first place) is this – whether or not you formally prove your claim in the estate, you must still contribute to the shortfall. 

That’s why, although applying for sequestration can be an excellent way of recovering debt from a recalcitrant debtor, it is essential to consider the danger of contribution before making any such application. 

What if you hold security for your claim? 

Note that we are only talking here about holding security over a debtor’s asset/s. If you hold outside security – a surety from a company director for example – you can recover that separately, entirely outside the sequestration/liquidation process.

  • If you hold some form of security for your claim, like a mortgage bond over the debtor’s property for example, you are a “secured creditor”. 
  • You need to prove your secured claim to be awarded the net proceeds of the property. In practice the trustee sells the “encumbered” property, pays out of the proceeds all costs directly related to that property – maintaining it, selling it, paying rates and taxes to pass transfer, the trustee’s fees and so on – and then pays out the balance to you as secured creditor in an “encumbered asset account”. 
  • On the other hand the proceeds of all unencumbered assets fall into the “free residue” account, and if after being paid your secured dividend as above there is still a shortfall on your claim, that shortfall ranks in the free residue as a “concurrent” claim.
  • And that’s where your danger comes in – you are now in line to pay a contribution based on the concurrent portion of your claim.
  • The good news is that you can largely protect yourself from having to contribute by “relying on the proceeds of your security” in satisfaction of your claim. That means you waive your concurrent claim for any shortfall, but equally by removing your shortfall claim from the free residue account you no longer contribute together with other proved (or petitioning) creditors.
  • In some very restricted circumstances even relying on your security won’t protect you from a contribution (for example when no one else has proved claims or other contributors are unable to pay their share), but relying on your security is the best protection you have.

Note that there are grey areas in some of these provisions, so there is no substitute to asking your lawyer for advice on your specific circumstances.

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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When is a Debtor “Insolvent”? A Case of Arrear Maintenance Illustrates

When is a Debtor “Insolvent”? A Case of Arrear Maintenance Illustrates

“To my mind the best proof of solvency is that a man should pay his debts” (quoted in the judgment below)

If you are owed maintenance you have a variety of enforcement options open to you and should ask your lawyer for advice on which is the best for your particular claim and circumstances.

A recent High Court judgment confirms that one of the weapons in your legal armoury is the sequestration application. And as the defaulter’s desperate attempt to avoid sequestration in this particular case illustrates, even just the threat of sequestration can be a powerful motivator to settle up, regardless of whether your claim is based on maintenance arrears or on any other form of debt.

The reason is that an insolvent has to surrender control of his/her estate to a Trustee, who collects and sells all the insolvent’s assets and divides the proceeds between the creditors. The insolvent can also be ordered to pay over any excess earnings – such as for example monthly salary less reasonable expenses – to the Insolvent Estate. That’s a lot of control to lose over one’s own affairs.

 

Maintenance arrears and a “no goods” return

In this particular case –

  • As part of a divorce settlement, a father was ordered to pay child maintenance, but fell behind and ran up substantial arrears.
  • His ex-wife obtained judgment against him in the maintenance court for R45k and the sheriff, with a warrant of execution against property in hand, attached a motor vehicle belonging to the father.
  • Unfortunately the sheriff did not actually remove and sell the vehicle at the time and three months later it was gone. The sheriff then rendered a nulla bona (“no goods”) return when the husband claimed to have no money or attachable assets.
  • The mother then applied for the sequestration of the father’s estate, and the father raised two main defences –

 

“I’m not actually insolvent”

To sequestrate someone’s estate you have to prove either actual insolvency (not always easy to do) or an “act of insolvency”. And although the sheriff’s nulla bonareturn in this matter qualified as an act of insolvency, the husband still insisted that he was actually solvent. He didn’t deny owing the R45k (plus by that stage another R183k) but said that he would make payment once he received tax refunds from SARS in the future.

The Court dismissed this argument, quoting from a 1907 judgment: “Speaking for myself, I always look with great suspicion upon, and examine very narrowly, the position of a debtor who says, ‘I am sorry that I cannot pay my creditor, but my assets far exceed my liabilities’. To my mind the best proof of solvency is that a man should pay his debts; and therefore I always examine in a critical spirit the case of a man who does not pay what he owes” (our emphasis).

It was just not good enough, said the Court, for the father to say that he would eventually pay.

 

“Sequestration won’t be to the advantage of my creditors”

To get a sequestration order you must also prove that “there is reason to believe that it will be to the advantage of creditors of the debtor if his estate is sequestrated”.

The husband’s contention here was that he was under debt review in terms of the National Credit Act, and was making payments to his creditors. The flaw in this argument, said the Court, was that only listed creditors were being paid under the debt review arrangement. Nothing at all had been paid towards maintenance for almost four years, and the arrears were increasing at a rate of some R7k every month.

In those circumstances the Court was satisfied that sequestration would indeed be to the advantage of the husband’s creditors.

 

The Court’s discretion

Even after you have proved that you have a “liquidated” (agreed or easily-established amount) claim of at least R100, plus insolvency and advantage to creditors as above, the court can still refuse to order sequestration. In this regard it has a wide discretion “to be exercised judicially taking into account all the facts as well as the general history and circumstances of the case”.

Finding there to be “no reasons or circumstances to disentitle her of this order”, the Court held for the mother and sequestrated the defaulting husband’s estate.

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

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