1 October 2009 by

As if it wasn't difficult enough.... Holding directors personally liable for reckless conduct

It is a well known principle of company law that the directors of a company cannot be held liable for the debts of the company except in certain limited circumstances. Section 424 of the Companies Act 61 of 1973 (the Act) relates to one of these exceptions and deals with the personal liability of directors who carry on the company's business recklessly or with the intent to defraud creditors.

While the meaning of fraudulent conduct may be relatively apparent, the concept of carrying on a business 'recklessly' and what it entails, is less obvious. The Supreme Court of Appeal (the SCA) held that 'recklessly' entailed that business was carried on with gross negligence and envisaged a situation such as incurring debts when a reasonable businessman would not consider there to be any reasonable prospect of paying creditors when necessary. Although it was held that it was not necessary to prove a causal link between the 'reckless' conduct and any specific debts or liabilities in order for a director to incur personal liability, the SCA emphasised that 'recklessness' would not be lightly found.

However, after the most recent decision in the SCA on the subject, it could be even more difficult to hold directors personally liable for any irresponsible conduct.

In Saincic and Others v Industro- Clean (Pty) Ltd and Another 2009 (1) SA 538 (SCA), a parent and subsidiary company instituted action under section 424 of the Act against the sole director of the subsidiary company, his wife (who was also formerly employed by the subsidiary as a bookkeeper) and a close corporation of which his wife was the sole member, for reckless and fraudulent trading.

Saincic was the managing director of the subsidiary and as such, responsible for its day to day running. Under his direction, the subsidiary company sold goods that it had purchased from the parent company (the parent company was an 80% shareholder in the subsidiary) on credit, almost at cost price to the close corporation to sell the goods at a profit. Saincic benefitted indirectly from these transactions, as at the time his wife, to whom he was married in community of property, was the sole member of the close corporation. The sale of goods by the close corporation was also in direct competition with the subsidiary.

The parent company instituted action under section 424 of the Act and obtained judgment in the High Court for R572 507.98, being the amount by which the debit balance on the subsidiary's trading account with the parent company increased during the period from 1 March 2002 to 19 March 2003, being the period for which the director was the managing director of the subsidiary.

On appeal, the SCA found that the evidence before the High Court (being the increase in the trading account as the sole measure of the computation of loss) was not sufficient to allow the court to conclude, purely on this basis, that it would be just and equitable for the wrongful parties to be held liable for the net balance. More evidence was required as to how and why the net balance on the trading account increased during the relevant period. Factors such as why and how the increase came about, the trading conditions during that period and other issues which may have contributed to the increase in the trading account had to be taken into account. While proof of a causal link between the relevant conduct and the debts or liabilities for which there is a declaration of personal liability in terms of section 424 would still not be required, the absence of such a proven link is a factor to be taken into consideration by the court in the exercise of its discretion and in order to decide whether a declaration of personal liability is, in all the circumstances, just and equitable.

The new Companies Act 71 of 2008 (section 22 prohibits reckless trading and section 77 imposes personal liability on directors thereon) is not yet in force. How the new Companies Act, read with the King III guidelines will contribute to the existing body of law relating to declarations of personal liability of directors who trade "recklessly", remains to be seen.

Anja Hofmeyr, Director and
Deshni Naidoo, Candidate Attorney
Dispute Resolution: Litigation and Arbitration

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