9 February 2022 by , and Business Rescue, Restructuring & Insolvency Newsletter

“Robbing Peter to pay Paul”

In the recent High Court judgment of Gore N.O & Another v Ward & Another (Case no 2977/2021), the applicants, who were joint liquidators of a company called Brandstock Exchange (Pty) Ltd (Brandstock), brought an application for an order setting aside two payments of R250,000 to each of the respondents. The company had been placed in liquidation at the behest of Mr CJ Louw (Louw), as the only creditor of Brandstock. 

The background to this case is rather miserable, much of the misery having been caused by a long-gone Mr Bruce Philip (Philip), the sole shareholder and director of Brandstock. Philip had entered into an oral agreement with Louw, whereby Louw would finance the purchase by Brandstock of cattle. Brandstock would then on-sell the cattle for a profit. Upon receipt of payment by the purchaser of the cattle, Louw would be reimbursed for his outlay, and would also be entitled to 70% of the profit. Louw paid the required sum of R2,257,200 to Brandstock (upon the request of Philip) and eagerly awaited payment in terms of the agreement, by no later than 8th May 2018. Needless to say, Louw was not paid any money on the 8th of May 2018, and after Louw made a few attempts to address the matter with Philip, Philip disappeared. Louw subsequently discovered that Philip is indebted to a number of other people, including his own (Philip’s) father-in law and that there was an application pending for the sequestration of Philip’s estate.

Louw subsequently brought an application for the winding up of Brandstock and testified that he had previously done business with Philip through another company called BRP Livestock CC. Philip had informed him that BRP Livestock’s bank account had been frozen for administrative reasons, whilst in truth the company too had been placed in liquidation. After reviewing Brandstock’s bank statements, the liquidators (applicants) noted two sums of R250,000 leaving the bank account, shortly after Louw made his payment of almost R2,8 million. An investigation revealed that these sums had been paid to the respondents for monies previously advanced by them to Philip, which amounts had been due and owing for more than three years.

Proceedings in the High Court

The applicants sought to set aside the payments made to the respondents totalling R500,000 on the basis that these payments constituted a disposition without value and therefore stood to be set aside in terms of section 26 of the Insolvency Act 24 of 1936, read with section 340 of the Companies Act 61 of 1973.

It was the first respondent’s case that he did not concern himself with where the money had come from and although he had never heard of Brandstock, he was aware that the money he received essentially came from Philip through Brandstock. He denied that Brandstock had obtained any rights to the money or had received any real benefit from the funds. Rather, that Brandstock had merely been used as a conduit through which to channel the money, which Philip had fraudulently obtained from Louw.

The applicants in turn argued that Louw had dealt with Brandstock, being a separate juristic entity, and not Philip in his personal capacity. As such, there was a valid contract between the parties, which Louw had entered into and performed in terms of, based on Philip’s representations and instructions.

In determining the matter, the court tasked itself with answering two questions. Firstly, whether Brandstock should be treated as bound to the agreement between itself and Louw or liable for the loss suffered by Louw. Secondly, whether Philip had been authorised to enter into the transaction on Brandstock’s behalf.

The court answered the first question by reiterating the fact that a company has no mind of its own and can therefore only be bound by a person representing it. Even though this representation may have been dishonest or fraudulent, the company remains bound thereby. On the second question, the court found that Philip, despite his deceitfulness in doing so, had actual authority to act on behalf of the company given that he was the sole director and shareholder. Brandstock was thus undoubtedly liable for the money stolen by Philip.

The respondents, however, were not giving up that easily and had one final argument up their sleeve – namely reliance on the so called “directing mind doctrine”. The doctrine says that, “the acts of the directing mind will be attributed to the company only when the action taken by the so-called directing mind (i) was within the field of the company’s operation assigned to him or her, (ii) was not totally a fraud on the company and (iii) was by design or result partly for the benefit of the company”.

The court gave serious consideration to this argument, Judge Binsward reflected on several previous judgments, some of which he had penned himself. What became clear was that the applicability of the doctrine was context specific, and the facts in this matter differed in material respects from those where the doctrine had been successfully applied. In this case there was a contractual reason for the payment by Louw to Brandstock and an intention by Louw to make the payment. Brandstock, at least from the perspective of the bank where its account lies, had obtained an effective right to the money and the bank would not be free to reverse the credit. Consequently, the funds essentially became Brandstock’s “property” within the wide definition contemplated in section 2 of the Insolvency Act. Additionally, the subsequent payments that went out to the respondents were not made by Philip in his personal capacity, as the bank specifically made those transfers on behalf of Brandstock, the account holder.

The final question that remained was whether these payments (essentially money stolen from Louw) fell within the definition of a “disposition”. The Insolvency Act defines a disposition as “any transfer or abandonment of rights to property and includes a sale, lease, mortgage, pledge, delivery, payment, release, compromise, donation or any contract therefor, but does not include a disposition in compliance with an order of the court”. The court found that the payments by Brandstock to the respondents constituted an abandonment of rights and was made for no value. In addition, as a result of the disposition, Brandstock could thereafter no longer reimburse Louw or pay its other creditors (bearing in mind that the respondents were never creditors of Brandstock, but rather of Philip). There was no dispute that the dispositions were without value and as such, the court proceeded to set the dispositions aside.

Conclusion

This judgment is a sad testament to the fact that unscrupulous directors quite often use a company’s juristic personality to drive their fraudulent activities. Despite the remedies offered by the Insolvency Act and the Companies Act, when such a director simply disappears it is likely that the victims of the fraud are left to fight over whatever money remains, culminating in a lose-lose situation.

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