When personal liability comes knocking

While a company generally has a separate legal personality from its directors, meaning the company’s debts are not automatically the directors’ debts, there are significant instances where the corporate veil can be pierced, leading to personal liability. Understanding these scenarios is the first step towards protection:

Reckless or grossly negligent trading

Section 22(1) of the Companies Act 71 of 2008 (Companies Act) prohibits a company from carrying on its business recklessly, with gross negligence, with intent to defraud any person, or for any fraudulent purpose. If directors are found to have acquiesced in such conduct, knowing the company was being conducted in this manner, they can be held personally liable by the company for any loss, damages, or costs sustained by the company. This includes situations where a company continues to incur debts with no reasonable prospect of paying its creditors. Should the company be placed into liquidation then the directors may be held liable to the company’s creditors too.

Breach of fiduciary duties

Directors owe common law and statutory fiduciary duties to the company, including acting in good faith, in the best interests of the company, and exercising reasonable care, skill and diligence. Breaching these duties by, for example, engaging in conflicts of interest or misusing company assets, can lead to personal liability for any resulting losses to the company.

Non-compliance with statutory obligations

The Companies Act and other legislation impose various duties on directors. Failure to maintain proper financial records, ensure accurate financial reporting or adhere to specific regulations, among other things, can result in fines, penalties and even personal liability for damages suffered due to the contravention.

Tax debts

The South African Revenue Service (SARS) has significant powers to pursue personal liability. Section 48(9) of the Value-Added Tax Act 89 of 1991, for instance, states that any member, shareholder, or director who controls or is regularly involved in the management of a company’s overall financial affairs can be held personally liable for the company’s value-added tax, additional tax, penalties or interest. Section 180 of the Tax Administration Act 28 of 2011 also empowers SARS to hold third parties personally responsible for a company’s tax debt if they controlled or were regularly involved in the management of the taxpayer’s financial affairs and acted negligently or fraudulently.

Personal liability companies

Certain company types, known as “personal liability companies”, explicitly render directors and past directors jointly and severally liable, together with the company, for any debts and liabilities arising during their periods of office. This is a specific type of company registration.

Professional negligence

For professionals (e.g. doctors, lawyers, accountants, engineers), personal liability can arise from professional negligence or errors and omissions in the course of providing their services. Even if they operate through a company, they can still be held personally accountable for their professional misconduct.

The shield of estate planning

This is where comprehensive estate planning by the right advisors becomes indispensable. While it cannot prevent all forms of personal liability, it can significantly mitigate the impact on your personal wealth and ensure your family is protected.

• Protecting assets through trusts and/or companies: A well-structured trust can be a powerful tool for asset protection. Assets settled into an inter vivos (living) trust or company, or combination thereof, generally no longer form part of your personal estate. This means that if you incur personal liability, those assets held within the trust are typically shielded from creditors, as they are not legally owned by you. It’s crucial that trusts are established correctly and managed independently to withstand legal challenges.
• Joint ownership of assets (and in certain common law jurisdictions, assets held subject to a joint tenancy or tenancy in common): Joint ownership makes assets difficult to attach;
• Transfer or donation of assets: This entails removal of assets from your personal risk exposure. It does, however, matter to whom and how those donations are made.
• Ring-fencing business and personal assets: Estate planning encourages a clear separation between your business and personal financial affairs. This includes ensuring company finances are distinct from personal accounts and that personal guarantees are minimised wherever possible.
• Liquidity planning: In the event of a personal liability claim, your estate might need to generate significant liquidity to settle debts. Estate planning involves assessing your liquidity needs and putting mechanisms in place, such as appropriate life insurance policies, to ensure there’s enough cash available without forcing the sale of illiquid assets at a loss.
• Professional indemnity insurance: For professionals, professional indemnity insurance is paramount. It protects against claims of professional negligence or mistakes, covering legal costs and potential damages, thereby safeguarding personal assets.
• Directors and officers’ liability insurance: While not strictly an estate planning tool, directors and officers’ insurance is a critical complementary measure. This insurance protects directors and officers against personal losses in case they are sued for alleged wrongful acts while managing the company. It can cover legal defence costs and damages, significantly reducing the direct financial impact on your personal estate. Estate planning should consider how such insurance integrates with your overall financial picture.
• Will and succession planning: A well-drafted will ensures that your assets are distributed according to your wishes, rather than by the law of intestate succession, which may not align with your family’s needs, particularly if your estate faces a liability claim. For business owners, the will can also specify how shares or members’ interests in a company should be dealt with, preventing business disruption.

In conclusion, for South African directors and professionals, estate planning is not a luxury, but a strategic imperative. By understanding the avenues of personal liability and proactively implementing robust estate planning strategies, you can safeguard your hard-earned wealth, ensure the financial well-being of your loved ones, and secure your legacy against unforeseen challenges. It’s an ongoing process that requires regular review and professional advice to remain effective.