The delinquent director: No tolerance for errant directors?

Errant company directors who fail to comply with their obligations set out in the Companies Act, 2008 (Companies Act), face the prospect of being declared “delinquent” under certain circumstances. As a director, the possibility of being declared delinquent under the Companies Act, and thus unable to serve as a director of any company (possibly for life), is a frightening prospect.

The following questions should be of concern:

What are the consequences of a director being declared delinquent?
When can a director be declared delinquent/ under probation?
How do I check if someone is delinquent or disqualified?

What are the consequences of being declared delinquent?

The delinquency remedy exists to protect the public and stakeholders (shareholders, creditors, etc.) from directors whose conduct has shown them to be incapable of managing a company properly, or with integrity. Our courts have declared directors, who have failed to discharge their duties under the Companies Act, to be delinquent, and have granted leave to the companies involved to claim damages from such director for losses incurred as a result of such director’s conduct.

Delinquent directors cannot continue to serve as, and are disqualified from being, directors. It is therefore incumbent on South African directors to take cognisance of the impact of section 162 of the Companies Act (declaration of delinquent directors) and to take steps to ensure that they do not open themselves up to the possibility of being declared delinquent.

Any declaration of delinquency will subsist for the lifetime of the person declared delinquent on account of having consented to serve as a director whilst ineligible or disqualified under the Companies Act, or whilst under a probation order in terms of the Companies Act that person acted in a manner that contravened the probation order. If the director is delinquent for other reasons, the order will be made for a minimum of seven years. The period of seven years is the minimum length. However, the court may make the delinquency order effective for a longer period. In egregious cases, the order can cover a director’s entire lifetime. Any declaration made by the court may be made subject to any conditions that the court considers appropriate, including a limitation of the application of such a declaration to one or more categories of companies. The directors can also be held personally liable under section 218 of the Companies Act for the losses incurred by any person as a result of the directors’ delinquent conduct.

As an alternative to a declaration of delinquency, a court may make an order placing a person under probation. This would occur when the court is satisfied that the declaration is justified. Such order for probation (similar to a suspended sentence) will be made subject to conditions that the court considers appropriate and which may subsist for a period not exceeding five years.

If a person is placed under probation, he or she is to be supervised by a mentor in any future participation as a director, while the order remains in force, or be limited to serving as a director of a private company or of a company of which that person is the sole shareholder.

Any person who has been declared delinquent or subject to an order of probation may apply to court to suspend the order of delinquency and substitute an order of probation, with or without conditions, at any time more than three years after the order of delinquency was made, or to set aside an order of delinquency at any time more than two years after it was suspended, or an order of probation at any time after such order was made. This will not be available to a person declared delinquent on account of having consented to serve as a director whilst ineligible or disqualified under the Companies Act or whilst under probation in terms of the Companies Act or the Close Corporations Act and acted in a manner that contravened that order.

Without limiting the powers of the court, a court may order as conditions applicable or ancillary to a declaration of delinquency or probation that the person concerned:

undertakes a designated programme of remedial education relevant to the nature of the person’s conduct as director.
carries out a designated programme of community service; or
pays compensation to any person adversely affected by the person’s conduct as a director to the extent that such a victim does not otherwise have a legal basis to claim compensation.

When is a director delinquent? – Section 162

A declaration of delinquency can only be made in relation to one of the legislated grounds stipulated in section 162 of the Companies Act, and there must be clear “evidence” of any conduct that warrants a director being declared delinquent.

In terms of section 162 of the Companies Act, a company, a shareholder, a director, company secretary or prescribed officer of the company, a registered trade union that represents employees of the company, or any other representative of the employees of the company, may apply to court for an order declaring a person delinquent or under probation if:

a) the person is a director of that company, or within 24 months immediately preceding the application, was a director of that company; and amongst other things –

b) such director has:

(i) whilst under a probation order in terms of the Companies Act or the Close Corporations Act, acted in a manner that contravened that order;

(ii) grossly abused the position of a director;

(iii) intentionally, or by gross negligence, inflicted harm upon the company or a subsidiary of the company, contrary to the provisions of the Companies Act;

(iv) acted in any manner that amounts to gross negligence, wilful misconduct, or breach of trust in relation to the performance of such director’s duties.

Ordinary negligence or poor decision-making are insufficient for a delinquency order. Proof of gross negligence, wilful misconduct, or deceptive conduct are necessary. For conduct to qualify as gross negligence,

… it must demonstrate, where there is found to be conscious risk taking, a complete obtuseness of mind or, where there is no conscious risk taking, a total failure to take care.

The Companies Act also provides that a director who uses his or her position or any information obtained while acting in the capacity of a director to:

gain an advantage for him- or herself or for another person other than the company or a wholly owned subsidiary of the company; or
knowingly cause harm to the company or a subsidiary of the company;
must be declared delinquent.

Any organ of state responsible for the administration of legislation may also apply to court for an order declaring a director delinquent, if such director has repeatedly been personally subjected to a compliance notice or similar enforcement mechanism for substantially similar conduct in terms of any legislation.

A court will be obligated to declare a person to be a delinquent director if the person consented to serve as a director while ineligible or disqualified. Such disqualifications are set out in section 69 of the Companies Act and include that such person:

was an unrehabilitated insolvent; or
is prohibited in terms of any public regulation to be a director; or
has been removed from an office of trust on the grounds of misconduct involving dishonesty; or
has been convicted in the Republic or elsewhere for theft, fraud, forgery, or any conduct involving fraud, misrepresentation or dishonesty or offences involving various statutes such as the Insolvency Act, the Close Corporation Act, the Competition Act, the Financial Intelligence Centre Act (FICA), the Securities Services Act or the Prevention and Combating of Corrupt Activities Act.
Any person who has at least twice been personally convicted of an offence or subjected to an administrative fine or similar penalty in terms of any legislation could also be subject to an application for a declaration of delinquency.

It is important to note that an order for probation applies to directors who were present at meetings of companies and failed to vote against a resolution despite the inability of the company to satisfy the solvency and liquidity test as set out in section 4 of the Companies Act. The solvency and liquidity test would apply to directors and any person who is obligated to consider whether, having regard to the reasonably foreseeable financial circumstances of the company at a particular point in time that the assets of the company are fairly valued, are equal to or exceed the liabilities of the company, and it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months thereafter.

Furthermore, any person may be placed under probation if he or she:

acts in a manner materially inconsistent with the duties of a director; or
acts in or supports a decision of a company to act in a manner which results in oppressive or prejudicial conduct; or
on some basis acted in a manner which constituted an abuse of the separate juristic personality of such company.

The court may also make an order placing a person under probation if, at any period of ten years after the effective date of the Companies Act, the person has been a director of more than one company (irrespective whether concurrently, sequentially or at unrelated times) and during the time that the person was a director of each of such companies, two or more of those companies each failed to fully pay all of its creditors or meet all of its obligations, except in terms of a business rescue plan as contemplated in Chapter 6 of the Companies Act or a compromise with creditors in terms of section 155 of the Companies Act. The effect of this provision is that directors who serially trade recklessly and/ or cause companies to enter liquidation may be declared delinquent by the imposition of a probation order. The court may only make such an order if the director was wholly or partly responsible for the company failing to meet its obligations, and that such order is justified given the circumstances of the businesses’ failures and the director’s involvement.

Delinquent Directors have reared their heads in the South African landscape recently
Image By: Canva

Case law – Examples of Conduct Sufficient for a Declaration of Delinquency

Some examples in our case law and which sets out the type of conduct sufficient for a delinquency order are:

reckless trading and a failure to timeously communicate to the board.
allowing the company to continue trading while insolvent.
misrepresentation of financial statements, and/ or failing to prepare them correctly/ timeously.
a director lying on their CV.
the siphoning of company monies for a directors personal use.

Is all of this constitutional? – Gihwala Case

In the more recent judgment of the SCA in the case of Gihwala v Grancy Property Limited 2017 (2) SA 337 (SCA), the constitutionality of section 162 of the Companies Act was called into question. The directors challenged the constitutionality of section 162 of the Companies Act on the grounds of retrospectivity and a director’s right to choose their trade. The court found that the purpose of section 162 is to protect the investing public against the type of conduct that leads to an order of delinquency, and to protect those who deal with companies against the misconduct of delinquent directors. The court rejected the argument of retrospectivity. Regarding the right to choose one’s trade, the SCA found that it was never suggested by the directors that section 162(5) is capricious or arbitrary and, on that ground alone, the constitutional challenge had to fail. Finally, the court found that s162 does not violate the right to dignity and is rational.

A tool for government accountability? – Myeni Case

In the recent case of Organisation Undoing Tax Abuse and another v Myeni and others [2020] JOL 47337 (GP), SAA chairperson Dudu Myeni was declared a delinquent director for life and was ordered to pay punitive costs. The Myeni case was ground-breaking for several reasons. It demonstrated that the delinquency mechanism can be used to hold directors of SOEs accountable, even if government is unable/unwilling to do so. It also established a subjective and objective test for whether a director deviated from their duties severely enough to warrant disqualification. The director’s conduct must be measured against their own skills and qualifications, as well as those of a reasonable director in their position. Directors of SOEs are also subject to a higher fiduciary duty than other directors, so the bar for delinquency is lower. The case also established that ignorance of a director’s duties is not an excuse, and that, in severe cases, the court may extend the delinquency period to a person’s whole lifetime, even if the minimum period is only seven years.

Is your director delinquent?

A company may not knowingly appoint a disqualified or delinquent director. It is therefore essential for a company to vet directors against the CIPC’s register. The Institute of Directors South Africa has compiled a guide for vetting director misconduct: CIPC Disqualified Director Register.

Lesson learned?

There is no doubt that directors of companies will have to carefully consider the manner in which they conduct the affairs of companies, particularly where there is the possibility of being declared delinquent. Directors who find themselves on the receiving end of such an order will not be nominated and, in fact, cannot be appointed to any other boards of companies. Moreover, delinquent directors cannot be incorporators of new companies because incorporators are, ex lege, the first directors of a company.

Furthermore, the word “delinquency” carries criminal connotations. Directors who are declared to be delinquent may also be held criminally liable under section 214 of the Companies Act. A judge may also refer evidence led in in delinquency proceedings to the National Prosecuting Authority (NPA) to conduct a criminal investigation (see OUTA v Myeni).

Directors will need to understand and make it their business to understand whether or not they are acting in compliance with the provisions of the Companies Act. In particular, a director is obligated to ensure that he or she is not trading his or her company recklessly, i.e., in a position of financial distress, which might push the company into a situation where it becomes insolvent and unable to pay its creditors.

Clearly these provisions significantly increase the expected level of directors’ duties to companies in South Africa and the standard of conduct required. Coupled with the provisions of King IV, directors need to carefully consider whether they are adhering to their duties as set out in section 75 and 76 of the Companies Act or face an order of delinquency with all of its negative and unfortunate consequences. Once an order declaring a person to be a delinquent director is made, that person may also be held liable in terms of section 218 of the Companies Act, for any loss or damage suffered as a result of that person’s conduct.

Key Takeaways

Various stakeholders may apply to court for an order to declare a director delinquent.
Directors must be declared unconditionally delinquent for their lifetime if they served as a director while ineligible, disqualified, or in contravention of a probation order.
Directors must be declared delinquent for at least seven years if they:
grossly abused the position of a director
used their position or inside knowledge to gain a personal advantage or to knowingly or by gross negligence harm the company
acted with “gross negligence, willful misconduct or breach of trust in relation to the performance of the director’s functions…”
have been repeatedly subject to compliance notices
have more than twice been criminally convicted of an offence, or
were a director of a company (or similar entity) which was convicted of an offence or a similar penalty, and the court is satisfied that a declaration of delinquency is justified
The court may also order a probation order of delinquency if the requirements are met.
Alongside an order of delinquency, a court may also order remedial programmes, community service, and/ or payment of compensation.