How do we sleep while the beds are burning?

What we have seen over the past two years have been the unprecedented events that have given birth to the Golden Age of Business Rescue.

While this is great for BRPs, these important agents of change need to be aware that business rescue is an emotional process requiring clients to face up to uncomfortable situations and questions that need to be answered in order for the rescue to be successfully implemented.

Often, leaders of distressed businesses bury their heads in the sand preferring to not face up to these situations or uncomfortable questions. The result – as Eric Levenstein puts it – is that Rome burns while Nero plays the Lyre. It seems as if this ignorance is akin to opening Pandora’s Box.

It is no coincidence that I labelled BRPs as agents of change earlier in the article. It is your duty to be open and honest about the distress and to encourage business leaders to take their heads out of the sand and manage the crisis at hand. There are often burning questions that need to be answered in the process of implementing a rescue. Werksmans Attorneys provided a workbook which outlines these questions and the answers that could be expected.

To whom do directors owe their obligations?
Every director owes a fiduciary duty to the company and must therefore use his or her particular skills, experience and intelligence to the advantage of the company.  That director must therefore promote the success of the company in the collective best interest of all the shareholders.

However, directors should be careful how they trade the business of their company because they may incur personal liability towards third parties, as discussed more fully below.

Can directors be held liable to their company for its obligations?
Section 77(3)(b) of the Act as read with section 22 of the Act penalises and holds directors personally liable to the company for any loss incurred through knowingly carrying in the business of the company recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose.

For instance, any director who allows his company to receive goods on credit knowing full well that the company is not in a position to make payment for such goods (i.e. trading in insolvent circumstances) opens himself up to a personal liability claim. If the debtor company has more than one director, the company will have to pursue claims against all those directors that had knowledge of the company’s financial situation.

What are the potential claims which third party’s might bring against directors?
A director can be held personally liable, based on sections 218(2), for any loss or damage to another person which resulted from any contravention of the Act.

As such, in terms of section 218(2), as read with section 77(3) and section 22, the directors may be held liable for any loss sustained by a third party as a result of the directors knowingly carrying in the business of the company recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose.

Directors can also be taken to task in other instances, for example in circumstances where the director’s conduct is considered to be abusive or prejudicial.

Can directors be liable for fraud?
Section 22(1) of the Act states that a company must not carry on its business, inter alia, with intent to defraud any person, or for any fraudulent purpose.

Section 77(3)(b) in turn states that any director of a company is liable for any loss, damages of costs sustained by the company as a direct or indirect consequence of the director having agreed to the carrying on of the company’s business in a manner prohibited by section 22(1) of the Act; or being party to an act or omission was calculated to defraud a company creditor, employee or shareholder, or had another fraudulent purpose.

As such, the directors who were knowingly a party to a fraud by the company can be held personally liable.

What other sanctions may be brought against directors?
In terms of Section 162 of the Act a court may on application, if justified, make an order declaring a person to be delinquent where:

• the person is a director of that company, or within 24 months immediately preceding the application, was a director of that company; and
• such director has, inter alia:
• grossly abused the position of a director;
• took personal advantage of information or an opportunity for him- or herself or for another person other than the company or a wholly owned subsidiary of the company;
• intentionally, or by gross negligence, inflicted harm upon the company or a subsidiary of the company, contrary to the provisions of the Act;
• 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; or
• acted in a manner contemplated in section 77(3).

A declaration of delinquency, following conduct described in paragraph 5.2 above, may be made subject to any conditions the court considers appropriate, and will subsist for a minimum of 7 years from the date of the order.  In terms of section 69(8)(a) of the Act, a person who has been declared delinquent is disqualified from being a director of a company.

Also, a court may make an order placing a person under probation if the court is satisfied that the declaration is justified where such director, inter alia:

A declaration placing a person under probation may be made subject to any conditions the court considers appropriate, and will subsist for a period not exceeding 5 years from the date of the order.  In terms of section 162(10)(d) the court may order that the person under probation 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 where that person is the sole shareholder.

It is important to mention that, if a director, while under an order of probation, acted in a manner that contravened that order, the court must make an order declaring that person to be a delinquent director, and that order will be unconditional and subsist for the director’s lifetime.

When declaring a director to be delinquent or under probation, the court may also order:

• Section 213 creates a new offence in respect of disclosure of confidential information if such information has been obtained by a person in the carrying out functions in terms of the Act or as a result of a complaint or proceedings under the Act. A “person” is not defined and includes anybody, including directors; or
• Section 214 of the Act provides for criminal liability if an act of fraud has been perpetrated by any person in relation to a company, its creditors or employees.

What steps should directors take to minimise their risk of liability?
In order to minimise their risk of liability, a director must perform his/her powers and functions in good faith and for a proper purpose; in the best interest of the company; and with the degree of care, skill and diligence that may be reasonably expected of a person carrying out the same functions in relation to the company as those carried out by that director; and having general knowledge, skill and experience of that director.

Section 76(4) of the Act states that, in respect of any particular matter arising in the exercise of the powers of the performance of the functions of a director, a particular director will have satisfied his/her obligations if that director has taken reasonably diligent steps to become informed about the matter, does not have a personal financial interest therein (or has declared such an interest to the board in terms of section 75), and has a rational basis to believe that the decision was in the best interest of the company at the time.  This goes to the degree of knowledge that a particular director would have as to the financial status of the company.

Can directors rely on others’ advice?
In terms of section 76(4) of the Act, a director must take reasonably diligent steps to become informed about the financial status, business and affairs of the company. 

In taking such steps, the directors are entitled to rely on information prepared by the employees of the company, accountants or any other professional person retained by the company. 

However, the director must reasonably believe that those duties falls within the particular person’s professional or expert competence; or that the particular person merits confidence.  Also, an unquestioning reliance on others by a director is not acceptable.

Next week we will focus on the remaining eight questions that need to be answered.