Squaring off with Directors in a no-holds-barred matchup

Jonathan Faurie
Founder Turnaround Talk

Last week, Turnaround Talk spoke to Alexander Forbes Chief Economist, Isaah Mhlanga, about the protracted economic recovery that South Africa faces. This is being driven both by the Covid-19 Pandemic and the fact that South Africa was facing tough economic challenges before the pandemic.

One of the issues discussed with Mhlanga was the fact that the World Economic Forum predicts that South Africa will only fully recover from the pandemic in 2024. This means that we will see a lot more distressed companies over the next two years.

The pandemic may be a cause of distress. However, for most companies, the distressed caused by the Pandemic is symptomatic of deeper-rooted challenges within the company, or the Pandemic was the final straw that broke the proverbial camel’s back.

Last week, we focused on the first half the workbook that was developed by Werksmans Attorneys regarding the questions that Directors have to answer during a business rescue. This week, we look at the other issues that are pertinent.

Can directors’ liability be limited?
Section 78(2) of the Act provides that any provision of an agreement, a company’s Memorandum of Incorporation (MOI) or rules of a company, or a resolution adopted by a company, which directly or indirectly purports to relieve a director of any duty or liability, or negate, limit or restrict any legal consequences arising from an act or omission that constitutes wilful misconduct or wilful breach of trust on the part of the director, is void.

However (and except to the extent that the MOI of a company provides otherwise), a company may, in terms of section 78(5) of the Act, indemnify a director in respect of any liability arising. This is except for a liability arising from wilful misconduct or wilful breach of trust on the part of the director; or where a fine has been imposed as a consequence of a director having been convicted of an offence; or where a director acted recklessly, or despite knowing he or she lacked authority, or with the intent to defraud creditors, or with any other fraudulent purpose.

Furthermore, the company may, in terms of section 78(4) of the Act and subject to its MOI: advance expenses to a director to defend litigation in any proceedings arising out of the director’s service to the company; and directly or indirectly indemnify a director for the expenses incurred, or to be incurred, for such litigation if such litigation is abandoned, or which exculpates the director, or which arises in respect of any liability for which the company may indemnify the director, as described above.

Section 78(7) of the Act provides further, that a company may (subject to its MOI) purchase insurance to protect: a director against liability or expenses for which it is permitted to indemnify a director; and the company against any liability for which the company is permitted to indemnify a director, or any contingency including any expenses it is permitted to advance in respect of the defending of litigation by a director, or to indemnify a director for such expenses.

Directors need to face challenging topics
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What is the position of non-executive directors?
In Howard v Herrigel1991 (2) SA 660 (A) the court held on appeal that:

“it is unhelpful and even misleading to classify company directors as ‘executive’ or ‘non-executive’ for purposes of ascertaining their duties to the company or when any specific or affirmative action is required of them. No such distinction is to be found in any statute. At common law, once a person accepts an appointment as a director, that person becomes a fiduciary in relation to the company and is obliged to display the utmost good faith towards the company and in his dealings on its behalf. That is the general rule and its application to any particular incumbent of the office of director must necessarily depend on the facts and circumstances of each“

The statutory duties and liabilities of non-executive directors under the Act are therefore the same for executive and non-executive directors alike.

However, the Act does sometimes delineate the responsibilities of executive and non-executive directors of public companies.  For example, executive directors (i.e. directors who are involved in the day-to-day operations of the company), prescribed officers and a company employees may not, in terms of section 94(4) of the Act, be members of the company’s audit committee.

It is also worth mentioning that the Listing Requirements of the Johannesburg Stock Exchange (JSE) and the King Code differentiates between the responsibilities and duties of executive and non-executive directors.  For example, the chairman must either be an independent non-executive director, or the issuer must appoint a lead independent director, in accordance with the King Code.

What is the position of shadow directors?
Shadow directors would qualify as prescribed officers.  A prescribed officer, as defined in the Act, includes every person, by whatever title the office is designated, that exercises, or regularly participates to a material degree in the exercise of, general executive control over and management of the business and activities of the company.  This is relevant, as most of the provisions of the Act pertaining to directors apply equally to prescribed officers.

Are there any different requirements and obligations for/on the directors of public companies in a pre-insolvency scenario?

The Act does not distinguish between directors of public companies and directors of private companies.  Therefore, the statutory requirements and obligations for/on directors of a public company are the same as those for/on directors of a private company.

However, directors of public companies listed on the JSE have additional duties and responsibilities, as the JSE Listing Requirements incorporates therein certain practices from the King Code which makes their implementation mandatory, even though implementation of those practices in the King Code is generally voluntary.

An honest discussion about the next steps is nessesary
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What steps should a Board then undertake when it realises that a company is in financial difficulties?
A company’s board should carefully assess whether or not the company is facing financial difficulties which it may well be able to overcome (albeit with some difficulty), or is financially distressed.

A company is financially distressed within the meaning of the Act if it is reasonably unlikely that it will be able to pay all its debts as they fall due and payable within the immediately ensuing six months, or it is reasonably unlikely that the company’s assets will continue to exceed its liabilities within the immediately ensuing six months.

When a company is facing financial difficulties it will be necessary for the board of directors to take the necessary steps to overcome those difficulties (e.g. restructure the company’s business operations and/or its financial affairs) and to continually assess the company’s financial status.

Should a company nevertheless become financially distressed, then the Board should either pass a resolution to place the company in business rescue, or deliver a statutory written notice to each affected person confirming that the company is financially distressed and is not being placed into business rescue and providing reasons for such decision. 

What then is the role and obligations of directors of a company in business rescue?
Once a company goes into business rescue, Chapter 6 of the Act sets out certain roles and obligations (in this changed environment) for directors.

Section 140(1)(a) and (b) states that “[d]uring a company’s business rescue proceedings, the practitioner, in addition to any other powers and duties set out in this Chapter- (a) has full management control of the company in substitution for its board and pre-existing management; (b) may delegate any power or function of the practitioner to a person who was part of the board or pre-existing management of the company”.  However, notwithstanding any such delegation, the KwaZulu Natal Division of the South High Court, in the as yet unreported case of Vengadesen v Standard Bank of South Africa Limited with case number 8575/17P, held that ultimate responsibility rests with the business rescue practitioner.

As such, section 137(2)(b) of the Act provides that during a company’s business rescue proceedings “each director of the company has a duty to the company to exercise any management function within the company in accordance with the express instructions or direction of the practitioner, to the extent that it is reasonable to do so”. In fact, section 137(3) goes further and states that “[d]uring a company’s business rescue proceedings, each director of the company must attend to the requests of the practitioner at all times, and provide the practitioner with any information about the company’s affairs as may reasonably be required”.

In addition, section 137(4) provides that if, during a company’s business rescue proceedings, the board, or one or more directors of the company, purports to take any action on behalf of the company that requires the approval of the practitioner, that action is void unless approved by the practitioner.

For these reasons, section 137(2)(d) states that “to the extent that the director acts in accordance with paragraphs (b) [to act in accordance with the practitioner’s express instructions] and (c) [requiring compliance with section 75 of the Act which concerns disclosure to the board of personal financial interests], is relieved from the duties of a director as set out in section 76, and the liabilities set out in section 77, other than section 77(3)(a), (b) and (c)” [our insertion for ease of reference].

If at any time during the business rescue proceedings, the director has:

then the practitioner may, in terms of section 137(5) of the Act, apply to a court for an order removing a director from office and may apply to have a director declared delinquent in terms of section 137(6) read with section 162 of the Act.

Moreover, if a director has acted in the manner set out in paragraphs 13.1 and 13.2 above, then section 218(2) provides that such director would be liable to any person who has suffered any loss or damage as a result thereof.

Metrics will help the Board plot the way forward
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What steps should a Board undertake when it realises that a company’s insolvency is likely?
If a company is trading in insolvent circumstances and there is no longer any prospect for business rescue to succeed, the Board should resolve to propose to the company’s shareholders that a special resolution for the company’s voluntary liquidation should be adopted.  Alternatively, a director on the Board can apply to court for the liquidation of the company.

Either way, any such steps will have to be taken by the Board or its members in terms of Chapter 14 of the Companies Act 61 of 1973 (the 1973 Act), as read with item 9 of Schedule 5 of the Act.

Should the Board not proceed in this manner, and allow the company to continue to  trade in insolvent circumstances, then the directors on the Board may be held personally liable in terms of section 77(3)(b) as read with section 22(1) of the Act, or section 424 of the 1973 Act.

What is the ongoing role of directors once a company is in an insolvency process?
Once an order for the liquidation of a company is granted, it will remain in existence; however, the directors cease to exercise control of its affairs. However, during liquidation proceedings, the directors have a duty to co-operate and provide any information is required from them.

The company is not divested of its assets but its assets are deemed to be in the custody and under the control the Master of the High Court at first, and eventually the liquidator.  The company’s assets will be sold (realised) and the proceeds will be used to satisfy the claims of creditors according to their order of preference. Any surplus remaining thereafter, will be distributed among the company’s shareholders in accordance with their rights. The company will then be dissolved, and its corporate existence will come to an end.