BETWEEN A ROCK AND A HARD PLACE

by Dirk Kotze

It is trite that the ultimate fate of a financially distressed company, unable to pay it creditors, are liquidation. Once in liquidation and should creditors elect to proceed with an insolvency enquiry, the directors of the company might, in appropriate circumstances, be faced with the uncomfortable question, “why did the board not timeously inform the stakeholders and creditors of the fact that the company was financially distressed and why did you not resolve to place the company under business rescue”.

Why would this be a relevant question? The relevance of this question is found  in the duty imposed on the board of directors in section 129 (7) of the Companies Act 71/2008 (“the Act”), which states that, “if the board of directors of a company has reasonable grounds to believe that the company is financially distressed, but the board has not adopted a resolution contemplated in this section (referring to a resolution to place the company in business rescue proceedings), the board must deliver a written notice to each affected person, setting out the criteria referred to in section 128 (1)(f) that are applicable [i.e. choose and explain the financially distressed scenarios as per the definition provided in section 128 (1)(f)] to the company, and its reasons for not adopting a resolution. Simply stated, if a company is in financial distress and it has not filed for business rescue, their is a positive duty on its board of directors (“the board”) to advise the affected persons being the creditors, shareholders and employees of the company that it is financially distressed, and also advance reasons why they have elected not to file for business rescue.

The language used in this section is not directory, but peremptory and it suggest that once the definition of financial distress in section 128 (de facto and commercial insolvency foreseen in the ensueing 6 months) of the Act are met, the board has a positive duty to act. Not only must they inform stakeholders of the fact that the company is in financial distress, but they must also advance reasons why they have not adopted a resolution and filed for business rescue.

A  further question that arises automatically is whether a failure of the board of directors to comply with this duty in terms of  section 129 (7) (hereinafter referred to as “this duty”) will have adverse consequences for the board, especially in circumstances where the company is eventually liquidated and creditors suffer huge losses as a result of unpaid claims, which losses could have been lessened if this duty had been complied with

The answer to this question is by no means staightforward. At the outset, section 129(7) does not contain any sanction if the board fails to comply with this  duty, nor does the Act provide any specified time limits within which such compliance must occur.  The main and obvious reason for the absence of a sanction, is the fact that such notice to creditors will in all likelihood be tantamount to commercial suicide by a company, as its creditors may no longer be willing to supply goods and services on favourable credit terms, if any at all. Banks and financial institutions will, in all likelihood, withdraw all credit facilities or at least substantially reduce such facilities.

Does this mean that the board could simply ignore this duty if they have reason to believe that the company is financially distressed? The answer should be a clear NO.

Although I do not propose that that a failure to comply with this duty will automatically lead to the directors being liable for the losses suffered by creditors in a liquidation, the following should be kept in mind.

Firstly, the Act, via section 218(2), makes it clear that, “any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention”. Thus for instance, an aggrieved shareholder (who continued to invest his money into a financially distressed company whilst not having been informed of its financially distressed status), and a creditor (who continues to supply goods and/or services to a financially distressed company whilst being blissfully unaware of its financially distressed status) might well choose to claim their losses from the directors of the company should the company end up in liquidation.

Secondly, a failure to comply with this duty, in conjuction with other relevant evidence, may lead to a conclusion that the directors of the company acted recklessly and with gross negligence. Section 424 of the old Companies Act (which still applies under our new company law regime) and the judicial pronouncements thereon [see Philotex (Pty)Ltd and Others v Snyman and Others 1998 (2) SA 138 (SCA)] makes it clear that directors will be held personally liable for the debts of a company if they traded recklessly.  When the Philotex judgement was handed down, this duty did not exist and under our new company laws it could well be argued that a failure to comply with this duty is an important factor from which an inference of “recklessness” can be made in event of a company continueing to trade and incurring huge debts in a financially distressed scenario. Filing for busines rescue could certainly and in appropriate circumstances be regarded as a reasonable step that a board of directors could and should have taken to prevent the losses being uncurred by creditors and shareholders.

Thirdly, the failure to act in terms of section 129(7) of the Act could also impact on an inference that a director acquiesced in the carrying on of the company’s business despite knowing that it was being conducted in a manner prohibited by section 22(1) of the Act (i.e. recklessly, with gross negligence, with intent to defraud or for any fraudulent purpose). This may lead to personal liability for any loss, damage or costs sustained by the company [see section 77(3)(b) of the Act].

Taking into account the risks involved, directors of companies should at least take note that a failure to comply with section 129(7) may in appropriate circumstances lead to personal liability for the debts of the company. The real conundrum is however that you are, in no way, “damned if you do and damned if you don’t.

It will be interesting how the Courts will interpret this provision, which, due to its possible adverse commmercial consequences, will not in isolation lead to personal liability, but will most certainly in appropriate circumstances be an important factor when considering reckless trading.

Dirk Kotze LLB (Stell) LLM (Unisa) is an attorney who practices for his own account in Stellenbosch.  www.dirkkotze.co.za

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.

DISCUSSION OF TWO HIGH COURT DECISIONS DEALING WITH TRUSTS

by Marthinus Cronje

Kidbrooke Place Management Association v Walton
(18932/2012) [2015] WCHC (25 March 2015)

Any person who has an interest in the trust property may apply for the removal from office of a trustee and not only a beneficiary of the trust.

The purchase of immovable property by trustees from a trust is something that is required by custom in South Africa to be sanctioned by a court. Not only did the trustees not see fit to seek such sanction, they failed to take independent advice or make prior disclosure to the beneficiaries of their actions.

No disclosure was made by the trustees of the willingness by FNB to write off that part of the Trust’s debt that exceeded R1,74 million. There was also no disclosure to the management committee of the precise nature of the personal interest of trustee and another person, or of the personal gain they stood to realise in a transaction. The fiduciary duty as trustees behoved the trustees to have made full disclosure before embarking on the undertaking. They should not have proceeded without the informed consent of the beneficiaries. Disturbingly, the respondent in his answering affidavit appears to dispute the necessity for prior or informed consent to have been obtained. Contrary, to the respondent’s assertions in this connection, it would seem that whatever disclosure did occur, was made only after searching questions were raised and pursued and the information provided in response to these enquiries was incomplete and, at least in certain respects, not always correct.

There was no disclosure that the commissions were paid to an entity (Code Design) controlled by the respondent, or that they generated an income for the first respondent in the form of that entity’s profits. The respondent’s conduct in this regard points to an inadequate appreciation of the nature of his fiduciary duties with the result that he failed to properly distinguish the proprietary affairs of the Trust from those of his own. It is disturbing that even in his answering affidavit, the respondent gives no indication – even with benefit of the opportunity for reflection – of being astute to how his conduct deviated from that expected of a trustee in his position. The trustee’s ‘profound misappreciation’ of his duties and obligations signifies a risk that he may act in breach of his fiduciary duty in other respects should he remain in office. The contention that the payment of commission to an entity controlled by the trustee was known to various persons, such members of the management committee and certain of the other rights-holders, also does not avail the trustee. It does not address the common law requirement of prior informed consent from all the beneficiaries, or the requirements of the trust deed.

A trustee, even though innocent, whose position involves a conflict of interest and duty may be removed from office by the court. The sufficiency of the cause for removal is to be tested by a consideration of the interests of the trust.

The prosecution of the current application is manifestly the precursor to further proceedings in which a proper accounting for and disgorgement of unauthorised profits will be sought from the trustee. He would have been well advised in the circumstances to have appreciated, with regard to the best interests of the administration of the trust, the untenability of his continuing in office in the context of the claims that it is intended to advance against him, and to have resigned. His failure to do so, and decision instead to oppose the application for his removal has exposed the Trust to potential liability for the costs of this application – all in defence of his own position. This affords an unsettling further indication of a material lack of insight by the respondent as to the legal character of his position as a trustee and serves only to confirm the conclusion that the interests of the Trust and its beneficiaries will be best served by the removal of the respondent from his position as trustee.

Regard was had to the clear intention of the founders of the Trust that the first respondent should be a trustee for as long as he should wish. However, it is regarded as more important in the whole conspectus of the matter to have regard to the best interests of the Trust in the context of events that subsequently unfolded.

Groeschke v Trustee, Groeschke Family Trust And Others
2013 (3) SA 254 (GSJ)

A trust inter vivos can be amended by a signed resolution to amend the trust deed where the resolution was lodged with the Master. Section 4(2) of the Trust Property Control Act, 57 of 1988 does not provide that, if a trust document is not lodged with the Master, the variation would not be valid; it simply enjoins the trustee to lodge it. As well, the section does not require an application to amend. Neither does the section stipulate a time frame for the lodgement of the document or the form and content of the document. The section also does not require the lodgement of a complete, amended deed of trust after the amendment; it requires only the lodgement of the document amending the deed. It is quite clear that the lodgement of a deed of trust and of the documents amending that deed is required under sections 2 and 4 of the Act simply in order to facilitate, for example, the identification of the terms of a trust and the powers, rights and obligations that flow from them. Hence, non-compliance with these sections, despite their peremptory tone, is not met with a suspension or even the invalidation of a trust.

A trust deed varied without the beneficiary’s consent after the latter has accepted the benefits conferred by the trust deed is invalid, but it can be varied by the contracts where the beneficiary has not accepted benefits. A trust with a sole trustee who is also the sole beneficiary cannot be validly created: Land and Agricultural Bank of South Africa v Parker and Others 2005 (2) SA 77 (SCA) at paragraph 19. However, if at some time after the creation of a trust the circumstances had changed so that the beneficiaries of that trust were also its trustees, the position might be undesirable, but it would also not cause the trust to fail. Section 7 empowers the Master, even in the absence of, or notwithstanding any provision in the trust instrument, to appoint any person whom he deems fit as trustee or as a co-trustee with any serving trustee.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.

YOUR WILL: AN IMPORTANT DOCUMENT

Life is unpredictable, therefore we advise our clients to lose no time in drawing up their will and planning their estate. Below are important reasons why this should be one of your top priorities.

Q:  Why should I have a will?

A:  A will enables you to name your heirs. Should you die without a will (intestate) your assets will be divided according to the Intestate Succession Act. That may advantage people whom you did not wish to name as heirs.

Q:  Who is allowed to sign your will as witness?

A:  Your will must be signed in the presence of two witnesses, who also sign in each other’s presence. Only persons older than 14 years are qualified to sign as witnesses.

Q:  What is the cost of Executor’s fees?

A:  The maximum remuneration payable to an Executor is determined by law and is currently fixed at 3.5% of the total gross estate value. Executor’s fees should, however, be negotiated with the person who has been appointed as Executor of your will.

Q:  How often should I revise my will?

A:  It is recommended that wills be revised at least every 2 years. It is also important to review your will after events like marriage, birth, divorce or the purchase of property.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.

SUCCESSION PLANNING

Owning a business requires careful succession planning and is part of your estate planning as you have to determine who will succeed you, or who will purchase your shares, or who will be entitled to the income after your death. The future ownership of your business is at stake.

A Partnership automatically dissolves upon the death of a partner and the remaining partners will then have to dissolve it and divide the assets amongst them.

In the case of a Company the shareholders may agree that:

  1. The remaining shareholders have a right of first refusal to purchase the deceased shareholder’s shareholding, as opposed to dealing with it in a will.
  2. The future of ownership of shares can be regulated by a written agreement between shareholders that is referred to as “buy and sell” agreement and has an influence at the death of a partner or shareholder.
  3. The buy and sell agreement compels the executor of the deceased to offer the shares at a pre-determined price, and life policies between shareholders normally cover the purchase price.
  4. The remaining shareholders are the beneficiaries of the policy on the life of the deceased and use it to purchase the shares, normally pro rata to the shares they already own.
  5. Buy and sell policies fall outside the deceased estate and are not subject to estate duty provided that three requirements are met:
    • None of the premiums should have been paid by the deceased;
    • The shareholder relationship must have existed at the time of death;
    • A written agreement must exist.
  6. When the skill and knowledge of a partner is essential for the survival of the business, “key man insurance“ can be taken out on the life of such a partner or shareholder. The premiums are paid by the business and the benefit is paid to the business to prevent financial loss or to appoint and train a replacement.

In the case of a “sole proprietor”, succession planning is dealt with in the Last Will and Testament.

  1. All the value of the business vests in the deceased estate.
  2. Planning is essential as the business terminates at death, although the executor may sell it as a going concern.
  3. It is a good idea to grant a right of first refusal to an associate, who can purchase the business and intellectual capital at the time of the death.
  4. A life policy can provide for cover on the life of the owner, with the associate being the beneficiary, and the proceeds at time of the death utilised to purchase the business.
  5. It deserves no debate that planning increases the benefit for the estate as opposed to closing the business down, where the assets will be worth far less.

Continued succession planning must be part of your business strategy to ensure your hard work benefits the right people.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice.