A new Companies Act – Standards of Conduct (the Scary Stuff)

This is part 4 of a series of posts about the new Companies Act. You can read the first three parts and other posts about South African corporate law right here.

This post was written by Shirley Fodor during her time as a partner at Jacobson Attorneys

One of the most fundamental changes introduced by the New Act relates to the standard of conduct expected from directors, prescribed officers and any member of a board committee (including the audit committee) even if certain committee members are not board members, and the liability that they may attract if they fail to adhere to these standards. The word “hectic” has frequently been associated with sections 75 to 77 (inclusive) by clients and fellow practitioners.

The need for the new, more stringent liability provisions are necessitated by the fact that in the past directors (in particular) have frequently treated companies as their personal fiefdoms while paying little heed to the potential consequences. After all, that is what the corporate veil was created for- to protect inter alia the directors from prying eyes.

The corporate veil was briefly referred to in part 1 of this series. The fiction of juristic personality means that the juristic person is viewed separately from the persons who comprise it. Even though a company cannot act or enter into agreements or sue and be sued, without the aid of individuals, the people who perform these actions are effectively acting as agents of the juristic person, and all rights and liabilities adhere to the juristic person and not the individual concerned. The courts, as a result of cases like Salamon v Salamon & Co Ltd 1897 AC 22 and Dadoo Ltd v Krugersdorp Municipal Council 1920 AD 530 have historically been loathe to look behind the corporate veil, unless some form of abuse of the juristic personality has been perpetrated. Unfortunately, the law in this area developed along very haphazard lines. However, ultimately in the matter of Cape Pacific Ltd v Lubner Controlling Investments (Pty) Ltd [1995] ZASCA 53 (also 1995 4 SA 790 (A)) the Appellate Division laid down that each inquiry as to whether or not the corporate veil should be lifted necessitates an enquiry into the facts, with emphasis being placed on the substance rather than the form of any corporate action taken. The court was additionally of the view that there is no general discretion to pierce the corporate veil, however where fraud, dishonesty or any other form of improper conduct is alleged, or by virtue of any policy consideration there are good grounds for piercing the corporate veil. This includes:

  • giving effect to the legislature: we are all permitted to arrange our affairs in the most effective way – however we cannot create a structure purely for avoiding a particular provision of the legislature – for example no matter how one attempts to paint it, tax evasion will be just that regardless of the clothes in which it is dressed. Tax avoidance on the other hand is a legitimate, for example, if a tax neutral amalgamation transaction is available to you, why would you select a structure that triggers capital gains tax?
  • to prevent fraud;
  • to prevent breaches of fiduciary duty;
  • to prevent improper evasion of any obligation, for example in the matter of Cattle Breeders Farm (Pvt) Ltd v Veldman 1974 1 SA 169 (RA), a matrimonial spat was brought before the court under the guise of a commercial ejectment. The immovable property in question happened to be the matrimonial home which the applicant had left after he had committed adultery, and the “squatter” was the applicant’s estranged wife. In the circumstances the applicant was the sole shareholder and director of the company from whom the immovable property was leased. The court held that the company was nothing other than the applicant’s alter ego and refused to allow him to use the corporate structure to avoid his obligations in terms of family law; and
  • when the court sees piercing the corporate veil as being in the public interest. For example in times of war, payments to enemy states are frequently forgiven as it would be seen as sleeping with the enemy. This was the case in Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd 1916 2 AC 307.

This is where the New Act steps in, as it is also legislatively possible to pierce the corporate veil, and to a greater and lesser extent, this is precisely what the New Act is aiming at: making it easier to prevent and prosecute abuses of the corporate structure.

The three sections that we are predominantly concerned with are section 75 (director’s personal financial interests), section 76 (standards of conduct) and section 77 (liability of directors and prescribed officers). It must be borne in mind however, that:

  • these sections apply equally to directors, prescribed officers and board committee members (including the audit committee) and whether or not the committee members are themselves directors (for ease of reference, these will be collectively referred to as “directors”); and
  • breaches of many of the clauses in the New Act will constitute breaches of these sections.

So what do these sections actually say in plain English?

Section 75 is concerned with personal financial interests. This section links quite closely with the common law concept of fiduciary duties. One of the fiduciary duties of a director is to prevent his personal interests from clashing with those of the company. The company’s interests must in all circumstances come first, and where there is a direct or indirect collision between the company and the director’s interests, the director is obliged to disclose this fact to the company (i.e. the remaining directors and the shareholders). This is what is commonly known as a conflict of interests.

Section 75 of the New Act goes further, the director who has a personal financial interest (read = conflict of interests) must disclose same in writing (at any time) setting out the details and importantly the extent of the conflict. Where a director realises he has a conflict of interests (or knows that a related party has a conflict of interests) in any matter to be raised at a board meeting then in terms of section 75(3) he/she is obliged to:

  • disclose the interest and its general nature before the matter is considered by the meeting;
  • disclose any material information relating to the matter and may disclose any relevant insights or observations;
  • leave the meeting immediately after making his disclosure and not take part in any consideration of the matter by the rest of the board;
  • not sign any document in relation to the matter unless specifically authorised to do so by the remainder of the board.

The director in question will still be considered as being present for purposes of a quorum, but will not be considered as being present for purposes of any decision or vote that must be taken in relation to the matter.

Where a conflict arises (either for the director or a related person) after an agreement has been entered into by the company, the director in question must likewise disclose such conflict of interests to the company detailing the nature and material circumstances of how that conflict arose.

Even if a director has a conflict of interest at the time any decision is taken or agreement is entered into, this conflict of interest will not invalidate the decision if it was approved as set out above, or if the shareholders have ratified it and the court may declare the decision or agreement valid on application of any interested party despite the failure of the conflicted director to comply with the provisions of section 75. Of course, in the latter instance good grounds shall have to be shown, and if the interested party and the conflicted director were acting collusively, it is unlikely that the order sought will be granted.

Section 76 sets out those standards of conduct to which all directors must adhere.

The things a director must do when exercising the powers and functions of a director are:

  • to act in good faith and for proper purpose;
  • to act in the best interests of the company;
  • to act with the degree of care, skill and diligence that may be expected of a person carrying out the same functions as those carried out by the particular director, having a comparable general knowledge and experience of that director;
  • to communicate to the board at the first possible opportunity of any information that comes to his/her attention that is material to the company or generally not available to the company, unless the director is bound not to disclose the information by virtue of legal or ethical obligations of confidentiality.

The things a director must not do when exercising the powers and functions of a director are:

  • to make use of any information while acting as a director;
  • to gain some personal advantage;
  • or an advantage for any other person than the company itself, or any of the company’s subsidiaries.

A director will be considered to have adhered to the above obligations if:

  • he/she has been reasonably diligent in becoming informed about any matter;
  • he/she has no personal interests in the outcome of the matter;
  • he/she has complied with the requirements of section 75;
  • the decision was taken and supported by a decision of a board committee and in taking the decision the director believed on a rational basis that the decision was in the best interests of the company and in so doing, the director is entitled to rely on any function that may have been reasonably delegated and any information, opinions, reports or statements (including financial statements) presented by the company’s employees, legal counsel, accountants or other professionals where the information is within that person’s professional expertise, or any board committee of which the director is not a member, in all circumstances if the information merits confidence. Red Bull may give you wings – but I have never seen a flying cow.

Where a director has not complied with these standards of conduct, which are really a codification of the common law position, and as such are nothing new, the director will attract liability in terms of section 77.

A director will be held personally liable for any loss, damages or costs (including costs of court proceedings) sustained by the company:

  • in accordance with the principles of common law relating to a breach of a director’s fiduciary duties or any other breach of a director’s duty contemplated in section 75 and section 76;
  • in accordance with the principles of the common law relating to delict as a result of a breach of section 75 and section 76, any other provision of the New Act or any provision contained in the company’s Memorandum of Incorporation;
  • if the director has signed any document on behalf of the company, or otherwise acted in its name in circumstances where the director knew he did not have the authority to act;
  • agreed to carry on the company’s business in a manner that is prohibited by section 22 (section 22 determines what constitutes reckless trading by a company);
  • if the director is party to any act or omission, the purpose of which is to defraud a creditor, employee or shareholder of the company, or for any other fraudulent purpose;
  • signed or consented to the publication of any financial statements, prospectus or other statement that contains information that is false or misleading in a material respect;
  • was present at a meeting, or participated in the taking of any decision in terms of section 74 (this is where a director takes a decision other than at a meeting of directors) and failed to vote against
    • the issuing of any unissued shares, which issue had not been authorised in terms of section 36 (in order to issue shares in terms of section 36(1)(d)(ii) require the board of the company to determine any rights, preferences or limitations associated with the shares, prior to their issue);
    • the issue of any authorised securities where this was contrary to the provisions of section 41 (this is where shareholder approval for the issuance is necessary);
    • the granting of options, where such options have not been authorised in terms of section 36;
    • the provision of financial assistance to any person for the purchase of shares in the company despite knowing that the provision of financial assistance in the circumstances is inconsistent with the provisions of section 44 or the company’s Memorandum of Association;
    • the provision of financial assistance to a director contrary to the provisions of section 45 or the company’s Memorandum of association;
    • a resolution approving a distribution, where the company has not passed the solvency and liquidity test;
    • any allotment by the company where such allotment is contrary to any provision of chapter 4, where the allotment is declared void.

Where the board of a company has taken any decision, which contravenes the New Act then the company or any director who has been held liable in terms thereof may apply to a court for an order setting aside that decision and the court may make any order which is equitable in the circumstances including rectifying the decision or reversing the transaction and requiring the company to indemnify any director who may have been held liable in terms of section 77, which would otherwise be joint and several with any other person who may be held liable in terms of the Act.

So for all the conduct and liability provisions appear to be daunting in their scope, they really are nothing other than a codification of the common law position on fiduciary duties and a more effective means of prosecuting those who offend against these duties, by creating a statutory mechanism for piercing the corporate veil. Thereby increasing the transparency and accountability of a company in accordance with the suggestions put forward by King Code on Corporate Governance. A responsible corporate citizen should have nothing to worry about.

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