Directors' Liability Opinion - July 2009

DIRECTORS’ LIABILITIES – IMPLICATIONS FOR THE COMPANY SECRETARY

Introduction

Directors are currently faced with the provisions of s424 of the Companies Act of 1973 which states that any person involved in the running of a business who does so recklessly or with the intent to defraud creditors, will be liable for all the debt or other liabilities of the company.  This is in addition to a number of other sections in the Act that also make provision for the potential liability of directors, such as the potential liability when a person who is disqualified from being appointed as a director, is allowed to act as such or to participate in the management of the company (s218(2)). 

Although s424 refers to any person, experience shows that liquidators set their target on the directors for a number of reasons, including the fact that the onus of proof, as far as involvement in the running of the business is concerned, is that much easier.  This was again evident in the recent press statements made by the liquidator appointed to attend to the possible liquidation of certain assets of Pamodzi Gold in which it was confirmed that an investigation would also be done as to the possible liability of the directors for reckless trading. 

In addition to the statutory provisions, the common law also addresses the duties of fiduciaries, such as directors, trustees and others appointed in a position of trust.  Any failure to fulfil these duties could potentially result in the fiduciary being held liable for the damages suffered by the company or a third party as a result of such failure.

The Companies Act 71 of 2008 has now combined all of these in sections 76 and 77, which is also to some extent a repeat of certain liability provisions found elsewhere in the Act.  It is important to note that the definition of “director” for purposes of these sections includes an alternate director, a prescribed officer and a board committee member (including audit committee) that is not a director. 

Standard of directors conduct – s76

The standard of conduct as expected of directors (see reference to definition above) can be summarised as follows:

• Directors must not use their position or the information obtained while acting as a director to gain any advantage for themselves or any third party or to cause harm to the company or any of its subsidiaries. 
• Directors must communicate to the board as soon as possible any material information that comes to the director’s attention unless it is in the public domain, or known to the other directors or the director is bound by legal or ethical obligations of confidentiality. 
• Directors must exercise their powers and perform their functions:
  • In good faith and for a proper purpose;
  • in the best interest of the company; and
  • with a degree of care, skill and diligence that may reasonably be expected of a person carrying out the same functions as the director and having the general knowledge, skill and experience of that director.

A director will have satisfied the above standards if the director can show that he/she:

• has taken reasonably diligent steps to become informed about the matter; and
• had no material personal financial interest in the subject matter of the decision (and no reasonable basis to know that any related party had such interest) or, if he had such interest or was aware of a related party’s interest, that such interest had been declared as required in terms of s75 of the Act; and
• had a rational basis for believing, and did believe, that the decision was in the best interest of the company.

The director is entitled to rely on the performance of and information provided by employees, professional advisors, board committees and others to whom board functions have been delegated, on condition that the director is comfortable with the competency and skills or expertise of such person or entity. 

Liability of directors and prescribed officers – s77

Directors, as defined above, will be liable:

·             in accordance with the principles of the common law relating to breach of a fiduciary duty, for any loss, damages or costs sustained by the company as a result of the director’ breach of the duty to disclose personal financial interests (s75), to not use his position or information for his own advantage (s76(2)(a)), to communicate material information to the board (s76(2)(b)) or to act in good faith, for a proper purpose and in the best interest of the company (s76(3)(a) and (b));

·             in accordance with the principles of the common law relating to delict for any loss, damages or costs sustained by the company as a consequence of a director’s breach of the duty to act with care, skill and diligence (s76(3)(c)), or a breach of any provision of the Act not mentioned in section 77 or any provision of the company’s memorandum of incorporation;

·             for any loss, damages or cost sustained by the company as a result of the director:

o   acting on behalf of the company without the necessary authority;

o   having consented to the business being carried on a in reckless manner (Note: s22 – includes trading under insolvent circumstances as reckless trading);

o   being party to an act or omission by the company despite knowing that the intent is to defraud a creditor, employee or shareholder or had another fraudulent purpose;

o   signing, consenting to or authorising the publication of false or misleading financial statements or a prospectus containing an untrue statement;

o   having been present at a meeting or participated in a decision by way of round robin and failed to vote against contraventions of ss 36, 41, 42(4), 44, 45, 46, 48 or Chapter 4.

The liability of directors for a contravention of s46 as envisaged above is qualified by the provisions of s77(4).  Furthermore, a director is entitled to bring an application to court to set aside the board decision contravening the relevant provisions of the Act as listed above.

Based on the provisions of s77(6) and (7), liability is joint and severable and proceedings to recover any loss, damages or costs have to be instituted within three years after the act or omission that gave rise to the claim.  Directors are also liable for the costs of any other party involved in such proceedings unless the proceedings are unsuccessful and to repay to the company any amounts paid by the company as a result of the unlawful actions of the director that can not otherwise be recovered. 

An important feature of directors’ liability is contained in s77(9) which is similar to the provisions of s248 of the Companies Act of 1973.  This section provides for some form of relieve for directors who acted honestly and reasonably and ought fairly to be excused, the focus being on “honest and reasonable behaviour.”  As would be expected, the protection can not be relied upon in the event of wilful misconduct or wilful breach of trust as such behaviour will in any event not meet the test of honesty and reasonableness.

Implications for the company secretary

As the main source of guidance and support to directors and management on issues of compliance and governance, the potential liability of directors as set out above have some demanding implications for the company secretary that need to be highlighted and appropriately addressed.

These would, inter alia, include the following:

·         For the company secretary to properly fulfil his/her duty in this regard, the company secretary need to be completely au fait with the relevant provisions of the new Act as referred to above, including the provisions regarding the indemnification of directors and the possible extent of directors’ and officers’ liability cover as provided for by the Act (s78).

·         The company secretary needs to ensure that the board of directors is fully briefed on and informed of the more important aspects of the new Companies Act with particular focus on the statutory liability of directors.

·         The content of minutes and the proper recording of proceedings of board and board committee meetings will become even more important than in the past and company secretaries need to urgently enhance their skills in this area if necessary. 

·         The company secretary need to play a proactive role in ensuring that directors do not take decisions based on inadequate information by supporting and guiding management in respect of the content, quality and timing of meeting papers. 

More and more the assistance of a competent and professional company secretary will become of enormous value to any director who appreciates the extent of his/her exposure – it is for the company secretary to ensure that he/she makes the best of this enormous opportunity and challenge.

ANNAMARIE VAN DER MERWE

JULY 2009