COVID-19: Tough Decisions – Business Management And The Role Of Directors (Part 2)

[Article prepared in conjunction with Michael Vieyra – Senior Associate]

This article is the second part in a series of articles that deals with business management and the role of directors under the restraints of COVID-19 and the various regulations enacted in terms of the National Disaster Act (“the Regulations”) while maintaining compliance with existing legislation and best practice enacted prior to the Regulations.

The first part of this article examined, inter alia, the duty imposed on directors, in terms of the of the Companies Act, 71 of 2008 (“the Act”) as well as the principles and recommended practices designed for proper governance contained in the Code to the King IV Report on Corporate Governance for South Africa, 2016 (“King IV”). 

Directors’ fiduciary duties are derived from common law and partially codified in the Act.  In terms of section 76 of the Act, directors must, inter alia, act in the best interests of the company doing so with a degree of care, skill and diligence.  In terms of section 77 of the Act, directors may however be held liable in various circumstances for the breach of their fiduciary duties, the breach of any provision of the Act or any provision of the company’s Memorandum of Incorporation.  The application of section 77 also applies to alternate directors, prescribed officers, persons who are members of board committees or members of audit committees of a company irrespective whether or not those persons are members of the company’s board of directors.

One such provision of the Act which is of particular significance in the present economic climate is section 22(1) which states that “A company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose”.  This section, read with section 77(3)(b) which states that a director is liable for loss, damage or costs of the company as a consequence of the director “having acquiesced in the carrying on of the company’s business despite knowing that it was being conducted in a manner prohibited by section 22”.

In circumstances where a company continues to incur debts notwithstanding the fact that there is no reasonable prospect of the company paying those debts, it could be inferred that the company is being carried on recklessly as envisaged in section 22(1).  In such circumstances, a director would have a duty to apply for the company to be placed in business rescue or to be wound up or liquidated.  If directors fail to do so, they may be held personally liable in terms of section 77(3)(b) of the Act.

Section 22(2) and (3) further states that the Companies and Intellectual Property Commission (“the Commission”), may, if it believes that a company is acting contrary to the provisions of section 22(2), or is unable to pay its debts as they become due and payable in the normal course of business, issue a notice, and if necessary, a compliance notice, to the company to show cause why the company should be allowed to continue to conduct business or trade.

In recognition of the reality that companies are and will suffer significant cash-flow restraints consequent on the effects of COVID-19 while attempting to “trade through” these difficult times, the Commission, on 24 March 2020, published a Practice Note (“the Practice Note”), dealing with section 22 of the Act.  The Practice Note provides that, for a period of 60 days after the declaration that the state of national disaster has been lifted, the Commission “will not invoke its powers under section 22 of the Companies Act in the case of a company which is temporarily insolvent and still carrying on business or trading”.

While it may seem that directors of companies may be sanctioned to trade in insolvent circumstances and thus recklessly, our view is that directors should not interpret this as a licence to trade recklessly, negligently or worse, fraudulently.  The Practice Note makes it clear that the suspension of invoking the Commission’s powers in terms of section 22(2) and (3) will only be applicable where the Commission reasonably believes that a company’s insolvency is due to the business conditions which were caused by the COVID-19 pandemic.

The consideration of a director’s liability will of course be dependent on the facts of each case and, in terms of section 77(9), the Court’s discretion to relieve the director from liability on terms the Court considers just if it appears that the director acted honestly and reasonably.  It seems likely therefore that company directors may be excused from liability if a company was allowed to trade in insolvent circumstances and thus recklessly if the reason for doing so is as a result of COVID-19 and the directors, at all times, acted honestly and reasonably.

http://www.cipc.co.za/files/1015/8504/6745/Practice_Note_1_of_2020.pdf