Directors duties poorly defined in the new companies Act

Craig Assheton-Smith, Director of Assheton Smith Incorporated.

The provisions of The Companies Act 71 of 2008 (“the Act”) places additional duties on directors of financially ailing companies and the risk of personal liability for failing to comply with these duties. However, such duties are poorly defined and expla

Our common law has historically viewed directors as occupying a position of trust and as such has obliged them to carry out their duties as cautiously, prudently and diligently as if they were managing their own affairs.

The Act, which came into effect on 1 May 2011, has codified many of directors’ duties that existed at common law and provides additional duties and responsibilities with which directors are to comply that did not previously exist under the Companies Act 61 of 1973 (“the 1973 Companies Act”).

Some of these additional duties are triggered when a company finds itself in financial difficulty. The consequences of a failure to comply with these duties in the manner prescribed by the Act are potentially severe and may expose non compliant directors to personal liability.

“It is crucial that when a company is in financial difficulty that the directors comply with their duties set forth in the Act to avoid personal liability,” says Craig Assheton-Smith, Director of Assheton Smith Incorporated, a litigation firm specialising in commercial litigation and dispute resolution.

Unfortunately some of the provisions of the Act are unclear and certain important terms are not adequately defined or not defined at all. Such provisions will have to be interpreted and applied by the courts in order to provide clarity for directors and lawyers and other professionals that advise them.

The duties specific to where a company is experiencing financial difficulties provide that if the board of directors of a company has reasonable grounds to believe that the company is financially distressed, the board is obliged to consider whether it should resolve that the company voluntarily begin business rescue proceedings and place such company under supervision.

Assheton Smith comments “The term “reasonable grounds” is not defined and it is my view that this term must have been envisaged by the legislature to be a subjective test to be applied by the board of directors with reference to the specific circumstances of the company at the time.”

The term “financially distressed” is defined as being where the company at a point in time appears to be reasonably unlikely to pay all its debts as and when they fall due within the ensuing six months, or where a company appears to be reasonably likely to become insolvent within the immediately ensuing six months.

If the board of directors is of the view that the company is financially distressed, the duty to consider whether the company voluntarily begins business rescue proceedings and is placed under supervision, is triggered.

Adds Assheton Smith “The board would only be in a position to conclude that there is a reasonable prospect of rescuing the company if it is able to formulate a workable and sustainable plan to do so, which would include the company having access to funding during its supervision.”

If there is no such reasonable prospect then the alternative that the board would have to consider is whether to wind-up the company.

If the board of directors decides not to pass a resolution that the company voluntarily begin business rescue proceedings and thereby be placed under supervision, the board is obliged to deliver a written notice to shareholders, creditors and employees or their representatives setting out the basis of the company’s financial distress and the board’s reason for not adopting the resolution.

The effect of delivering such notice would practically result in creditors refusing to extend further credit, banks withdrawing facilities and key employees resigning. It would also provide unassailable grounds for a creditor to institute winding-up proceedings.

“Although it seems that the intention is to give affected parties notice of the board’s election not to proceed with voluntary business rescue, it is difficult to envisage how these provisions could ever be effectively implemented. In this regard, should the board elect not to resolve to place the company under supervision in most instances they would have a duty to proceed to wind up the company,” concludes Assheton-Smith.

For further commentary and opinion from Craig Assheton-Smith, visit www.asilaw.co.za