Register as a client

Abusing the principle of separate corporate identity: A court warning to trustees of a shareholder trust by Lizanne Visser

LIZANNE VISSER

It is a well-established principle that a company is a separate juristic person, distinct from its shareholders and directors. This is significant, because it implies ‘limited liability’ – the shareholders will not be held liable for the debts incurred by the company. Only in exceptional circumstances will the courts impose liability on shareholders for the debts of the company. These cases involve what is known as “piercing the corporate veil”.

Recently, in Cooper NO and Another v Myburg and Others (9040/2019) [2020] ZAWCHC 174 (4 December 2020), the Western Cape High Court referred to another instance that could conceivably lead to shareholder liability. The liquidators of a company applied for a declaratory order under section 424(1) of the Companies Act 61 of 1973 (“the Old Act”) that the trustees of a trust – the sole shareholder of a company in liquidation -, be held personally liable for the debts of the company, for the part they played in the reckless trading by the company. Section 424(1) allows a court to declare persons liable for the company’s debts where they carried on the business of the company in a reckless or fraudulent manner.

The liquidators alleged that the trustees of the shareholder-trust acted recklessly by permitting the disposal of a greater part of the company’s assets under s 115 of the Companies 71 of 2008, (“The Act”), at a time when the company experienced severe financial difficulties and liquidation was reasonably foreseeable. The disposal of assets was part of a dubious scheme devised by the sole director (one of the trustees of the shareholder-trust) involving divesting the company of all its hard assets by disposal to a related company. The scheme would effectively deprive creditors with currently due and payable claims of any prospect of recovery, because there were no assets left in the company on liquidation.

To determine whether the trustees as shareholders could be held personally liable, the Court considered the following two questions:

  1. Whether by adopting the special resolution in terms of section 115 of the Act to permit the disposal of its assets, the trustees could be said to be party to carrying on the company’s business.
  2. Whether in exercising the powers conferred to them in terms of section 115 the shareholders are required to have reasonable regard to the interest of the creditors.

On the first question the court held that a disposal of a company’s assets may be characterised as carrying on its business. The effect of s 115 of the Act is to bring about an exception to the general rule that a company’s business is ordinarily undertaken by its directors or its employees. The consequence of the provision is that “control of the disposition of the greater part of a company’s assets or its undertaking is taken out of the hands of the directors and ultimately placed into the hands of the shareholders.

The significant part of the judgment deals with the second question. Noting that reported jurisprudence does not provide an answer, Binns-Ward J expressed the view that, where shareholders exercise control over the disposal of assets, as contemplated by s 115 of the Act, they must take cognisance of the effect of their decision on the company’s ability to meet its obligations towards its creditors.  A failure to do so, especially in circumstances where a company finds itself in a state of insolvency, would amount to an abuse of the limitation of personal liability enjoyed by shareholders. The Court described the directors’ professed belief that the disposal of assets would be to the advantage of any of the company’s creditors as so “far-fetched and fanciful as to be nothing short of risible”.

The Court elaborated on the character of the trust in question and the manner in which the trustees exercised their duties. The trust had three trustees: the sole director of the company and his parents. It was clear that the trust was a glaring example of the violation of the ‘core idea’ of the trust. In the absence of an independent trustee the director effectively reserved for himself most of the control over the trust. His parents, as co-trustees, never played a substantial part when it came to trust business and more often than not endorsed whatever their son put before them. In this manner they voted in favour of the disposal of the company’s assets without giving the matter any independent consideration, thereby abdicating their decision-making power in favour of their son.

It is trite that a director cannot shelter behind culpable ignorance or failure to understand the affairs of the company. Although entitled to rely on information or advice, directors must give due consideration thereto and must exercise their own judgement. The Court held that this is the same for the shareholders in a private company when exercising their powers under s 115 of the Act.

On these facts the Court concluded that the trustees who supported the resolution to dispose of the assets could be held personally liable under s 424 of the Old Act. However, as a result of a technical error in the applicant’s founding papers, in which the parents were only cited in their capacity as trustees, they could not be held personally liable.

The judgment established an important principle on personal liability of shareholders of a company in liquidation.

It is important to note also that the Court ordered the Chief Registrar to forward a copy of the judgment to the Master of the High Court, to consider and to take appropriate action in light of the findings and evidence on the administration of the trust. The Court further ordered that the judgment be forwarded to the Commissioner of the Companies and Intellectual Properties Commission, to consider whether it would be appropriate for the Commission to make an application in terms of section 162 of the Act for an order declaring the director in question a delinquent director, in light of his total disrespect for the principle of separate juristic personality and grossly deficient appreciation of his responsibilities as a director.

Share this article