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Directors, Creditors – Do Personal Suretyships Survive Business Rescue?

“Creditors have better memories than debtors” (Benjamin Franklin)

In these hard times of pandemic and economically destructive unrest, an unfortunate number of businesses face collapse, and many will opt for the “first aid for companies” option of business rescue.   

Creditors coming out of that process with a shortfall (only the luckiest creditors are likely to emerge with full settlement) will naturally look to any personal suretyships they hold to cover that shortfall.

A recent SCA (Supreme Court of Appeal) decision has brought welcome clarity to the question of whether – and in what circumstances – such personal suretyships will survive the business rescue process.

Both directors and creditors need to understand the outcome, and to act accordingly.

Sued for R6m, a CEO’s defence crumbles
  • A company CEO (Chief Executive Officer) signed a personal suretyship in favour of a creditor supplying the company with petroleum products.  
  • When the company fell upon hard times it was placed into business rescue. Eventually a business rescue plan was adopted, the rescue process was terminated, and the creditor sued the CEO for the shortfall on its claim of just over R6m.   
  • The CEO’s main defence was that his liability as surety was an “accessory obligation” – in other words, if the creditor’s claim against the principal debtor (the company) fell away, he should be released from his liability as surety.  
  • But, held the Court, although a principal debtor’s discharge from liability does indeed ordinarily release the surety, our law allows the creditor and the surety to agree otherwise.   
  • And the suretyship agreement in this case did just that. It contained “unobjectionable” and “standard” terms which included a specific agreement by the surety that he would remain liable even if the creditor “compounded with” the company by accepting a reduced amount in settlement of its claim. Nor was there any mention in the business rescue plan of its effect on creditor claims against sureties (it could, for example, have provided specifically for sureties to remain on the hook, or to be released). But the deciding factor remained that the wording of the suretyship was such that the creditor did not abandon its claim against the surety by supporting the business rescue plan.  
  • Bottom line – the CEO goes down over R6m, and the creditor has another shot at emerging unscathed from the mess.

Heed these lessons from the judgment!

The SCA in its judgment undertook a comprehensive interpretation of the terms of the deed of suretyship, of the business rescue plan, and of the relevant legislation. Although the detail will be of more interest to lawyers and academics than it will be to the average director or creditor, it did bring welcome clarity to an issue of great practical importance, and the valuable lessons therein should be heeded –

Directors: As always, think twice before signing any personal suretyship, and if you absolutely have no alternative, at least understand fully what you are letting yourself in for both legally and practically. Equally, ensure that the business rescue plan lets you fully off the hook as regards any possible personal liability; you may be advised to go further and have a separate release agreement with any creditor/s holding your surety. Although not directly relevant to this article, think also of managing any risk of personal liability beyond suretyship, such as allegations of reckless trading and the like.

Creditors: You on the other hand should always try for watertight and upfront suretyships from directors and others with attachable assets (again not directly relevant to this article, but also take whatever security you can over company assets such as debtors, fixed property etc). And when it comes to the business rescue plan, make sure that it leaves your claim against sureties unaffected.

Upfront professional advice and assistance is a real no-brainer here!

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Companies: Are Restraints of Trade Valid in a Time of Covid?

“For him to be forced out of a career of choice to start working in a different field at a time when many businesses are closing down, retrenchments and lay-offs being commonplace and individual[s] doing everything possible to survive and cope with the health and economic devastating effects of the covid 19 pandemic, is plainly unreasonable and contrary to public policy and constitutional values” (extract from judgment below)

Consider this unhappy (but not unlikely) scenario: For whatever reason, you part ways with your fellow director/shareholder (or perhaps a key employee), who goes off immediately to join (or found) the opposition. 

Now you have a major problem – he/she was privy to all your trade secrets and confidential information and they are now being used to compete against you. Your business could be crippled.

Using the time-tested restraint of trade clause

An effective and time-tested way of protecting your business from such a risk is to insist on all directors, shareholders and key employees signing restraint of trade agreements from the start. Such restraints are usually included as clauses in employment contracts and/or (less commonly) in shareholder agreements. 

However, it is vital to word the restraint clause correctly if it is to stand up to legal scrutiny.  Although our law has long recognised the right of businesses to enforce this type of contract so as to protect their “proprietary and protectable interests”, and although in general we are held by the law to the agreements that we conclude, there is always a balance struck with the employee’s constitutional rights to be economically active and to earn a living.

As the High Court put it recently: “It is settled law that restraints of trade are valid and binding and, as a matter of principle, enforceable unless, and to the extent that, they are contrary to public policy because they impose an unreasonable restriction on the former employee’s freedom to trade or to work. It is also settled that the onus of establishing that the restraint of trade is unreasonable falls on the former employee.”

A common mistake – going “too wide”

The most common mistake businesses make is to word the restraint of trade too widely (in one or more of type of activity, geographical area or time period). No matter how tempting it may be to do so, that is courting disaster. The wider the clause is, the greater the chances of a court holding it either totally invalid or only partially enforceable. Rather word your clauses tightly and defensibly.

Two recent High Court decisions illustrate both this principle, and the potential impact of the Covid-19 pandemic on our courts’ approach to the questions of reasonableness and time periods.

The impact of the pandemic on the “reasonableness” test
  • A director, shareholder and employee of a company specialising in media and advertising solutions resigned as both director and employee after a breakdown in relations, the company owing him R1.2m in short-paid salary. He however retained his shareholding. 
  • He was subject to restraints of trade (in both his employment and shareholder agreements) which prohibited him from working for a competitor, and from sharing confidential information and trade secrets with them, for 18 months in any of 29 African countries.
  • He nevertheless joined a direct competitor (active in 2 of the 29 African countries) and acted in breach of the restraint by contacting customers and business associates. When sued in the High Court for enforcement of the restraint clauses, his main defence was that they were unreasonable and prevented him from earning a living.
  • The Court confirmed the need to consider all the relevant circumstances, not only at the time a restraint is entered into, but also at the time that the business tries to enforce its restraint. In this case, the company’s attempts at enforcement encompassed the period March to July 2020 – a time of strict lockdowns and economic turmoil.
  • The upshot – the Court rejected the company’s suggestion that the ex-director could remain economically active in another field for which he was qualified, commenting: “For him to be forced out of a career of choice to start working in a different field at a time when many businesses are closing down, retrenchments and lay-offs being commonplace and individual[s] doing everything possible to survive and cope with the health and economic devastating effects of the Covid-19 pandemic, is plainly unreasonable and contrary to public policy and constitutional values”. The restraints were rejected as unenforceable.
The impact of the pandemic on time periods 

Another recent High Court decision saw the Court reducing a 2-year restraint, on sales employees who resigned in March and April 2020 respectively, to 14 months. 

In doing so the Court took what it considered to be a reasonable base period in the circumstances of 12 months and added 2 months “to compensate for the lockdown period”, also commenting that “…I am aware that our society is living in strange times. The COVID-19 pandemic has played havoc with, inter alia, our economy. Businesses have been prevented from operating and the ability of the applicants to appoint and train new salespersons will undoubtedly have been blunted by the state of the economy. This is of some relevance when considering the length of the period of restraint…”.  

So – are restraints of trade valid in times of pandemic and upheaval?

Neither decision means that restraints are necessarily unenforceable or only partially enforceable during times of economic turmoil and high unemployment. Each case will be decided on its own merits, but in assessing whether your own restraint clauses will be considered reasonable and enforceable, they are clearly factors to be borne in mind.

When Company Directors and Shareholders Come to Blows….

“…the mere exercise of majority shareholding voting rights does not amount to oppression…” (extract from judgment below)

What happens when a company’s directors and shareholders fall out and cannot reconcile their differences? 

“Relief from oppressive or prejudicial conduct”

If you should find yourself in such an unfortunate situation, our Companies Act offers you several possible remedies. 

Professional advice specific to your case is essential here but be aware of a particularly versatile remedy in the form of a court application for relief from “oppressive or prejudicial conduct”. This relief is available where –

  1. “any act or omission of the company, or a related person, has had a result that is oppressive or unfairly prejudicial to, or that unfairly disregards the interests of, the applicant”,
  2. “the business of the company, or a related person, is being or has been carried on or conducted in a manner that is oppressive or unfairly prejudicial to, or that unfairly disregards the interests of, the applicant”, or
  3. “the powers of a director or prescribed officer of the company, or a person related to the company, are being or have been exercised in a manner that is oppressive or unfairly prejudicial to, or that unfairly disregards the interests of, the applicant.”

If you can prove any of the above, the court has a wide discretion to make any order “it deems fit”, including (a long but not exhaustive list) an interdict against the improper conduct, liquidation if the company is insolvent, business rescue if appropriate, amendment of the Memorandum of Incorporation, “to create or amend a unanimous shareholder agreement”, issue or exchange of shares, appointing additional or replacement directors, declaring persons “delinquent or under probation”, refund of consideration paid for shares, varying or setting aside transactions and agreements, requiring production of financial statements or an accounting/reconciliation, compensation orders, rectification of company registers or records, or trial of any issue.

The critical part, as a recent SCA (Supreme Court of Appeal) judgment shows, is to be able to prove one of those three categories of wrongful conduct. Without that, and no matter how bitter the dispute between you and your nemesis may be, the court has no discretion to grant any of the above relief.

The facts and outcome of the SCA matter are a case in point –

Majority shareholder v fired director
  • In a long-established and closely-held fencing manufacturer with only two shareholders but substantial value (the total value of the shares seems to be in the region of between R46m and R74m), the two fell out over a range of issues.
  • The fall out culminated in the minority (46.67%) shareholder being removed from his directorship by the majority (53.33%) shareholder. After his removal as director he was also dismissed from his employment as a general manager after being found guilty at a disciplinary hearing of four counts of gross misconduct (one of which involved dishonesty). The misconduct complained of included abuse of trust, conflict of interest and abortive attempts to have the company placed under business rescue and liquidation. 
  • Long story short, the dispute ended up first in the High Court and ultimately before the SCA, the minority shareholder alleging that he had been excluded from the management of the company, denied management and financial information, excluded from decision making, removed as director to be replaced by the majority shareholder’s husband and brother-in-law, and unlawfully and unfairly dismissed from employment.
  • The Court however found on the facts that he had failed to prove that the majority shareholder’s conduct towards him was oppressive or unfairly prejudicial, or that his interests had been unfairly disregarded. He had been validly removed as a director of the company at a properly constituted shareholders’ meeting (as the Court put it “…the mere exercise of majority shareholding voting rights does not amount to oppression…), and his dismissal as general manager did not amount to oppressive or prejudicial conduct. 
  • That finding, held the Court, meant that none of the avenues of relief listed above were available to the minority shareholder despite findings that the shareholders’ relationship had broken down irretrievably and was not capable of being resolved. 
  • As a result, the High Court’s order that the majority shareholder sell her shares to him – an attempt by the High Court “to design or craft a mechanism which would result in a ‘clean break’ between the parties” because “it was not in their best interests to remain ‘in the same bed’” could not stand. Equally the minority shareholder’s new request that the majority shareholder be ordered to buy his shares from him could not succeed. 

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Directors, Trustees: Can You Hold Your AGMs and General Meetings on Zoom?

“O Wonder! …O Brave New World” (Shakespeare)

Regrettably the pandemic still shows no sign of going away any time soon, and the social distancing it has brought to our “new normal” leaves companies with a dilemma. How can you comply – safely and lawfully – with the Companies Act’s stringent requirements for the holding of Annual General Meetings and (where needed) interim General Meetings?

The good news is that our South African legislation has for many years allowed the holding of company meetings via electronic communication.

The savings in cost, efficiency and convenience have now – courtesy of the lockdown – been experienced first-hand by many a company and its stakeholders, and a Google search reveals a multitude of AGMs held recently via Zoom or similar platforms (there are also several proprietary platforms specializing in shareholder meetings).

The benefits of meeting virtually are such that even after Covid-19 is no more than a bad memory many of us will continue doing so in place of the traditional “face-to-face all in one place” gatherings. 

Expect also an upsurge in hybrid physical/virtual meetings as things get safer.

The formal requirements
  1. Comply strictly with all the Companies Act’s requirements in regard to proper notice, conduct and minuting of meetings and decisions.  
  2. Observe all the legal requirements set out in ECTA (the Electronic Communications and Transactions Act) in regard to identification of originator, accessibility, storage, retrieval etc. 
  3. Shareholder meetings can be conducted entirely by electronic communication unless prohibited by your MOI (Memorandum of Incorporation) but if you want to avoid any uncertainty have your lawyer draw your MOI to clearly allow them.
  4. How you hold the virtual meeting is important, the requirement being that “The electronic communication employed ordinarily enables all persons participating in that meeting to communicate concurrently with each other without an intermediary, and to participate reasonably effectively in the meeting.”
  5. Notice of the meeting – over and above the normal requirements for notice, “the notice of that meeting must inform shareholders of the availability of that form of participation, and provide any necessary information to enable shareholders or their proxies to access the available medium or means of electronic communication”.
  6. It’s then over to shareholders (or their proxies) to arrange their own access at their own expense, although good practice might be to assist with technical and perhaps even financial support where necessary. Any suggestion of an infringement of shareholder rights could come back to haunt you.
Board decisions generally 

Unless your MOI says otherwise, your board can make decisions electronically (without a virtual or physical meeting) if the decision is one “that could be voted on at a meeting of the board of that company”. Decisions can be “adopted by written consent of a majority of the directors” after “each director has received notice of the matter to be decided.” 

Shareholder decisions generally

Shareholders can also vote electronically on resolutions relating to any business not required by the Companies Act or by the MOI to be conducted at an AGM

Public companies

Meetings of public company shareholders “must be reasonably accessible within the Republic for electronic participation by shareholders … irrespective of whether the meeting is held in the Republic or elsewhere”.

Bodies Corporate and Home Owners Associations

Community schemes should take advice on whether in their particular circumstances they can/should postpone their AGMs and/or hold them remotely. Bodies Corporate will need to comply with their Rules and Home Owners Associations with their founding documents (either a Constitution or an MOI).

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Directors and Business Rescue in the Time of COVID-19

“A stitch in time saves nine” (wise old proverb)

The COVID-19 pandemic and the resultant lockdown have opened up new avenues of profit for some businesses, but they have also subjected many others to the spectre of business failure. 

Unfortunately we can expect the level of bankruptcies to surge for some time to come, and the domino effect will multiply the numbers until our economy turns the corner.

If financial distress looms for your own company, bear in mind the very onerous duties imposed on directors by the Companies Act. One of those duties is to avoid any form of “reckless trading” or “trading in insolvent circumstances”, and if you drop the ball on that one you risk personal liability, claims for damages, and even criminal prosecution.

What action should you take? There is a lot at stake here so specific professional advice is indispensable, but it is essential to face realities and to take decisive action quickly. Your legal options are likely to be either liquidation or business rescue. Let’s compare them…

Business rescue v liquidation

Liquidation: If your company is terminally ill you will probably have no option but to put it out of its misery by applying for liquidation. In that event a liquidator is appointed to oversee the winding-up of the company, to sell its assets and to distribute the net proceeds to creditors. Liquidation’s big advantage is in providing an orderly winding up of the company’s affairs, but there will be few winners emerging from the process.

All stakeholders are likely to lose out in a liquidation scenario. Shares become worthless, you lose your directorship, employees lose their jobs and, although they have preferent claims for outstanding pay, leave etc, these could well be worthless. Creditors holding some form of security aside, other creditors (which would include you if you have a loan account) are left with concurrent claims – which are probably worthless too. 

To top all that off, if you signed suretyship for any claims, you will be personally liable for them.

Business rescue: Business rescue on the other hand is designed to restructure the company’s affairs and business “in a manner that maximises the likelihood of the company continuing in existence on a solvent basis or, if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company.”

Either way all stakeholders stand to benefit, including you as a director, shareholder and/or loan account creditor. Your staff have a better chance of keeping their jobs, suppliers have a better chance of retaining your company as an ongoing customer, and the economy benefits from avoiding another business failure (SARS in particular will be happy to retain your company as a taxpayer!).

The success rate for business rescues is not high, but even if it is partially successful it is likely to be better than liquidation. 

There have also been concerns expressed about the costs of business rescue, and although these concerns have been disputed, cost is perhaps a factor to be put in the balance with all the other factors mentioned above when deciding between the two options.

How does it work?

In a nutshell (this is of necessity just a brief overview of what can be a very complex subject) –

  • Normally you would voluntarily place the company into business rescue with a board resolution; alternatively an outside stakeholder can apply for a court order (which you could oppose). 
  • A business rescue practitioner (often referred to as a “BRP”) is then appointed to take full management control of the company in substitution for the existing board and management, and to investigate the company’s affairs in order to “consider whether there is any reasonable prospect of the company being rescued”. The company is in the interim protected from legal action by creditors via a moratorium.
  • As a director you “must continue to exercise the functions of director, subject to the authority of the practitioner”, plus you have “a duty to the company to exercise any management function within the company in accordance with the express instructions or direction of the practitioner, to the extent that it is reasonable to do so”. In other words, you must assist and cooperate with the BRP as required.
  • The BRP convenes a first meeting of creditors to advise whether there is a reasonable prospect of rescuing the company.
  • If rescue seems feasible the BRP will then formulate a business rescue plan and present it to another meeting of creditors for consideration and voting. 
  • If the business rescue plan is adopted and successfully implemented, the company is returned to the marketplace as a viable business. 
  • If it turns out that there is no prospect of rescue or if the business rescue plan is rejected without any extension of the business rescue proceedings, the court can convert the rescue proceedings into a full liquidation. It can also in some circumstances set aside the business rescue resolution or court order.
Timing is everything!

“A stitch in time” really does make sense here. Your chances of rescuing the business are statistically (and logically) much greater if you take action as quickly as possible after the threat of financial distress first rears its ugly head. 

As to the legal position, our courts have put it this way: “… it is clear that the business rescue procedure is intended to be used at the earliest possible moment, i.e. when a company is showing signs of pending insolvency, but where it has not yet reached the stage of actual insolvency.”

Moreover the longer you leave it, the more likely you are to find yourself personally in trouble with the law and the higher the chance of all stakeholders losing everything.

Bear in mind that access to financing will be critical here, as will active support from major creditors both during the business rescue proceedings and in the longer term. 

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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Directors: Reckless Trading and Personal Liability in the Time of Coronavirus

“Better safe than sorry” (wise old proverb)

The COVID-19 pandemic and its ongoing economic fallout have left many businesses struggling with cash flow and even viability challenges. 

The result is that an increasing number of companies are either trading in insolvent circumstances, or in grave danger of doing so.

Reckless trading and your risk of personal liability

To quote from the Companies Act (section 22(1)): “A company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose.” 

And per section 77(3) any director “is liable for any loss, damages or costs sustained by the company as a direct or indirect 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(1)”. 

That’s a lot of potential for liability and it demands very careful management at any time – but perhaps even more so in these times of uncertainty and heightened economic risk.

What is “reckless trading”?

As the Supreme Court of Appeal has put it: “If a company continues to carry on business and to incur debts when, in the opinion of reasonable businessmen, standing in the shoes of the directors, there would be no reasonable prospect of the creditors receiving payment when due, it will in general be a proper inference that the business is being carried on recklessly.” A lot of companies must currently be in danger of falling into that net.

Who is at risk? Not just directors… 

The Companies Act defines a “director” for the purposes of personal liability as including an “alternate director”, a “prescribed officer” (which brings many senior managers into the net), a “person who is a member of a committee of a board of a company, or of the audit committee of a company”, “irrespective of whether or not the person is also a member of the company’s board”.

Does the CIPC Notice protect you?

On 24 March 2020 the Companies and Intellectual Property Commission (CIPC) issued a formal Notice to the effect that it will not exercise its power to issue a compliance notice to a company “which is temporarily insolvent and still carrying on business or trading” but only where “it has reason to believe that the insolvency is due to business conditions, which were caused by the COVID-19 pandemic.” That practice, said the CIPC, will lapse 60 days after the declaration of a national disaster has been lifted. 

That announcement has been interpreted by some commentators as “allowing” reckless trading by companies, and indeed it may well be that at least some directors under attack will give that defence a try. 

But that is not what the CIPC Notice actually says, and the more cautious view is that the Companies Act’s prohibition against reckless trading remains intact and that all that has changed is a temporary waiver by CIPC of its power to enforce statutory compliance.

So what should you do if your company is struggling?

We are in uncharted territory here with the pandemic, and on the principle of “better safe than sorry”, this is no time to take chances. If your company is financially distressed or the prospect of trading in insolvent circumstances looms, take professional advice immediately on how best to proceed. Business rescue or even liquidation may be unavoidable or you may be advised to pursue another route after full good-faith discussion with all role-players, but whatever the outcome quick and decisive action is critical.

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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