What happened?
Yokogawa South Africa (Pty) Ltd. (“Yokogawa“) carries on business of marketing and selling to the mining sector process control instrumentation products manufactured by the Yokogawa Group. In November 2019, Yokogawa and 3E Control and Instrumentation (Pty) Ltd. (“3E Control“) concluded a distribution agreement, in terms of which 3E Control was appointed as a distributor of the Yokogawa products in the North-West Province. 3E Control purchased products from Yokogawa on credit and sold them to its own customers. Mr Theko Letsie (“Mr Letsie“) and Ms Makabele Belinah Letsie (“Ms Letsie“) were the co-directors of 3E Control.
Between November 2019 and April 2021, 3E Control accumulated significant outstanding debt to Yokogawa. On 25 November 2019, the parties entered into a payment plan. In terms of that plan, 3E Control acknowledged the indebtedness of approximately R 6.5 million towards Yokogawa. This was to be paid by monthly instalments of R 30 000 for a period of 24 months and through a loan facility from Anglo-Zimele. Importantly, the payment plan recorded that certain customers had already paid 3E Control for Yokogawa’s products, but 3E Control had not remitted those funds to Yokogawa.
Despite the confirmed financial difficulties of 3E Control, Mr Letsie continued to place orders with Yokogawa on credit. Between December 2019 and April 2021, Mr Letsie placed 59 purchase orders, and Yokogawa delivered products, while 3E Control remained unable to meet its existing payment obligations.
On 30 June 2021, Mr Letsie sent a letter to Yokogawa requesting that 3E Control withdraw from the distribution agreement. Yokogawa sent a letter demanding payment of the outstanding debt. In response, Mr Letsie admitted that 3E Control was unable to pay because of its financial position. Shortly thereafter, Mr Letsie notified Yokogawa that 3E Control had been voluntarily liquidated.
During the liquidation process, it was established that the liabilities of 3E Control substantially exceeded its assets and that an amount of approximately R2.9 million was owing to Yokogawa. The liquidator also reported that Mr Letsie and Ms Letsie, as directors, had failed to provide the accounting records of 3E Control required in terms of section 28 of the Companies Act.
Yokogawa subsequently instituted proceedings in terms of section 218(2), against Mr Letsie and Ms Letsie, jointly and severally, in their personal capacities for the recovery of losses it suffered as a result of the alleged contravention by 3E Control of section 22(1) (reckless trading) and the breach by Mr Lestie and Ms Letsie of section 214(1)(c) (knowingly being party to an act calculated to defraud a creditor; Yokogawa).
What do sections 22(1), 214(1)(c) and 218(2) of the Companies Act say?
First, section 22(1) deals with prohibition of reckless trading; it provides as follows –
“(1) A company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose.”
Second, section 214(1)(c) creates an offence relating to certain reckless conduct; it reads as follows –
“(1) A person is guilty of an offence if the person –
(a) …;
(b) …;
(c) was knowingly a party to an act or omission by a company calculated to defraud a creditor or employee of the company, or a holder of the company’s securities, or with another fraudulent purpose; or
(d) …“
Third, section 218(2) creates a novel, general and distinct liability arising from the contravention of any provision of the Companies Act; it reads as follows –
“(2) Any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention.”
WHAT WERE THE QUESTIONS FOR DETERMINATION?
The High Court formulated the questions for its determination as follows –
- whether the business of 3E Control was carried on recklessly in contravention of section 22(1), and whether Mr Lestie and Ms Letsie, as directors, were knowingly a party to that conduct;
- whether Mr Letsie and Ms Letsie, or either of them, were knowingly a part to conduct by 3E Control calculated to defraud Yokogawa as creditor, in contravention of section 214(1)(c);
- whether, by reason of the above contraventions, Mr Letsie and Ms Letsie were liable to Yokogawa in terms of section 218(2); and
- if personal liability was established, whether the quantum of liability was R 2 832 601.73, together with interest.
WHAT DID THE COURT SAY?
The High Court acknowledged that there is now less confusion regarding the interpretation of sections 22(1), 214(1)(c) and 218(2) because there are about three judgments of the Supreme Court of Appeal of South Africa that have provided useful interpretation guidelines.
Section 22(1)
In relation to section 22(1) (prohibition of reckless trading), Petersen ADJP said the following –
- “[38] …The prohibition [in section 22(1)] is directed at the company as a legal entity. A director is not personally liable merely by reason of being a director. Section 22 contains no express provision making a director individually liable for acting in the manner described in section 22(1)…Section 22 is, however, the predicate condition for an offence created by section 214(1)(c) and the consequent civil liability in section 218(2).“;
- “[39] The concept of recklessness connotes a complete failure to consider the consequences of one’s actions or an attitude of reckless disregard for them. A company carries on business recklessly when, in the opinion of a reasonable businessman standing in the shoes of the directors, there would be no reasonable prospect of the creditors receiving payment when due. Incurring debts at a time when there is no reasonable prospect of repayment will almost invariably be reckless. The test is objective.” [Emphasis added]; and
- “[40] In determining whether a company’s business has been conducted recklessly, relevant considerations include the scope of the company’s operations, the functions and powers of the directors, its assets and liabilities, working capital, cash flow, access to capital, the extent of the company’s financial difficulties, the amount of the debt, the prospects of payment at the dates when particular debts were incurred, and, if any, the prospects of recovery. If a company continues to carry on business and to incur debts at a time when, to the directors’ knowledge, there is no reasonable prospect that the company will be able to pay its debts when they are due, it is in general a proper inference that the business is being carried on with intent to defraud creditors.” [Emphasis added].
Petersen ADJP then decided that 3E Control carried on its business recklessly within the meaning of section 22(1). This decision was made based on the following findings –
- when Mr Letsie signed the payment plan between 3E Control and Yokogawa in November 2019, he knew that 3E Control was unable to pay its debts;
- after November 2019, 3E Control continued to place purchase orders with, and received products from, Yokogawa generating 59 invoicing adding up to R 2 832 601.73, which remained unpaid;
- 3E Control acknowledged in the payment plan that it had received payments from clients but failed to pay the relevant funds to Yokogawa; and
- 3E Control failed to provide its accounting records to the liquidators.
Sections 214(1)(c) and 218(2)
In relation to the civil liability mechanism in sections 214(1)(c) and 218(2), Petersen ADJP said the following —
- section 214(1)(c) “…does not require proof of all elements of common-law fraud. It requires knowledge and participation in the company’s conduct that is “calculated to defraud”, that is, conduct that has the objective tendency or design to cause financial prejudice to a creditor; ” [at paragraph [41]];
- “[42] A director who is knowingly a party to the carrying on of the company’s business in contravention of s 22(1) is, in the exercise of that directorial function, a person who contravenes a provision of the Companies Act for the purposes of s 218(2). Section 218(2) provides that any person who contravenes any provision of the Companies Act is liable to any other person for any loss or damage suffered as a result of that contravention. The ordinary meaning of “contravenes” encompasses a breach or infringement of any provision of the Act that is prescriptive or otherwise regulates conduct.” [Emphasis added];
- “[43] A person who is found guilty of the offence created by s 214(1)(c) must accordingly be found to have contravened a provision of the Companies Act for the purposes of section 218(2). Civil liability in terms of s 218(2) arises upon the commission of the s 214(1)(c) offence, and the plaintiff does not additionally need to prove the ordinary common-law elements of delict such as wrongfulness or fault independently of the statutory contravention. The section creates a lex specialis right of recovery for creditors harmed by the prescribed conduct.” [Emphasis added]; and
- “[44] To establish that a director contravened s 214(1)(c), however, the plaintiff must prove that the director was knowingly a party to the relevant conduct. It is not sufficient to show that the director ought to have known. Actual knowledge must be proved, though it may be inferred from the surrounding circumstances, including the director’s role in and control over the company’s affairs, as well as the information available to them.” [Emphasis added]
In regard to Mr Letsie, Petersen ADJP decided that he contravened section 214(1)(c) by knowingly participating in the reckless trading of 3E Control in breach of section 22(1) and from being knowingly a party to conduct calculated to defraud Yokogawa as creditor. He said that the conduct of Mr Letsie crossed the threshold into conduct knowingly calculated to defraud Yokogawa in at least two respects –
- first, the retention of payments received for Yokogawa’s products while continuing to place orders on credit without remitting the funds already collected; and
- second, the preferential repayment of directors’ loans from the 3E Control bank account in circumstances where no board resolutions or written loan agreements existed, as required by section 45 of the Companies Act, while the Yokogawa’s invoices remained unpaid.
In respect of Ms Letsie, Petersen ADJP–
- decided that she (Ms Letsie) was knowingly a party to the reckless trading of 3E Control within the meaning of section 22(1) and was therefore liable to the Yokogawa under section 218(2) ; and
- concluded that in the absence of evidence directly linking her to the acts by Mr Letsie that were found to be calculated to defraud Yokogawa, he could not find that Ms Letsie contravened section 214(1)(c).
He said the following regarding the role of Ms Letsie in the reckless trading by 3E Control –
“[71] …As a director, she owed the obligations imposed by section 76 of the Companies Act. As co-director and co-owner of a closely held company, she was in a position to know, or to make herself aware of, the company’s financial affairs, including the existence of the payment plan, the accumulated indebtedness, and the failure to service that debt. Mr Letsie’s evidence does not suggest that she was kept in ignorance of these matters. The opposite may reasonably be inferred from the fact that she was a director from the beginning of the business and from the closely held, two-person directorial structure of the enterprise. In the absence of her own evidence to the contrary, this court must necessarily draw the adverse inference that she was aware of the reckless trading and acquiesced in its continuation.” [Emphasis added]
Why is the Yokogawa Judgment important?
South African courts have consistently upheld the principle that a company is a separate juristic person, distinct from its directors and shareholders. As a general rule, directors are protected by the doctrine of limited liability and are not personally responsible for the debts and obligations of the company merely by virtue of holding office.
In the Yokogawa Judgment, the High Court –
- reaffirmed the limited liability principle by confirming that the prohibition against reckless trading in section 22(1) is directed at the company itself and does not, without more, impose personal liability on directors;
- demonstrates that limited liability is not absolute; directors who knowingly participate in conduct that is calculated to defraud creditors may be held personally liable for the resulting losses;
- confirmed that passive directors (such as Ms Letsie) will, notwithstanding their supineness, still be exposed to personal liability for the contravention of the Companies Act.
The Yokogawa Judgment also demonstrates a welcomed maturity of jurisprudence regarding section 218(2) of the Companies Act.
Author: Fezile Tembe (under supervision by Siyabonga Shandu)