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South Africa: Piercing the corporate veil – Creditor’s sword not sharp enough

23 May 2024
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Overview

  • A recent judgment in the Supreme Court of Appeal reaffirms the principle of separate juristic personality that protects directors from being held personally liable for the debts of a company in solvent circumstances.
  • Importantly, the position is different should the company in question be in liquidation and unable to pay its debts. This is because section 424 of the 1973 Companies Act, which allows a creditor to claim against a director for reckless or fraudulent trading, continues to apply.
  • In this article, we unpack the judgment in the matter of Venator Africa (Pty) Ltd v Watts and Another (053/2023) [2024] ZASCA 60.

In the case of Venator Africa (Pty) Ltd v Watts and Another (053/2023) [2024] ZASCA 60 (24 April 2024), the Supreme Court of Appeal (SCA) handed down a noteworthy judgment relating to the conduct and liability of directors acting recklessly and the rights of creditors to claim damages in this instance.

The appeal arose from an exception upheld by the Kwa-Zulu Natal High Court in Pietermaritzburg concerning, inter alia:

  • the interpretation of section 218(2) of the Companies Act No 71 of 2008 (Act), which provides for civil liability against any person who contravenes the provisions of the Act;
  • as read with section 22(1) of the Act, which prohibits reckless or fraudulent trading by a company;
  • viewed alongside the provisions dealing with fiduciary duties of directors (s76(3)), consequential liability (s77(2)) and the longstanding principle that a company has a legal personality separate from its directors and shareholders.

Facts and High Court findings

Venator Africa (Pty) Ltd (Venator), the plaintiff in the High Court proceedings and appellant in the SCA, initiated legal proceedings against the directors of Siyazi Logistics and Trading Ltd (Siyazi), following claims that they had conducted the business of Siyazi recklessly, with gross negligence and with an intent to defraud.

Siyazi was contracted by Venator to clear and forward its duties on Venator’s behalf. According to their agreement, Siyazi was responsible for issuing disbursement accounts to Venator, reflecting the duties owed to the South African Revenue Service (SARS).

After SARS raised an assessment for Venator indicating VAT short payments, penalties and interest due of almost ZAR 41.5 million, it became apparent to Venator that Siyazi, although having collected the correct amounts from Venator, had failed to pay the full amount of duties owed to SARS on behalf of Venator.

Venator, in its capacity as creditor of Siyazi, pursued legal action against its directors for damages on the grounds that the short payment to SARS occurred as a result of fraud and/ or theft by Siyazi’s employees and/ or its directors.

Venator alleged that, as the guiding minds of Siyazi, the defendants acting recklessly and/ or fraudulently, contravened section 22(1) of the Act, and as such, should be held liable in terms of section 218(2) of the Act.

Two exceptions to Venator’s particulars of claim were raised, only the first of which was relevant. The second defendant’s objection was that Venator’s claim against him as a director was misplaced. This was argued on the basis that section 22 imposes a duty upon a company and not its directors. Therefore, section 218(2) could not find application because Venator had not identified a valid breach of a provision of the Act that could be attributable to the conduct of the directors.

The second defendant also argued that sections 76 and 77 of the Act provide adequate remedies for breaches committed by directors and, as such, section 218 cannot be used as a ‘catch-all’ to create a coordinate liability where a statute expressly creates liability for breaching a section of that Act.

The High Court was faced with the task of critically considering the proper interpretation of section 218(2) as read with section 22. In so doing, the High Court considered a plethora of cases, but ultimately embraced the approaches adopted in De Bruyn v Steinhoff International Holdings N.V. and Others (Steinhoff) and Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (Hlumisa). 

In considering the interpretation of section 218(2) the Court in Steinhoff held that: ‘… s218(2) should not be interpreted in the literal sense, but rather that the section merely recognises that liability for loss or damage may arise from contraventions of the Act and so the statute confers a right of action. What this right consists of, who enjoys the right and against whom the right may be exercised are all issues to be resolved by reference to the substantive provisions of the Companies Act.’

In Hlumisa, in considering sections 77(2)(b) and 77(3)(b) of the Act, the High Court held:

‘These provisions of the Act make it clear that the legislature decided where liability should lie for conduct by directors in contravention of certain sections of the Act and who could recover the resultant loss. It is also clear that the legislature was astute to preserve certain common law principles. It makes for a harmonious blend.’

The court in Hlumisa went on to state that: ‘…the so-called lacuna created by the legislature in not providing expressly for the liability of directors to other persons, such as creditors, for loss or damage suffered, is a clear indication that it was not its intention to do so, thereby continuing to recognise what has been referred to as a foundation of company law.’

Taking the above into account, the High Court upheld the exception raised by the second defendant and set aside the plaintiff’s particulars of claim.

SCA appeal and findings

On appeal before the SCA, Venator, as the appellant, argued, inter alia, that the High Court erred in its interpretative analysis of section 218(2) and that it was unlikely to have been the purpose of the Act to deny creditors the right to pursue the directors of a company for fraudulent or reckless trading, given that this claim has been permitted by common law. 

Second, Venator sought to highlight that the court should not view the conduct as a breach of a fiduciary duty owed to a company, but rather as a breach of a statutory duty.

The SCA confirmed that the issue before it was in fact a question of law, in that either section 218(2), read with section 22(1), permits what is contended by Venator, or it does not. In considering the legislative framework underpinning this question, the SCA raised the imperative considerations of section 19 of the Act, dealing with the legal status of companies, and the long-standing principle that the company’s legal persona cannot be ignored.

As the Court in Hlumisa confirmed, the separate personality is ‘no mere technicality. It is foundational to company law.’ As such, a party cannot simply disregard the ‘corporate veil’; it must be permitted by law to do so.

It is against this backdrop that the SCA endorsed the interpretation adopted by the High Court, as supported by the interpretation and principles adopted in Steinhoff and Hlumisa, i.e., that section 218(2) does not itself create liability but rather imposes liability in the event of a contravention of some other provision of the Act.

It follows that relying on section 22(1) (a section which plainly imposes a duty on the company and not its directors) to prove a contravention on the part of the directors as a contravention referred to in section 218(2), is then to read into the section a prohibition that is not there.

Finally, the SCA highlighted that, in considering directors’ liability in terms of section 76 and 77 of the Act and the principles in Hlumisa and Gihwala and Others v Grancy Property Ltd and Others, it was clear that the legislature had decided where liability should lie for conduct of directors in contravention of certain sections of the Act, and who could recover the resultant loss – this being the company, and not a creditor or shareholder.

Given the above, the SCA maintained that Venator had failed to identify a provision of the Act that had been contravened by the directors in order to successfully invoke section 218(2), and as such found that the High Court’s findings in upholding the second defendant’s exception could not be faulted.

The appeal was accordingly dismissed with costs.

Conclusion

The judgment of the SCA reaffirms the principle of separate juristic personality that protects directors from being held personally liable for the debts of the company in solvent circumstances.

However, all is not lost for aggrieved creditors. If a company is wound up and unable to pay its debts, a creditor may have recourse under section 424 of the Companies Act, 1973 (the provisions of which continue to apply to insolvent companies).

Section 424 allows a creditor to apply to court to declare the directors (provided they were knowingly a party to this conduct) personally liable for the debts of the company if the business of the company was carried on recklessly or with intent to defraud creditors of the company or for any fraudulent purpose.