In terms of certain provisions of the new Companies Act, No 71 of 2008, government has prohibited any form of reckless trading by a company, reports law firm Werksmans Attorneys.
In terms of the new Act, reckless trading is specifically prohibited in that a company must not carry on its business recklessly with gross negligence, with intent to defraud any person or for any fraudulent purpose or trade in insolvent circumstances.
Directors who allow their companies to trade under such circumstances may be held liable for any loss or damages sustained by the company, as a consequence of allowing the company to continue to trade in a position of financial distress, or where the company is clearly insolvent on its balance sheet, or alternatively in a position where it cannot pay its debts as and when they fall due, says Werksmans.
The legislator has made it clear that it is unacceptable for a director to acquiesce to the continuation of a company's business when he/she knows that it is being conducted in a manner prejudicial to creditors and where the continued conduct of the company in insolvent circumstances is calculated to defraud a creditor, employee or shareholder of the company.
Creditors will be entitled to sue both the company for damages, as well as the director personally, for any loss sustained by such creditor in providing credit to a company in a situation where the directors were fully aware that such advance of credit would not be repaid in the future.
Of more concern is that the Companies and Intellectual Properties Commission (which replaces the old Companies Office) will determine whether or not a company is trading in a reckless situation and, if so, is entitled, in terms of the provisions of the new Act to shut down the company from continuing to trade in such a manner, says Werksmans.
The commission may issue a notice to the company to show cause why the company should not be permitted to continue carrying on its business, or to trade recklessly. If the company to whom the notice has been issued fails, within 20 business days, to satisfy the commission that it is not engaging in reckless trading, the commission may issue a compliance notice to the company requiring it to cease continuing its business, or trading, as the case may be.
There is no doubt that directors of companies will have to take careful cognisance of the manner in which companies are trading and whether there is any realistic hope of such a company trading from its position of financial distress, into a situation where it becomes solvent and is in a position to pay its creditors. If directors fail in this duty, they can be personally sued for loss or damages, reports Werksmans.
Further, the provisions of the new Act allow directors to be declared delinquent if a director grossly abuses their position, or intentionally, or by gross negligence inflicts harm upon the company or a subsidiary of the company, contrary to the provisions of the Act. Directors will also be declared delinquent if they act in any manner that amounts to gross negligence, wilful misconduct or breach of trust in relation to the performance of such director's duties. This ups the ante in respect of the expected level of director's duties to companies in South Africa and in turn, to the company's creditors, says Werksmans.
Coupled with the provisions of King III, which sets the tone for corporate governance, directors will have to conduct proper financial risk assessments to establish whether or not their companies are trading in insolvent circumstances, if they can be saved in terms of the business rescue provisions of the new Act, or if they should be placed into liquidation. Failing to adhere to these duties could potentially result in litigation against the directors, for a failure of their duties.