Whether a party to an agreement has abandoned an accrued right is a question of fact. A debtor wishing to succeed in a defence that its creditor has abandoned the right to claim payment from the debtor must be able to show that the creditor intentionally abandoned its right to claim such monies.

Introduction

In a scenario where a company impairs an amount owed to it in its financial statements, the question that arises is whether such conduct amounts to an abandonment of such amount?

This is the very question which the court in the Western Cape Division had to consider in the unreported case ofMaloney & Another v FX Africa Foreign Exchange (Pty) Ltd & 3 Others, case no 1056/2014 (“Western Cape case”). In this matter, the creditor applied for the liquidation of the debtor company. This application was successful and an order for the liquidation of the debtor company was granted. Thereafter, a director of the debtor company applied for the rescission of thatorder, on the basis that the creditor had abandoned its claim when it “wrote off” in its annual financial statements the indebtedness owed to it by the debtor company. That is, the aforesaid director alleged that because the creditor had impaired its claim, it had abandoned that claim and therefore had no legal standing to bring the winding-up application in the first place.

It is common practice for management to assess whether or not there are any objective indications that suggest that the carrying value of a loan in the company’s financial statements should be impaired. This exercise is conducted by identifying events which may result in a loss and assessing the impact that this will have on the estimated future cash flows of the loans. Deterioration in credit quality of the debtor is the most common loss event which results in impairment. This means that if there is no longer a reasonable expectation that the full principal amount and interest due thereon will be timeously recovered from the debtor, then the carrying value of a loan in the company’s financial statements will likely be impaired.

Revising impairment

However, despite such an amount being reduced for the purposes of an accurate evaluation of cash flow, it is also a well-established practice that the impairment may be revised. Accordingly, the amount previously ‘written off’ can be ‘written back’ if any recoveries are made in a subsequent financial statement. Therefore, in the event that the amount that was previously written off is recovered, the debt will simply be written back into the company’s financial statements and will be accounted for as income or profit in the year in which the recovery was made. The creditor may therefore continue in its attempts to recover the debt and enforce its claim.

Case studies

The aforesaid principles were recognised in the Commissioner for Inland Revenue v D Delfos 1933 AD 242, where Curlewis JA held that making provision for a bad debt enables a company to draw up an accurate statement of profit and loss for the income tax year which reflects the actual financial position of the company. Accordingly, Curlewis JA held that this practice is consistent with ordinary commercial and accounting practice.

Further to the above, for a debtor to succeed with the aforementioned defence, it must be shown that the abandonment was inconsistent with any intention of the creditor to enforce the right. In the Alfred McAlpine& Son Proprietary Limited v Transvaal Provincial Administration 1977 (4) All SA 262 (T) matter, the court made reference and concurred with the findings of the court in Laws v Rutherford 1924 AD 261 wherein a two-fold test was established. Firstly, the alleging party must prove on a balance of probabilities that the other party had knowledge of their rights. Secondly, it must be shown that these rights in respect of the debt owed were deliberately abandoned.

The two-fold test of Alfred McAlpine& Son Proprietary Limited should be read together with the principles established in thedecision of Roodepoort-Maraisburg Town Council v Eastern Properties Proprietary Limited 1933 WLD 224, where the court found that for an abandonment to be effective, it is essential that the person granting it should be fully informed of their rights. Furthermore, such person must fully appreciate the consequences of their election to abandon their right.

Conclusion

The aforementioned judgments confirm that there is a very strict and onerous burden on the debtor to successfully demonstrate that the creditor intentionally waived their right without an option to recover the debt.

Therefore it is not surprising that in the Western Cape case, the court found that the debt owed to the creditor was still valid and it had consequently not been abandoned. Furthermore, it was found that the argument put forward by the debtors that they did not remain liable for the written-off debt that was subsequently written back was without substance. Thus the financial impairment of an asset, as an accepted accounting practice, cannot be said to be tantamount to a permanent abandonment of debt.

Written by Nastascha van Vuuren, Director and co-authored by Candidate Attorney Khathu Neluheni, Werksmans Attorneys.