The consequences of non-compliance with  sections 44, 45 and 46 of the Companies Act, No 71 of 2008 (Companies Act) are discussed in this article.

Each of s 44 and 45 provides that both a resolution/decision to provide financial assistance and the financial assistance itself is void to the extent that the provision of that assistance would be inconsistent with either the applicable section or any restriction in the company's memorandum of incorporation (MOI). In addition, those sections contain language to the effect that if a resolution or agreement is void in terms of the section; and a director was present at the meeting at which the board approved the resolution or agreement, and the director failed to vote against that resolution or agreement, despite knowing that the provision of financial assistance was inconsistent with the section or any prohibition, condition or requirement contained in the company's MOI, the director is liable to the extent set out in s77(3)(e). Section 46, however, contains no provision to the effect that a distribution made contrary to that section is void, and provides that if a director attends a meeting at which the board approves a distribution, and fails to vote against that distribution despite knowing that the distribution is 'contrary' to the section, the director is liable.

Section 77(3)(e) is to the effect that a director is liable to the company (of which he is a director), if he was present at a meeting or participated in the making of a decision and failed to vote against the provision of financial assistance to a person envisaged in s44, despite knowing that the provision of that financial assistance was inconsistent with s44 or the company's MOI; the provision of financial assistance 'to a director for a purpose contemplated in section 45', despite knowing that the provision of financial assistance was inconsistent with that section or the company's MOI; and a resolution approving a distribution, despite knowing that the distribution was contrary to s46 (the director's liability is, however, subject to s77(4)).

Section 218 of the Companies Act provides that unless another provision specifically provides otherwise, no provision 'renders void any other agreement, resolution or provision of an agreement, memorandum of incorporation or rules of a company that is prohibited, voidable or that may be declared unlawful in terms of this Act, unless a court has made a declaration to that effect regarding that agreement, resolution or provision'. In relation to s46, therefore, since the section does not say that a distribution made contrary to s46 is void, the effect of s218 is that the distribution is valid except if a court declares it void under any applicable provision of the Companies Act; and s77(5) deals with a situation where a company has made a decision in a manner that contravened the Companies Act in any manner envisaged in s77(3)(e), and provides that the company or any director who has been held liable in terms of s77(3) may apply to a court for an order setting aside the decision of the board. Section 77(5) further provides that the court may make 'an order setting aside the decision in whole or in part, absolutely or conditionally', or 'any further order that is just and equitable in the circumstances'.

I think it is clear that if a company provides financial assistance (as envisaged in s44 and 45) without obtaining the required special resolution and without the required solvency and liquidity determination by its board and/or in contravention of its MOI, (together the 'formal requirements'), the financial assistance is void. Section 46 does not contain any language to the effect that a distribution made contrary thereto is void and, instead, s77(5) (read with s218) empowers a court to declare that the distribution is void. Since s77(5) requires the court to make a decision that is just and equitable, it is likely that a court will hold, if a distribution is made in the absence of compliance with the formal requirements, that such distribution is void in its totality.

What then are the consequences if a company complies with the formal requirements, but the board of a company makes a solvency and liquidity determination which is wrong? There are three possible answers, namely that, for the purposes of s44 and 45, the financial assistance is completely void and unenforceable; valid and enforceable in its entirety; or void to the extent to which it causes the company to fail the test and valid to the extent to which the company will pass the test.

Neither complete voidness nor validity and enforceability in its entirety, can be right. Sections 44 and 45 provide for voidness of the financial assistance only to the extent to which it is inconsistent with the sections. It is strongly arguable, in my view, that if a company provides financial assistance, and the board of the relevant company complies with the formal requirements, and it appears subsequently that, at the time of the provision of the financial assistance, the company did not in fact comply with the solvency and liquidity test, the following position will arise:

• the financial assistance is potentially void (at least to the extent to which it caused the company to fail the test) under s44 and 45; and
• if the financial assistance also constitutes a distribution, it is contrary to s46, but is not void under s46 until the court declares it to be void under section 77(5).

By virtue of the overlap between s44, 45 and 46, it is unlikely that the legislature have intended that, if a solvency and liquidity determination is wrong, the financial assistance in question is completely valid and enforceable since if a court, acting under s77(5), then declares that a portion of the distribution is void, s44 and 45 would have a result which differs from the result of the application of s46; or completely void, for the same reason (in such a case the court, acting under s77(5), may hold that a portion of the distribution is valid whereas the effect of s44 and 45 would be that the entire financial assistance/distribution is void).

The question then is what order a court should make under s77(5). In this regard the following are relevant:

• an order to the effect that a distribution made contrary to s46 is completely void would be commercially unrealistic as s46 deals with distributions, and there can be no basis in my view to prohibit a distribution which does not result in the company's insolvency or illiquidity;
• the just and equitable order that a court should make is that the distribution is valid to the extent to which the company will not fail the test and void to the extent to which it causes the company to fail the test;
• this approach is supported by s77(4) which limits a director's liability for a distribution made contrary to s46, to the irrecoverable amount in excess of 'the amount by which the value of the distribution exceeded the amount that could have been distributed without causing the company to fail to satisfy the solvency and liquidity test'.

It therefore seems that the only reasonable interpretation is that if a solvency and liquidity determination is wrong, the financial assistance is void only to the extent to which it causes the company to fail the solvency and liquidity test. If such financial assistance also constitutes a distribution, a court could then, under s46, declare such distribution partially void (to the extent that the distribution causes the company to fail the solvency and liquidity test). This would then result in an interpretation of s44, 45 and 46 which is consistent. As regards s46, it is probable that a court may also order the person who receives the distribution to refund the amount of that distribution to the extent to which it exceeds the amount which the company could have distributed without failing the solvency and liquidity test.

Written by Izak Lessing, Director, Finance and Banking, Cliffe Dekker Hofmeyr

Click here to read about the applicability of Sections 44, 45 and 46 of the Companies Act, 2008