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Pyramid schemes on the rise and applications to set aside dispositions following suit

Pyramid schemes on the rise and applications to set aside dispositions following suit

27th June 2016

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In recent times, the South African Rand has become extremely volatile against the United States Dollar and the fear of being reduced to junk status has gripped our economy. The Rand has struggled over the past few months reaching R15.58 at the end of May 2016, causing liquidations, sequestrations and business rescues to continue to rise.

According to Statistics SA, liquidations within South Africa have already increased by 16% in 2015. As the economy continues to struggle, businesses will experience even more financial pressure given the rise of operating expenses, loss of income due to labour unrest, decrease in commodity prices, drought and an increase in inflation.

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This perfect storm of events, has led to increased fraud, embezzlement and other related financial crimes and we anticipate an escalation of applications being instituted by liquidators and trustees of insolvent estates to set aside dispositions made prior to the company or individual being wound-up or sequestrated. Such dispositions would in all likelihood be made by the company or individual with the hope of ensuring that the property which is the subject of the disposition does not fall within the winding-up or sequestration process.

We will also see more consumers succumb to "quick and easy" methods of making money including various forms of pyramid schemes.

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Dispositions in terms of section 29(1) of the Insolvency Act 24 of 1936 (Insolvency Act) within the context of pyramid schemes came under scrutiny in the case of Griffiths v Janse van Rensburg NO and another [2016] 1 All SA 643 (SCA).

In relation to companies, the equivalent provision of section 29(1) of the Insolvency Act is section 340 of the Companies Act 61 of 1973.

Facilitation of a pyramid scheme in the Griffiths case
In establishing a pyramid scheme, the parties thereto cunningly set up a trust to receive "investments" and subsequently make repayments to its "investors" together with interest thereon. Of particular concern were the investments made by Mr Griffiths who had been referred to the trust by a bank employee. Under the guise of investment agreements, Mr Griffiths made two payments to the trust consisting of R100 000 each.

After considerable duress was placed by Mr Griffiths on the trust for the repayment of the capital investment together with interest, Mr Griffiths received repayment of his capital investment together with R12 000 for each investment. Four repayments were thus received by Mr Griffiths, two payments of R100 000 and two payments of R12 000 totalling R224 000.

False and fraudulent representations were made by the representatives of the trust which included representations that the deposits made into the trust would be utilised by the trust to purchase from certain estate agents their rights to commissions which has been earned but not yet paid. The pyramid scheme collapsed and the trust was consequently sequestrated.

The duly appointed trustees of the sequestrated trust instituted an application in terms of section 29 of the Insolvency Act to set aside the four repayments made to Mr Griffiths by the trust.

Prior to the hearing before the SCA, the parties agreed the following:

  • that the payments were dispositions made by the trust;
  • that they were made less than six months before the trust was sequestrated;
  • that the payments had the effect of preferring Mr Griffiths above other creditors;
  • after each of the payments were made the liabilities of the trust exceeded its assets; and
  • that the business carried on by the trust was that of a pyramid scheme.

As such, the SCA in essence only had to decide whether the repayments "were made in the ordinary course of business" as provided for in the proviso to section 29(1) of the Insolvency Act.

Ruling of the court a quo
The Court a quo found that neither the capital investments nor the interest repayments made by the trust to Mr Griffiths had been made in the ordinary course of business and thus set all four dispositions aside and ordered Mr Griffiths to pay R 224 000.00 along with interest from date of judgment and costs.

Judgement of the SCA
The SCA was faced with an appeal by Mr Griffiths and had to determine whether the decision of the court a quo was correct. During the hearing, it was conceded that the two payments of R 12 000.00 in respect of the interest were not made in the ordinary course of business and therefore the SCA only had to determine the repayment of the capital amount.

The SCA held that in terms of section 29(1) of the Insolvency Act, a trustee must prove the following: • the dispositions were made 6 months before the trust was sequestrated;

  • disposition has the effect of preferring one creditor above another and immediately after making the disposition; and
  • after making the dispositions the liabilities of the debtor exceed the value of his/her assets.

If the aforementioned has been proved, the person receiving the disposition must prove the following:

  • the disposition was made in the ordinary course of business; and
  • that it has not intended to prefer one creditor above another.

The SCA reiterated that the test for assessing whether the dispositions "were made during the ordinary course of business" is an objective test. The dispositions should be evaluated in light of all the relevant facts and must be done on a case by case basis. The question is whether ordinary, solvent, business people would in similar circumstances themselves, act as the parties to the transaction did. In other words, the disposition in question should not raise questions among solvent business people who know the circumstances in which it was made.

In making the assessment, the SCA considered the case of Gazit Properties v Botha & Others NNO 2012 (2) SA 306 (SCA) (Gazit Properties) and disagreed with the trial Court therein which found that a "tainted" business model had the result that no dispositions of that business could be said to have been made in the ordinary course of business.

The SCA noted that the concern is not the illegality of the business in determining whether the dispositions were made in the ordinary course of business, but rather the nature of the business relationship between the insolvent and the recipient at the time the disposition was made and thus due weight must be given to the relationship between Mr Griffiths and the trust.

The SCA considered the case of Fourie NO and Others v Edeling NO and others [2005] 4 All SA 393 (SCA), which held that loans made to a pyramid scheme were illegal and therefore void. The SCA held that the investments made by Mr Griffiths followed the same fate. It is trite law that where payments were made pursuant to void agreements, a claim for repayment would ordinarily lie under the enrichment action, condictio ob turpem vel iniustam causam (condictio) and the only defence thereto would be if it can be established that Mr Griffiths acted ex turpi causa or had knowledge that the investments were tainted.

The SCA reasoned that had Mr Griffiths demanded repayment of the investments in terms of the condictio (that is, he became aware that the investments were illegal and thus void and therefore claimed repayment and not because the investments was due to him), his claims for repayment would have been enforceable and not capable of being set aside as the business relationship between Mr Griffiths and the trust would have been one arising from the condictio.

The ordinary, solvent business people, aware of the illegality of loans, would have seen nothing extraordinary or untoward about repayment on the basis of a condictio. In other words, had Mr Griffiths made a claim against the trust for the repayment of the investment on the basis that the agreements were illegal and thus void, this would have been in the ordinary course of business and enforceable.

In applying the objective test to the facts of this matter, the SCA therefore found that the repayments of the capital amounts did not take place in the ordinary course of business. Therefore, not only the dispositions relating to interest, also those relating to capital were correctly set aside and the appeal must fail.

In the dissenting judgment, Petse J specifically looked at Mr Griffiths' ability to invoke the condictio when he demanded repayment of the investment amounts and noted that Mr Griffiths could not have been expected to invoke the condictio when demanding repayment if he was unaware of the illegality of the business conducted by the trust. Moreover, Mr Griffiths would surely not have been aware that the transactions arising from the business relationship between Mr Griffiths and the trust at the time arose from void agreements. The fact that Mr Griffiths misconceived the nature of his cause in making demand for repayment of the investment amounts is understandable as he was not aware at that stage that his agreements with the trust were void.

Petse JA therefore found that nothing suggested the two repayments made in respect of the capital amounts invested with the trust were not made in the ordinary course of business of the trust and would have upheld the appeal.

Conclusion
Although the dissenting judgement of Petse JA appears more plausible, the public must be weary of entering into investment agreements and agreements alike which do not on the face of it appear dubious, but on a deeper inspection are not only illegal and void agreements but may also be set aside given that liquidations and sequestrations are on the rise.

Moreover, the public must be aware that once they become aware that the agreement is illegal and void, they should immediately demand payment in terms of the condictio which entitles a party to repayment as a result of a void agreement.

LexisNexis South Africa, in partnership with Cliffe Dekker Hofmeyr Inc, has produced the online solution, Practical Guidance Insolvency Law to help any insolvency practitioner or reader navigate through the law of insolvency pertaining to sequestration of individuals and liquidations of companies. The guidance notes embodied in Practical Guidance Insolvency Law are user friendly and allow access to an array of legal precedents, examples, templates and step-by-step guides.
For more information, visit: http://practicalguidance.lexisnexis.co.za/index.php/practice-areas/insolvency-law

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