CAN A CREDITOR HOLD A DIRECTOR PERSONALLY LIABLE FOR THE DEBTS OF A COMPANY?




In practice it often happens that a creditor ‘loses’ its claim against a debtor company, for example services rendered or loans advanced by the creditor to such company, due to the company entering into liquidation/winding-up proceedings. In such an instance, without going into too much detail regarding the liquidation process and subsequent creditors’ claims, the creditor of a company in the above scenario would have to prove its claim against said company at a creditors’ meeting and will more often than not be left with a fraction of its initial claim against said company, depending on the company’s assets and preferential and concurrent creditor’s claims. It would therefore in many instances not be financially viable to become involved in the above proceedings as a creditor, weighing up the quantum of your claim against the costs of proceedings and what fraction of your claim you might successfully claim back. It is the latter situation which begs the question as to whether there is any other recourse available to a creditor who finds itself in the above position.


At this stage it is important to mention that in terms of the Companies Act No 71 of 2008 (“the 2008 Act”) a juristic person (a company) generally enjoys a separate juristic personality from that of its members/officers and therefore offers limited liability to its members/officers. This means that, as a point of departure, one cannot institute legal proceedings against the directors or shareholders of a company for the liabilities of that company, as the company is responsible for its liabilities. There are, however, exceptions to the latter and more specifically as set out in the scenario described above. Notwithstanding the Companies Act of 1973 (“the old Act”) being repealed and replaced by the 2008 Act, sections 423 and 424 of the old Act forms part of Schedule 5, Item 9 of the 2008 Act and is therefore still applicable, albeit restricted to companies being wound-up, as set out below;


Section 423:

Where in the course of the winding-up or judicial management of a company it appears that any person who has taken part in the formation or promotion of the company, or any past or present director or any officer of the company has misapplied or retained or become liable or accountable for any money or property of the company or has been guilty of any breach of faith or trust in relation to the company the Court may, on the application of the Master or of the liquidator or of any creditor or member or contributory of the company, enquire into the conduct of the promotor, director or officer concerned and may order him to repay or restore the money or property or any part thereof, with interest at such rate as the Court thinks just, or to contribute such sum to the assets of the company by way of compensation in respect of the misapplication, retention, breach of faith or trust as the Court thinks just.”


It is clear from the above excerpt that section 423 finds its application in holding the director of a company accountable and liable toward said company and not directly towards a creditor, however given the circumstances may still be useful to a creditor. Section 424 on the other hand is of more relevance for purposes of holding a director personally and directly liable towards a creditor as it entails;


Section 424:

(1) When it appears, whether it be in a winding-up, judicial management or otherwise, that any business of the company was or is being carried on recklessly or with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the Court may, on the application of the Master, the liquidator, the judicial manager, any creditor or member or contributory of the company, declare that any person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Court may direct.”


It is evident however that section 424 does not expressly make mention of a “director”, however “person” is interpreted wide enough to include a director and therefore, if a company continues to incur debts, where in the opinion of a reasonable person standing in the shoes of the company director(s), there would be no reasonable prospect of the creditors receiving payment when due, it can be inferred that the business of the company is being carried on recklessly or negligently as contemplated in section 22(1) of the 2008 Act. When considering whether a company’s business has been carried on recklessly, the court has further regard to various factors such as the scope of operations of the company, the functions, role and powers of the director(s), the extent of the company’s financial difficulties, the amount of the company’s debts and the prospects, if any, of recovery. It is important to note that the enquiry is essentially whether, at the time a debt was incurred, the director(s) genuinely believed that the company would be able to repay the debt and therefore the mere fact that a company trades while insolvent does not imply its business is being carried on recklessly.


Therefore, to conclude, the liabilities of a company are that of the company and one cannot take recourse against its directors or shareholders. Any litigious proceedings instituted by a creditor against a company, would be against the company as a juristic person. The exceptions to the latter, as set out above, comes during the liquidation process and winding up of a company, where the separate legal identity of the company can be disregarded and a director or directors be held personally liable for the debts or any specific debt of a company, should the facts of the matter so allow and be in line with the above sections 423 or 424. Taken the above into account, it might prove the difference to a creditor whether to bring such proceedings or becoming involved therein, depending on whether it is factually possible for it to hold a director of such a company personally liable for its debt towards the creditor.


- Liam Connan


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