A perspective on directors’ duties in the time of COVID-19 June 2020

By BOUWER VAN NIEKERK AND PARVEEN MUNGA, Published in COVID-19 Company Law

The standard of directors' conduct is key to the success, or failure, of companies. The Companies Act of 2008 sets out the duties, standards of conduct and liabilities of directors. These duties include fiduciary duties, a duty to act in the best interests of the company and a duty of reasonable care. Directors may be held liable for any loss, damages or costs sustained by a company as a consequence of any breach by directors in the execution of these duties.

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The COVID-19 pandemic has impacted virtually all aspects of commerce. The manner in which goods and services are supplied has changed, companies face daily challenges in running their businesses and those in charge are confronted with circumstances, unseen in decades, that may affect their decision-making. During these uncertain times, directors' conduct will be put to the test as never before.

This being said, the fundamental principles of running a company, and the responsibilities antecedent thereto, have not changed – these are still governed by statute and the common law.

The prohibition of reckless trading

Section 22 of the Act provides that:

  1. A company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose.
  2. If the Companies and Intellectual Property Commission (CIPC) has reasonable grounds to believe that a company is engaging in conduct prohibited by subsection (1), or is unable to pay its debts as they become due and payable in the normal course of business, the CIPC may issue a notice to the company to show cause why the company should be permitted to continue carrying on its business, or to trade, as the case may be.

The CIPC Notice to Customers of 24 March 2020

On 24 March, the CIPC issued a practice note in terms of paragraph 4(1)(b) of the Companies Regulations (GNR 351 of 26 April 2011) advising that, in light of the COVID-19 pandemic and the national state of disaster, it would not be invoking its powers under s22 of the Act in the case of a company which is temporarily insolvent and still carrying on business or trading. CIPC will not be issuing notices in terms of s22(2) or compliance notices in terms of s22(3) where they have reason to believe that the insolvency is due to business conditions caused by the COVID-19 pandemic.

Why the CIPC Notice is problematic

This CIPC Notice is problematic as it may create the misapprehension of a reprieve, allowing companies to trade in insolvent circumstances.

It must be understood that issuing notices in terms of s22(2) and s22(3) of the Act has no bearing on the statutory obligations placed on companies in terms of s22(1). The prohibitions contained in s22(1) are not discretionary; they are peremptory, and apply in all circumstances, including a worldwide pandemic.

So what manner of carrying on of a business would be prohibited? The most obvious example that comes to mind is trading under insolvent circumstances. The inescapable inference is that a company which continues to do business, knowing that it will unable to pay its creditors, is that they are trying to defraud them by letting them continue to deliver goods or services despite knowing that they will not be paid. To do so would be reckless (or, at the very least, grossly negligent), and would place a company firmly within the ambit of s22(1).

Financial distress and insolvent circumstances

The Act provides recourse for companies faced with financial difficulties and directors must consider whether their companies are, or are likely to become, financially distressed.

In terms of Chapter 6 of the Act, a company is financially distressed if it appears to be:

(i) reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months (section 128(1)(f)(i)); or
(ii) reasonably likely that the company will become insolvent within the immediately ensuing six months (section 128(1)(f)(ii)).

In such circumstances, the board of a company may resolve that the company should voluntarily begin business rescue proceedings and be placed under supervision.

The aim of business rescue proceedings is to rehabilitate a financially distressed company by restructuring its affairs to maximise the likelihood of the company continuing to exist or, if that is not possible, to result in a better return for the company's creditors or shareholders than would result from immediate liquidation. This is achieved by providing for:

(i) the temporary supervision on the company and the management of its affairs, business and property;
(ii) a temporary moratorium on the rights of claimants against the company or in respect of property in its (lawful) possession, thereby safeguarding it against immediate claims by creditors;
(iii) the development and implementation of a business rescue plan to restructure the affairs, business, property, debt, and other liabilities and equity of the company. (Section 128(b) of the Act)

If there appears to be no reasonable prospect of rescuing the company, the directors may resolve to wind-up the company or apply to court to have the company wound-up. This entails the orderly administration of the dissolution of the company by a liquidator, including selling off company assets to settle creditors.

Directors' duties and liabilities

While neither business rescue nor winding-up are ideal prospects for any company, it is the duty of directors to consider these options, if a company is in financial distress. In making these decisions, the board has a duty to account to affected persons (shareholders, creditors, employees/registered trade unions representing employees). In terms of s129(7) of the Act, if the board of a company has reasonable grounds to believe that the company is financially distressed, but does not begin business rescue proceedings, a written notice must be delivered to each affected person setting out the nature of financial distress and the reasons for not placing the company in business rescue. Failure to do so may be seen as a breach of the duty to act with reasonable care and in the best interests of the company and, in terms of s77, may incur liability for any loss, damages or costs sustained by the company. Trading in insolvent circumstances would expose directors to liability for the company's losses, including being held accountable in terms of s424 of the Companies Act 1973 (still applicable by virtue of item 9 of schedule 5 of the Act). In terms of this, anybody party to permitting the company to continue to operate recklessly or with the intent to defraud its creditors may be held personally responsible for all or any of the debts or other liabilities of the company.

These extraordinary times have given rise to extraordinary circumstances and many companies are likely to face financial distress and insolvency. The COVID-19 pandemic will not, however, absolve directors from a breach of duty. If directors anticipate the effects that the pandemic may have and are aware of the options available, this will enable directors to fulfil their duties with the necessary skill.

Van Niekerk is a Director and Munga a Junior Associate at Smit Sewgoolam in Johannesburg.