DIRECTORS: DELINQUENCY FOLLOWING THE BREACH OF THEIR FIDUCIARY DUTIES

INTRODUCTION

After President Jacob Zuma’s most recent cabinet reshuffle and the dismissal of Dudu Myeni, who acted as a director and chairperson of the board of directors of South African Airways, the issue of delinquency of directors of companies has received much attention in the media. According to reports, Mrs Myeni’s conduct is being investigated to ascertain whether she has acted in a delinquent manner in executing her duties as a director of SAA. What follows seeks to enlighten the reader as to the general nature of directors’ duties, and the legal remedy of a declaration of delinquency.

COMPANIES AS PERSONS

A company exists independently from the persons who establish and run it, and is capable of having legal rights and incurring legal obligations in its own right. However, every company must be represented by human beings, who are empowered to act on the company’s behalf and referred to as its directors. These people act on behalf of the company, to incur rights and obligations on the company’s behalf.

The fact that obligations are incurred for the company is exactly why people tend to conduct their businesses through the company – to keep the company’s debts (and assets) separate from their own. Reducing the risk to the natural persons who own and/or run the business encourages such persons to take calculated risks in order to build a profitable business. Such owners and/or managers should accordingly not, as a general rule, be punished for the execution of their functions, even where a decision made in good faith turns out to be the wrong one. However, there are certain circumstances that give rise to grounds for a court to ignore the separation between the director and the company and punish the director for their conduct.

LEGAL BACKGROUND

In terms of section 162 of the Companies Act 71 of 2008 (“the Companies Act”), where certain circumstances are present, certain parties may apply to a court for an order, the effect of which would be to declare a director to be delinquent.

An application to declare a director delinquent can be brought against a director of a company, or a person who within the immediately preceding 24 months acted as a director.

FIDUCIARY DUTIES

Companies are owed fiduciary duties by their directors which are expressly taken up in the Companies Act. The duties, very succinctly put are:

The duty not to exceed the powers as set out in the company’s Memorandum of Incorporation;
The duty to exercise the powers of director for a proper purpose;
The duty to exercise an independent and unfettered discretion;
The duty to avoid conflicts of interest (which includes the duty not to make secret or incidental profits, not to take up corporate opportunities for personal gain, not to compete with the company and not to misuse confidential information; and
The duty to act with care, skill and diligence.

Although section 162 of the Companies Act does not refer to all of these duties by name, the provisions of section 162(5) it appears are phrased wide enough to encapsulate the fiduciary duties in such a way as to make their breaches actionable in terms of the section – for example seeking a declaration of delinquency.

ORDERS OF DELINQUENCY IN THE COMPANIES ACT

Section 165(5)(c) sets out grounds for a declaration of delinquency by a court which refers to the manner in which the director conducted himself in the execution of his fiduciary duties. A director is amongst others delinquent if he grossly abused the position of director, took personal advantage of information or an opportunity, or intentionally, or by gross negligence inflicted harm upon the company or a subsidiary of the company.

From the wording of section 165(5)(c), and court cases launched in terms of this section, it is clear that the conduct of the director, in order to fall under the ambit of section 165(5)(c), must be shown to be very serious. Ordinary commercial misjudgement is not sufficient to justify an order of delinquency. Courts have made orders of delinquency in respect of directors of companies where such directors:

Allowed money destined for the company to be paid into an account other than that of the company;
Failed to detect fraud in the company and report it SARS;
Uses funds of the company for the benefit of other companies;
Failed to alert fellow directors of fraudulent activities in the company;
Paid themselves unlawful (and extravagant) directors’ fees;
Unlawfully made loans to a director on behalf of the company;
Used company funds to pay for personal legal fees;
Failed to keep accounting records of the company;
Failed to hold Annual General Meetings.

CONSEQUENCES OF ORDERS OF DELINQUENCY

A declaration of delinquency subsists for 7 years, or for a longer period if the court deems it necessary. A court is also competent to impose any conditions it deems appropriate, such as limiting the application to one or more particular categories of companies. A court is further entitled to enforce ancillary conditions on a director such as committing the person to undertake a designated programme of remedial education, community service, or the payment of compensation to any person adversely affected by the director’s conduct.

The effect of a declaration of delinquency is that a director is disqualified from acting as a director. Where a person acts as director of different companies, all such appointments are terminated immediately upon the declaration of delinquency. There are other remedies available to interested parties where a director’s breach of a fiduciary duty does not warrant a declaration of delinquency. While breaches of a director’s fiduciary duties is always serious, the declaration of delinquency is however a severe remedy, which will not always be warranted for a breach.

Onerous directors’ fiduciary duties and the consequences for breaches thereof can deter persons to accept the responsibilities thereof, are imperative to ensure effective boards lead their companies to sustainability.

For more information, contact Goldberg & de Villiers Inc on 041 501 9800.