Is your company trading recklessly and who can be held liable?
In South Africa “insolvent trading” is spoken about in a loose way such as “wrongful, fraudulent or reckless trading and we do not use the term “insolvent trading”. The South African approach is company and director centred.
Where a company or its directors purport to be in a position or create the impression that the company is able to pay its debts when they are due but are unable to may be considered as trading fraudulently.
Section 22 of the Companies Act states that a company may not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. A “company” is defined as a juristic entity in terms of the Act and in order to be deemed carrying on a fraudulent purpose intention will need to be proved.
The Act refers to company only within the definition of reckless trading and fails to mention directors. As intention is an element required when proving fraud it will be impossible to suggest that a juristic person is capable of having an intention. The procedure adopted is twofold, firstly a company will be investigated by the Companies Commission and secondly the directors may be held liable under a separate action.
The Act does not include a definition of “reckless” and one may look at the statutory meaning of insolvency being factual insolvency. An interested party or the Companies Commission may look at the balance sheet and quickly ascertain whether or not the assets of the company exceed the liabilities. The common law tends to refer to commercial insolvency where a company is unable to pay their debts as they fall due.
If the Companies Commission has reason to believe that the company is engaged in such conduct or if the Companies Commission believes that the company is unable to pay its debts as they fall due, it may request that the company answer in respect of such allegations. If the company fails to convince the Companies Commission within twenty days that they are not trading recklessly or are able to pay their debts, the commission can issue a stop trading notice.
Regulation 19 of the Act describes the form that the Companies Commission can use to state the allegations to the respective company and such allegations must clearly set out the grounds on which the relief is justified.
On a finding that the company is not trading recklessly or with gross negligence, the Companies Commission must issue a notice that the company can carry on trading or a compliance notice which may absolve the directors from liability. During the period that the company is being investigated they will not be able to trade.
The duty which has been placed on the Companies Commission is an onerous duty. The Commission receives a complaint, and then based on a single form submitted, they must make a decision. The Act fails to provide a time period for the validity of the notice issued by the Companies Commission, which means that the company will have to shut its doors to business until further notice.
In order to determine if the company has been trading recklessly, with gross negligence fraudulently or with the intention to defraud creditors we must look at the actions of the directors. Section 77 (3) states that a director of a company is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of a director having acquiesced in the carrying on of the company’s business despite knowing that it was being conducted in a manner prohibited by section 22(1). The director must have known about the irregularities which directly or indirectly resulted in the irregular conduct.
The main concern with the definition above is that it is extremely wide and the manner in which liability can be placed on a director is almost inescapable.
The Legislature could not have expected that a director maintain a record of minutes of each and every transaction undertaken in the carrying on of a normal business day. If a director is unable to prove that he did not know about an irregularity and is found guilty of an offence for reckless conduct he may be sentenced to ten years imprisonment or a fine.
The Commission must establish and maintain a public register of persons who are disqualified from serving as a director, in terms of an order of court pursuant to the Act or any other law.
In terms of the provisions of the Act it will be easy for a director who is unaware of the day to day happenings of the company to fall into the trap of liability and we wish to stress the importance of recording decisions taken at meetings as well as in day to day business to prevent such liability.
Michelle Van Heerden
 71 of 2008 hereinafter referred to as the Act.
 n 3 s22(2).
 n 3 s 22(3).
 n 1 s 216.
 n 1 s 69(13).