Directors Beware -creditors may play a more active public interest role in declaring directors delinquent

[Article by Jeff Buckland and Thabiso Rahlaga]

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In a stable civilised society and a modern economy there is nothing worse than a thief in the camp, or akin to that, a debtor who does not pay back the money they took on loan and agreed to pay back. The whole camp may become tainted and less attractive to its honest occupants or would-be occupants.

Neither a borrower nor a lender be, Polonius advised his son Laertes in Shakespeare’s Hamlet, which although of English origin may still be sound universal parental advice in personal ‘family & friend’ relationships because when the borrower does not pay back the money the relationship may sour. This souring of relationships could be entirely avoided, according to Shakespeare’s wise Polonius, by neither lending nor borrowing.

However, modern economies run on foreign and domestic investments and money-lending, and an essential element of diligent ethical money-lending is that typically lenders expect the return of monies lent plus, where applicable,  permitted interest, and borrowers are obliged to manage cash-flows and repay the money over the agreed time. Where one or more borrowers in a particular economy take the money purportedly to genuinely grow their earnings and cash-flows, and agree to pay back the money over an agreed time but do not, relationships between foreign and domestic investors and local borrowers could sour and the whole economy could become tainted and less attractive.

There are many objective reasons why a lender should not or ought not to lend cash to a company or group of companies; but if they do (whether diligently, intentionally or recklessly) then conversely there may be many reasons, some good, some bad and possibly some already known to the lender, why a borrower who is given and taken the money offered on loan does not or may not be able to pay back the money to the lender within the agreed time.

In circumstances where the reasons for non-payment are not good, for example, decision-makers in a group of companies take a pattern of evasive action and intentionally divert cash-flows due by other group companies to the debtor company away from the debtor company so that the debtor company is never in a position to pay back the money, there are remedies available to stakeholders and creditors of the company directly against these decision-makers, as is evident from the Vantage Mezzanine Fund II case discussed below.

The question arises whether or not, in order to keep the camp or economy clean for the benefit of all participants and would-be participants and the public, honest and ethical stakeholders and creditors of a company should not more pro-actively attempt to enforce these remedies?

It is relatively easy to identify the decision-makers in a company and in the group of companies to which it belongs.

It is well known that the individuals elected or appointed to ‘serve’ as directors on the board of a company typically have the power and authority in terms of section 66(1) of the Companies Act, 71 of 2008 (“Companies Act”), the company’s memorandum of incorporation (“MOI”) and any delegation of authority to the individual/s (“DoA”) to exercise all or some of the powers and functions of the company, subject to the provisions of the Companies Act, the MOI and any DoA.  Hand-in-hand with this typical division of power and authority within the company between the body of shareholders and the board of directors (and further between the executive and the non-executive directors on the board, and prescribed officers of the company), also comes great individual responsibility, fiduciary obligations and the risk of personal risk and liability for the individual directors (both executive directors and non-executive directors) and prescribed officers.

The Companies Act provides an arsenal of statutory remedies for stakeholders of a company against individual directors who meet the prescribed requirements for application of the remedy in question against them. These remedies are available for persons with the necessary legal standing (locus standi) to apply to a Court to enforce these remedies in the appropriate circumstances against the directors concerned.

One such statutory remedy available against individual directors, is for an applicant with legal standing to apply to Court to declare the director delinquent in terms of section 162 of the Companies Act, if the applicant contends that the director meets the requirements of delinquency under section 162. If a delinquency order is slapped on a director, they are no longer entitled for the duration of the order to serve or act as a director in South Africa. It could well be regarded as beneficial to the South African business world as a whole and a form of protection for all involved in that business world and the public to have those individuals who, possibly repeatedly, meet the prescribed requirements of delinquency in section 162, actually declared delinquent and stopped from serving and acting as a director of any company in South Africa.

A critical legal hurdle an aspirant applicant to Court to declare a director delinquent in terms of section 162 must overcome, is to establish upfront the applicant’s legal ‘standing’ and entitlement to bring the application in question to Court. Legal ‘standing’ is a tool a Court employs to determine whether the applicant is entitled to bring its claim, and to put the opposing director to trouble. Put another way, an aspirant applicant can’t get its case even heard in Court if it can’t overcome the legal hurdle of establishing legal ‘standing’.

This upfront hurdle and the interpretation and application of extended legal ‘standing’ permitted by section 157(1) of the Companies Act was clarified to some extent in relation to a creditor of a debtor company in the recent 2023 judgment of Vantage Mezzanine Fund II Partnership and another vs Hopeson and others 2023 JDR 4547 (GJ). The creditor in this case, Vantage Mezzanine Fund II Partnership, successfully argued that it had legal standing to bring the application to have three directors of the debtor company in question declared delinquent on the grounds that, in that case, it was indeed genuinely “acting in the public interest” as contemplated by section 157(1)(d) of the Companies Act.

The Vantage Mezzanine Fund II case is worthwhile reading for creditors and directors of debtor companies alike!

The Companies Act deals with ‘standing’ and extended ‘standing’ in section 157(1). In terms of section 157(1) four separate and distinct categories of person/s may apply to a Court to enforce a remedy provided in the Companies Act, in this case the section 162 delinquency remedy, namely:

(a)   a person directly contemplated by section 162 (being the company itself, a shareholder, director, company secretary or prescribed officer of a company, a registered trade union that represents employees of the company, or another representative of the employees of the company); or

(b)   a person “acting on behalf” of a person directly contemplated by section 162; or

(c)   a person acting as a member of, or “in the interest of” a group or class of affected persons, or an association acting in the interests of its members; or

(d)   a person “acting in the public interest”, with the leave of the court.

As can be seen, section 157(1)(a) provides for ‘standing’, and sections 157(1) (b), (c) and (d) provides for ‘extended standing’ and extends legal standing to include ‘representative applicants’, ‘champion applicants’ for other categories of applicants for example in a class action, and persons “acting in the public interest”.

An advantage of extending legal standing in this way should have been to open the way for more applications to be made to Court by knowledgeable and well-resourced qualifying applicants so as to enable a higher volume of enforcement of available remedies against the underlying conduct which these available remedies are intended to curtail.  But having regard to the few applications to Court by qualifying applicants with extended legal standing under section 157(1), particularly enforcing the delinquency remedy under section 162, it appears that this notional advantage is not being realised, possibly to the detriment of the South African economy, particularly if the underlying offending conduct is rampant, which creditors engaged with debtor companies would have a better line of sight on.

What makes the Vantage Mezzanine Fund II case novel, is that a creditor of the company which is owed money can successfully argue for extended legal standing while “acting in the public interest” under section 157(1)(d). Creditors of a debtor company are clearly not included in the section 157(1)(a) list of persons directly contemplated by section 162 who have legal standing to apply to court to declare a director of the debtor company delinquent.  Nor would a creditor company owed money typically ‘represent’ or ‘champion’ others as contemplated by the second and third categories of persons qualifying for extended legal standing under section 157(1)(b) or (c).

That then leaves the section 157(1)(d) category open to creditors (who are owed money and motivated to stop possibly repeatedly delinquent directors) to argue for extended legal standing under this section. A creditor would need to demonstrate, among other things, that independently of and separately from the issue of the debtor company’s prevailing outstanding indebtedness to the creditor, they are genuinely “acting in the public interest” in terms of section 157(1)(d) when bringing their application to Court to declare directors of the debtor company delinquent, which the creditor did successfully in the Vantage Mezzanine Fund II case.

When the matter of interpreting section 157(1)(d) and determining whether or not in any particular set of circumstances a creditor who is owed money is “acting in the public interest” for purposes of establishing extended legal standing in terms of section 157(1)(d), and making an order in this regard, a Court is required -

·        in terms of section 158(a) of the Companies Act, to develop the common law as necessary to improve the realisation and enjoyment of rights established by the Companies Act; and

·        in terms of section 158(b) of the Companies Act, to promote the spirit, purpose and objects of the Companies Act, and if any provision of the Companies Act (such as acting in the public interest) read in its context is capable of more than one meaning, to prefer the meaning that best promotes the spirit and purpose of the Companies Act, and will best improve the realisation of rights.

One of the aims of the Companies Act, stated on the front page of the Companies Act, is “to provide appropriate legal redress for investors and third parties with respect to companies”, and one of the key purposes of the Companies Act stated in section 7(b)(iii) of the Companies Act is “to promote the development of the South African economy” by, among other things, “encouraging transparency and high standards of corporate governance as appropriate, given the significant role of enterprises within the social and economic life of the nation”. 

While this may indeed be a novel approach for creditors owed money to get to Court to have their application heard as to why directors of the debtor company in question should be declared delinquent by the Court, this gate to do so is wide open and not closed to creditors, as is apparent from the judgment of Judge Manoim in the 2023 Vantage Mezzanine Fund II case.

In dismissing all of the objections raised by the directors of the debtor company in the Vantage Mezzanine Fund II case and all of their arguments as to why a creditor owed money could not be acting in the public interest and should not have extended legal standing under section 157(1)(d) of the Companies Act to bring an application to Court to declare directors of the debtor company delinquent under section 162, Judge Manoim in his judgment confirmed among other things that:

“It may be that in some circumstances a creditor may be acting opportunistically and cynically, but this does not apply in every case.  So it cannot be a general rule that a creditor can never be a genuine applicant to vindicate the public interest”.

In conclusion, creditors and other investors and stakeholders in companies in the South African economy who have significant visibility and insight into possibly both the good and/or repeatedly bad conduct of directors of companies might carefully consider the facts and findings of the Vantage Mezzanine Fund II case, the Court’s interpretation and application of section 157(1)(d) of the Companies Act and what “acting in the public interest” means for creditors and other investors , as well as the gate that has been left open to them (extended legal standing) to “act in the public interest” and bring applications to Court where appropriate to declare directors of companies delinquent.

It remains to be seen whether or not a more active role on the part of creditors and other investors and stakeholders under sections 157(1)(d) and 162 of the Companies Act against directors would put pressure on and act as a deterrent to directors of debtor companies who for example, like in the Vantage Mezzanine Fund II case, may also sit on multiple other boards of group companies and other companies and who engage in conduct that meets the prescribed requirements for delinquency in section 162 of the Companies Act.

It certainly does not benefit the South African economy and its reputation if directors are allowed to continue with delinquent conduct without attempted sanction by those with the standing, knowledge, resources and remedies available to them to enforce such sanction. 

The gate left open to creditors and other investors by the Court’s interpretation and application of section 157(1)(d) in the Vantage Mezzanine Fund II case can also hardly be called a ‘flood-gate’ by critics of that interpretation and application, having regard to the dearth of applications brought by creditors and other investors to date acting in the public interest to declare directors of debtor companies delinquent in terms of sections 157(1)(d) and 162 of the Companies Act. However, this may change over time as creditors and other investors may consider playing a more active role applying in the public interest to have errant directors declared delinquent and clamp down on repeat offenders.