Company directors and personal liability
Directors of companies should take note of the provisions regarding financial assistance to directors or director-related parties, as laid down by the new Companies Act of 2008 and, particularly, section 45 of the Act.
According to this section, directors may incur personal liability for any damage, costs or loss suffered by the company as a result of a resolution approved by the board that is inconsistent with the requirements of section 45. Any such resolution will be void despite provisions by a company’s Memorandum of Incorporation.
Does this apply to you?
Despite its title, Financial assistance to directors, section 45 also includes parties other than directors. It applies to:
- a director or prescribed officer of the company or a related or inter-related company;
- a related or inter-related company or corporation;
- a member of a related or inter-related company or corporation; or
- a person related to any of the above parties.
What is the definition of financial assistance?
Section 45 defines financial assistance to include the lending of money, guaranteeing of a loan and securing any debt or obligation. It excludes:
- The lending of money in the ordinary course of business of a company whose primary business activity is the lending of money;
- An advance to cover expenses on behalf of the company (general, legal expenses or moving expenses if the company requires the person to relocate for work purposes).
By whom and when can such financial assistance be authorised?
The board of directors may authorise direct or indirect financial assistance unless the company’s Memorandum of Incorporation provides otherwise. The board may not under any circumstances and despite any provisions in the company’s Memorandum of Incorporation, authorise any such financial assistance unless all of the following requirements are met:
The financial assistance is:
- provided in terms of an employee share scheme or
- provided in line with a special resolution which was adopted within the two years preceding the financial assistance.
The board has ensured that:
- the company will satisfy the solvency and liquidity test immediately after providing the financial assistance; and
- the terms under which the financial assistance is provided are fair and reasonable to the company.
In addition to the above requirements, the board should notify all shareholders of the company in writing of their approval of any such assistance which meets the above requirements within:
- 10 working days after the board has adopted the resolution should the total value of the financial assistance together with any previous such resolutions during the financial year, exceed one tenth of 1% of the company’s net asset value at any time of the resolution, or
- In all other cases, 30 working days after the end of the financial year.
The above-mentioned requirements will not be applicable if all the shareholders are also directors of the company.
What is the solvency and liquidity test?
Section 4 of the Companies Act defines a company as having met this test at any time when, after taking into account all relevant and available financial matters and information:
- the company’s assets, fairly valued, are equal to or exceed the liabilities of the company as fairly valued and
- it appears that the company will be able to pay its debts as they become due and payable in the ordinary course of business in the 12 months after this test has been performed (which, in the case of Section 45, will be before providing the financial assistance).
How do I apply these requirements?
The most important requirement is the special resolution. It would be quite impractical to adopt a special resolution every time financial assistance is provided (i.e. with every transaction). It is advisable to draft a special resolution every two years which:
- instead of specifying a person or entity, rather nominates a group of parties (section 45 should provide rather good guidance regarding these parties) and
- specifies a maximum limit of financial assistance which may be provided with regards to this particular resolution.
The ability to specify a limit goes hand in hand with the outcome of the solvency and liquidity test. Having adopted this resolution, the shareholders will have to assess the company’s financial and cash-flow position for the following two years to ensure that the company would be able to provide such financial assistance without solvency or liquidity problems.
This resolution should be adopted prior to the further assistance that it applies to. The good news is that the new Companies Act has provided a much more practical way of adopting special resolutions, viz.
- a company does not have to wait for a special shareholders’ meeting to adopt a special resolution anymore, but can do so by way of a round-robin;
- a company is also not required to register a special resolution with CIPC anymore.
It is advisable that the board keep the solvency and liquidity test on record. The Companies Act requires accounting records and financial statements to serve as the basis for such calculations (not necessarily audited or reviewed annual financial statements). In accordance with section 29, monthly management accounts may be used. In addition, budgets and cash-flow forecasts are crucial for the performance of the liquidity test.
The liquidity test is extremely important:
- At the time at which a special resolution is adopted and a limit (for which financial assistance may be provided) is specified by the shareholders, the limit is based on financial information available at that time. By the time the assistance is provided, circumstances may have changed and such assistance may result in solvency and liquidity problems for the company.
- In terms of section 22, directors may incur personal liability if the company trades under insolvent conditions. An example of a case where liability could be incurred is where debt is incurred from a third party which the company knowingly does not have the ability to settle.
It is therefore essential that all company directors and boards not only familiarise themselves with these requirements, but implement them as soon as possible.