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The art of law - a creditor who is tardy in enforcing his claim risks the extinction of his rights by way of prescription

The extinction by prescription of a creditor's claim that directors of a debtor company are personally liable for its debts in terms of section 424 of the Companies Act 1973

For the business community, one of the most worrisome sections of the now-repealed Companies Act 61 of 1973 was the so-called reckless and fraudulent trading provision contained in section 424.

In terms of this provision, a court had the power to declare those individuals who were party to the fraudulent or reckless carrying on of business by a company to be personally liable for all or any of the company's debts.

The text of section 424(1) reads as follows:

'When it appears, whether it may be in winding-up, judicial management or otherwise, that any business of the company was or is being carried on recklessly or with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the Court may . . . declare that any person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Court may direct.'

Section 424 remains in force in certain circumstances

Significantly, the new Companies Act 71 of 2008, despite repealing the Companies Act 1973, provides in its 'transitional arrangements' that section 424 remains in force in the context of the winding up of insolvent companies. (See the Companies Act 2008, schedule 5, item 9(1)-(2)).

The onus of proof resting on a creditor seeking a declaration of personal liability in terms of section 424 of the Companies Act 1973

For a creditor to prove that a debtor company was carrying on business recklessly or fraudulently is usually no easy task. However, before an aggrieved creditor can argue the merits of his claim, he may be faced with a daunting preliminary obstacle, namely to show that his claim in terms of section 424(1) has not prescribed.

The period laid down by the Prescription Act 68 of 1969 for the prescription (that is to say, the extinguishment) of such a claim is three years from the date that the debt in question - in this case the claim in terms of section 424(1) - became due. Section 12(3) provides that -

'A debt shall not be deemed to be due until the creditor has knowledge of the identity of the debtor and of the facts from which the debt arises: Provided that a creditor shall be deemed to have such knowledge if he could have acquired it by exercising reasonable care.'

A recent decision in which a creditor's claim in terms of section 424(1) (namely, that the directors of the debtor company were personally liable for its debts) failed on the grounds that the claim had prescribed is that of the Cape High Court in Nampak Wiegand Glass (Pty) Ltd v Finlayson [2014] ZAWCHC 137 in which judgment was handed down on 8 September 2014.

At what juncture does prescription start running in respect of a claim in terms of section 424?

Where a creditor is seeking a court order in terms of section 424, declaring the persons (usually, the directors) who were knowingly party to the reckless or fraudulent carrying on of business by a debtor company to be personally liable for its debts, the issue in relation to prescription is - at what point in time did the creditor become aware - or could with the exercise of reasonable care have become aware - that the debtor company was carrying on business recklessly or fraudulently?

In the Nampak case, referred to above, it was held at (para [31] of the judgment), citing the decision in Ozinsky NO v Lloyd 1992 (3) SA 396 (C) at 414F, that -

'It is only when debts are incurred in circumstances in which 'in the opinion of reasonable businessmen, standing in the shoes of the directors, there would be no reasonable prospect of the creditors receiving payment' that a proper inference may be drawn that the business is being carried on recklessly.' (Emphasis added.)

In that case the court added that, for prescription to commence running -

'The creditor . . . requires knowledge only of the material facts from which the debt arises, not of the relevant legal conclusion or of an expert opinion. The knowledge required is the minimum necessary to enable a creditor to institute action.' (Emphasis added.)

It was held in Minister of Finance v Gore [2007 (1) SA 111 (SCA) at 120A that, for the purposes of prescription -

'…time begins to run against a creditor when it has the minimum facts that are necessary to institute action. The running of prescription is not postponed until a creditor becomes aware of the full extent of its legal rights, nor until the creditor has evidence that would enable it to prove a case "comfortably"'. (Emphasis added.)

These principles can present great difficulties to a creditor who foresees that a debtor company is likely to go insolvent and wishes to hold its directors personally liable for its debts in terms of section 424.

A court may take the view that the creditor should at an early stage have drawn the inference that the debtor company was carrying on business recklessly or fraudulently. It is at that juncture that the three year prescriptive period in respect of a claim in terms of section 424(1) will have commenced running.

In the Nampak case, the creditors' claim in terms of section 424(1) was held to have prescribed

In the Nampak case it was held (see para [42] of the judgment) that the plaintiff had, by 26 January 2006, been cognisant of the basic facts on which it could make a claim against the defendants in terms of section 424. However, the plaintiff issued summons only on 21 January 2009 and it was served on the respective defendants on 27 January 2009 and on 5 February 2009 - in other words, more than three years after the cause of action arose.

It was accordingly held (at para [43]) that the claim in question had already prescribed when the summons was served on the defendants.

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