The art of law – creditors of a struggling debtor may be tripped up by legal technicalities that only a commercial lawyer would be aware of
For an individual to be sequestrated, or for a company to be wound-up on the grounds of insolvency, is of course a financial tragedy for that person or entity.
But there can also be seriously prejudicial consequences for persons who have received payment from that person or entity in the six months prior to insolvency, for in certain circumstances they may be compelled to repay the money they received back into the insolvent estate, so that it can be distributed to all the creditors on a pro rata basis.
Voidable preferences under the Insolvency Act
Section 29(1) of the Insolvency Act 24 of 1936 provides that –
‘Every disposition of his property made by a debtor not more than six months before the sequestration of his estate . . . which has had the effect of preferring one of his creditors above another, may be set aside by the Court if immediately after the making of such disposition the liabilities of the debtor exceeded the value of his assets, unless the person in whose favour the disposition was made proves that the disposition was made in the ordinary course of business and that it was not intended thereby to prefer one creditor above another.’
The rationale behind this provision is that, if a person or company goes insolvent and is unable to pay their debts in full, then all unsecured creditors should be treated equally by paying them all the same pro rata proportion of their respective claims.
Moreover, as section 29(1) provides, all amounts that the insolvent has paid to creditors in the six months preceding insolvency can be clawed back (that is to say, recovered) and paid into the insolvent estate for the benefit of the entire body of creditors, if, immediately after the payment, the debtor’s liabilities exceeded his assets – unless the person who received payment can discharge the onus of proving, firstly, that the payment was made in the ordinary course of business and, secondly, that there was no intention to prefer one creditor above another.
Without such a claw-back provision, a debtor who realised that insolvency was inevitable would be tempted to use the remaining funds to pay favoured creditors (eg friends, family or business associates) and a creditor who suspected a looming insolvency might bring pressure to bear on the debtor to pay his claim before the axe fell.
The interpretation of section 29(1) – and in particular the meaning of a payment in the ordinary course of business – has been the subject of many judicial decisions over the years, the most recent of which was that in Griffiths v Janse van Rensburg NO  ZASCA 158 where judgment was delivered on 26 October 2015.
As a decision of the Supreme Court of Appeal, binding on all lower courts, this judgment brings welcome clarity to this area of law.
The facts in Griffiths v Janse van Rensburg NO
The case of Griffiths v van Rensburg NO involved an illegal pyramid scheme, that is to say, a bogus investment scheme in which no genuine profits are generated and in which persons who “invest” money in the scheme are simply paid a commission for persuading others to join the scheme and pay enrolment fees.
As with all pyramid schemes, this one collapsed when the time came that no new investors were joining the scheme and there was consequently no fresh money coming in with which to pay returns to anyone.
In this case, the scheme had been operated by a trust, registered under the Trust Property Control Act.
The plaintiff, Griffiths, had invested two amounts of R1 000 000 in the scheme by way of loans, which he had paid to the Trust at the centre of the scheme. Those two loans were repaid to him, plus two amounts of interest, less than six months before 24 September 2000, when the scheme collapsed and the Trust was sequestrated.
The trustees of the Trust’s insolvent estate instituted legal proceedings against Griffiths to recover those loan repayments in terms of section 29(1) of the Insolvency Act, quoted above.
Were the repayments of capital by the Trust to Griffiths made “in the ordinary course of business”?
The only issue in dispute at the trial was whether the two repayments of loan capital and the two payments of interest to Griffiths within six months of the Trust’s insolvency had been made in the ordinary course of business by the Trust. If so, Griffiths would not be obliged, in terms of the Insolvency Act, to repay what he had received into the coffers of the Trust’s insolvent estate.
It was not disputed that the business carried on by the Trust had been that of an illegal pyramid scheme, though Griffiths had not been aware of its illegal and fraudulent nature. He had thought that the money he invested would be lawfully used by the Trust to earn income sufficient to repay his capital plus the promised interest.
At issue were four payment from the Trust to Griffiths, being two repayments of the loan capital he had invested and two payments of interest. At the trial, Griffiths abandoned the argument that the payments of interest had been made by the Trust in the ordinary course of business and he confined his argument in this regard to the two repayments of capital.
The Supreme Court of Appeal held (at para ) that in circumstances such as this, the primary focus is on –
“the nature of the business relationship between the insolvent and the recipient at the time the disposition was made and whether ordinary, solvent business people would shrink from the transaction in question.”
Thus, for example, (see para  of the judgment) if the Trust in the present matter had (in the course of carrying on its unlawful scheme) leased business premises, its payments of rent to the lessor would have been made in the ordinary course of business, as envisaged in section 29(1).
In the present case (see para ) the loan agreements entered into between Griffiths and the Trust were illegal and void and the scheme therefore had no entitlement to retain his funds until the date agreed for repayment.
It followed that the moneys invested by Griffiths and paid to the Trust were repayable to him on demand – not in terms of a contract (for the contract between Griffiths and the Trust was illegal and thus void) but on the grounds that the Trust had been unjustifiably enriched by its receipt of Griffiths’s money– that is to say, the Trust had been enriched without any legal basis. The Trust would have had a defence to a claim for repayment by Griffiths based on contract – for the contract was illegal and thus a nullity – but would have had no defence to a claim for repayment based on unjustified enrichment.
Repayment of capital on the basis of contract or on the basis of unjustified enrichment
The court said (at para ) that it was prepared to accept that if the Trust had repaid Griffiths the capital amount of his investments on the basis of its liability for unjustified enrichment, this would have been a payment made by the Trust in the ordinary course of business (because the claim for repayment would have had a legal basis) and therefore could not have been clawed back by the Trust’s insolvent estate in terms of section 29(1) of the Insolvency Act, quoted above.
However, the court pointed out (at para ) that, at the time the Trust repaid Griffiths the capital amount of his investments, he was unaware that the investment agreement was illegal and void. He was also unaware that he had a claim based on unjustified enrichment, and he had claimed repayment on the basis of his investment agreement with the Trust, which was now revealed to have been an illegal and void agreement.
The court accordingly held that, when the Trust acceded to Griffiths’s demand for repayment of his loans, this was not a payment by the Trust in the ordinary course of business and Griffiths was therefore obliged, in terms of section 29(1) of the Insolvency Act, to repay that money to the insolvent estate of the Trust for the benefit of the general body of creditors.
The judgment in this case will be wholly satisfying to lawyers for the legal logic is impeccable.
But the judgment is not likely to be welcomed by the business community, who may well regard it as based on an overly-technical legal distinction.
Thus, the business community may point out that the effect of the judgment is that if Griffiths had said to the Trust, “I am demanding repayment of my capital investment in your scheme on the grounds of unjustified enrichment,” the repayment by the Trust would have been in the ordinary course of business and could not have been clawed back by the Trust’s insolvent estate.
But because Griffiths, not realising that the scheme was illegal, had demanded repayment on the implicit basis of his contract with the Trust (an agreement later revealed to be illegal and void), the repayment by the Trust was not in the ordinary course of business, and Griffiths was consequently obliged, in terms of section 29(1) of the Insolvency Act, to disgorge the repayment into the coffers of the Trust’s insolvent estate.
The business community can however take away from this judgment two broader lessons.
Firstly, that substantial loans should not be given without diligent investigation into the nature of the investment.
Secondly, that if a debtor for an unsecured debt seems to be at risk of insolvency, and the creditor wants to exert pressure to have the debt paid, the creditor should be acutely aware of the provisions of section 29(1) of the Insolvency Act and should take expert legal advice on whether, and if so how, payment of the debt can be arranged so as to be made in the ordinary course of business and therefore immune from being clawed back in terms of this provision of the Act.