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Directors of a company may incur personal liability for its debts

What are your rights where you are induced to enter into a contract by an untrue statement made fraudulently or negligently by the other party?

The fraudulent and reckless trading provisions of the Companies Act come to the aid of a person whose claim would otherwise have lain only against an insolvent company.

A cornerstone of our law of contract is expressed in the Latin maxim pacta sunt servanda - “contracts must be honoured”: In other words, once you have entered into a contract, you are legally bound to do what you have contractually promised to do - and if you do not, the other party can get a court order compelling you to do so.

But the law also recognises that, where A has induced B to enter into a contract by some assurance that has proved to be untrue, Bought to have a legal claim against A - sometimes this will be a right to cancel the contract, sometimes it will be a right to claim damages from A as compensation for financial loss.

But in some situations, a right to claim damages is worthless (for example, where the claim lies against a company that has no assets) and sometimes cancelling the contract will be of no assistance (for example, where property that was the subject of the contract has passed into the hands of an innocent third party and cannot be recovered).

The remedy under the Companies Act for reckless or fraudulent trading Where a company, via a manager or director, has made the untrue statement that induced the contract, the Companies Act offers highly effective relief, by way of a legal remedy in circumstances where the telling of that untruth amounted to fraudulent or reckless trading.

The recent decision of the Cape High Court in Bid Financial Services (Pty) Ltd v Forster [2010] JOL 25090 (WCC) illustrates how the Companies Act can provide relief for the victim of deception in such a situation.

In this case, company A had entered into an agreement with company B in terms of which A took cession of (in effect purchased) the rights held by company B under certain rental agreements which were producing an income stream. The price paid by A to B was some R7 million.

Unbeknown to company A, company B had previously sold the self-same rights under those rental agreements to company C.

These facts came to light when company C went insolvent. One of the assets in its insolvent estate was those rental agreements which, in law, belonged to it, not to company A. Company A was now in the situation where it had paid company B a large sum of money, but had nothing whatever to show for it, since the rental agreements were, on the facts, undeniably the property of company C.

Company A's remedy lay in section 424 of the Companies Act of 1973.

The personal liability of an individual who participated in the company's fraudulent or reckless conduct. This section says, in essence, that if a company has carried on business recklessly or fraudulently, the court can declare any director or manager or any other person of the company who knowingly participated in that recklessness or fraud to be personally liable for the company's debts.

In this case, company A sued a director of company B on the basis of section 424, claiming that the director had known, at the time when company A purchased the rights under the rental agreement from company B, that those rights had already been sold to company C.

The court held that, although there was not enough evidence to show that the director in question had acted fraudulently (that is to say, dishonestly), the evidence showed that he had acted recklessly (in other words, with gross negligence).

The Cape High Court ordered that the director in question, having participated in the reckless conduct of company B's business, was personally liable to company A for repayment of the amount paid by company A to company B.

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