Roodt Inc South Africa
Block A 7 Eton Road Sandhurst Johannesburg
Tel +27 11 685 0000
info@roodtinc.com
Johannesburg Office
JOHAN ROODT
jaroodt@roodtinc.com
UK Office
JOHN COHEN
jcohen@roodtinc.com

A claim against a director or manager for being party to reckless or fraudulent trading will be extinguished if not enforced within three years.

Is a claim against a director or manager for reckless or fraudulent trading by a company or close corporation subject to extinction by way of prescription?

Where a company or close corporation engages in the "reckless" or "fraudulent" carrying on of business, section 424 of the Companies Act 71 of 1973 and section 65 of the Close Corporations Act 69 of 1984 empower the court, on the application of a creditor, to declare those persons who knowingly took part in the managerial decisions authorising such reckless or fraudulent conduct to be personally liable for the debts of the company or close corporation.

In terms of new Companies Act 71 of 2008, which is not yet in force, a director or perceived officer of the Company is personally liable for costs, losses or damages which a company suffers or incurs, directly or indirectly, if that director has acquiesced in the carrying on of the company's business despite knowing that the Company is trading fraudulently, recklessly or in insolvent circumstances.

These statutory provisions will, in such circumstances, enable a company to recover such costs, losses or damages from such directors or officers or a creditor of a company or close corporation that has become insolvent to enforce the debt against those directors or managing members in their personal capacity.

In any situation, under current legislation, where the insolvency of a company or close corporation has resulted in irrecoverable debts, a creditor should therefore immediately investigate whether a case can be made for such a declaration of personal liability.

A vital question is - does a creditor's claim in this regard prescribe, that is to say, is it extinguished by law if it is not enforced within the three year prescriptive period? If so, when do those three years start running?

The answers to these questions were provided in the judgement of the Cape High Court in the case of Burley Appliances Ltd v Grobbelaar 2004 (1) SA 602 (C).

In this case, the court held that section 64 of the Close Corporations Act and section 424(1) of the Companies Act 61 of 1973, referred to above, have the effect of creating a new right in favour of the creditors of a company or close corporation - namely a right to apply to court for a declaration of personal liability for the company's or the corporation's debts - and that this right comes into existence as soon as "it appears" that any business of the company is or was being carried on recklessly or fraudulently.

Section 12 of the Prescription Act of 1969 provides that the prescriptive period of three years does not commence running until the creditor has knowledge of the identity of the debtor and of the facts from which the debt arises, but that a creditor is deemed to have such knowledge if he could have acquired it by exercising reasonable care.

These are the principles which determine the time when the three year prescriptive period begins to run in respect of a claim that a company's directors or a cc's managers should be declared personally liable for its debts on the grounds that they were party to reckless or fraudulent trading.

In short, therefore, an unpaid creditor of an insolvent company or close corporation should immediately commence investigations to establish the identity of its directors or managers at the time the debt in question was incurred, and attempt to ascertain facts which establish that the company or cc had been carrying on business recklessly or fraudulently.

Usually, recklessness in this context is proved by showing that the debt in question was incurred at a time when the company was already insolvent, with no reasonable prospect of being able to pay any new debts.

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