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How does an aggrieved creditor of an insolvent company acquire evidence that it had been carrying on business recklessly?

A creditor's right to inspect the records of an insolvent company for evidence of reckless trading

A company, being a juristic person in its own right, is liable for its own debts and, as a general rule, its shareholders and directors have no personal liability for those debts if the company is unable to pay.

Naturally, creditors of the company are often aggrieved to learn that the company is insolvent and unable to pay their claims, and cast around for some legal basis on which to hold the directors personally liable for its debts.

The most valuable weapon available to creditors in this regard is the fraudulent and reckless trading provision of the Companies Act, namely section 424 of the Companies Act of 1973, which allows a court to declare those directors of a company who were party to the "fraudulent" or "reckless" decisions to be personally liable for some or all of the company's debts.

The onus of proof is on the aggrieved creditor to show that the company had indeed carried on business "fraudulently" or "recklessly" and to prove which of its directors were complicit in allowing it to do so.

How does the aggrieved creditor discharge that onus of proof? In particular, how does the creditor gain access to the financial records of the company which may contain evidence of such fraudulent or reckless conduct?

The most promising avenue is to request the Master of the High Court to convene an inquiry into the affairs of the company in terms of section 417 and 418 of the Companies Act of 1973. However, the Master would not agree to hold such an inquiry unless there is at least prima facie evidence of fraudulent or reckless trading by the company or some other improper conduct.

How is a creditor to acquire such prima facie evidence, given that all he is likely to have at this juncture is a mere suspicion of irregularities in the company's affairs?

In particular, how can a creditor gain access to the requisite documents and financial information of the company to see whether they show that the company was recklessly incurring further debts at a time when it was already insolvent?

The recent decision of the High Court in RAM Transport (Pty) Ltd v Replication Technology Group (Pty) Ltd (in liquidation) 2011 (1) SA 223 (GSJ) illustrates a valuable avenue that is open to a creditor in this situation, namely to apply to court for an order authorizing the creditor to inspect the records of the company.

Section 360(1) of the Companies Act of 1973 provides that (emphasis added) -

Any member or creditor of any company unable to pay its debts and being wound up by the Court or by a creditors' voluntary winding-up may apply to the Court for an order authorizing him to inspect any or all of the books and papers of that company, whether in possession of the company or the liquidator, and the Court may impose any condition it thinks fit in granting that authority.

This section of the Companies Act of 1973 remains in effect even after the coming into force of the Companies Act of 2008, and must be read in conjunction with section 22(1)(a) of the latter Act.

In the Ram Transport decision the court referred to earlier judgments which had cast doubt on whether this provision in the Companies Act can be relied on by an individual creditor who is seeking an advantage for himself rather than for the company's creditors in the generality.

In the present case, the court came to the conclusion that this section of the Companies Act gives the court a wide discretion and that, on the evidence before the court, the applicant creditor had established that it was entitled to inspect the books of the company in order to ascertain whether there were grounds to apply to the Master of the High Court to order an inquiry into the affairs of the company.

Consequently, this High Court decision does not go so far as to establish that an aggrieved creditor of an insolvent company will, in every case, be entitled to an order in terms of section 360(1) of the Companies Act of 1973. However, it is likely that where a company has gone into liquidation with debts far exceeding its assets, a court will not require much persuasion that such an order should be granted.

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