The simultaneous application of section 424 (1) and section 22 (1) May 2017

By JEROME GRAY, Published in Company Law

The imposition of personal liability on directors for reckless trading may be regarded as an important prophylactic against gross mismanagement of the business and affairs of a company. The burden of personal liability in this regard is well placed if one considers that the management of a company's business and affairs is vested with its board of directors. However, South African corporate law currently regulates reckless trading under two different pieces of legislation, namely, s424(1) of the Companies Act No (61 of 1973) (1973 Act) and s22(1) of the Companies Act (71 of 2008) (2008 Act).

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Chapter XIV of the 1973 Act has been recycled by the 2008 Act, which has had the effect of preserving s424(1) but only during the winding-up and liquidation of a company. A major distinction between s424(1) and s22(1) is their contrasting potency, the upshot being that s424(1) may be a more attractive remedy from a creditor's perspective because of its punitive nature and its plaintiff-friendly predisposition.

Scope and application of s424(1)

Section 424(1) may only find application during the winding-up and liquidation of a company. The provision survives the repeal of the 1973 Act through the retention of Chapter XIV of the 1973 Act by s224 and Schedule 5 of the 2008 Act which restricts the continued application of Chapter XIV of the 1973 Act to the winding-up and liquidation of companies. Chapter XIV regulates the "winding-up of companies and amongst others things, personal liability of delinquent directors and other offences."

Three important observations appear from item 9 of Schedule 5 concerning s424(1) that are worth mentioning. Firstly, s424(1) is con- fined to the winding-up and liquidation of companies and, therefore, will not find application where a company is not being wound up and liquidated.

Secondly, s424(1) avoids the exclusionary effect of item 9(2) of Schedule 5 and applies during the winding-up and liquidation of solvent companies. Daffue J in Herman and Another v Set-Mak Civils confirmed that only sections 343, 344, 346 and 348 to 353 of Chapter XIV are excluded by item 9(2). Section 424(1), therefore, applies during the winding-up and liquidation of a company, whether solvent or not. Lastly, item 9 of Schedule 5 continues to apply until alternate legislation has been brought into force to regulate the winding-up and liquidation of companies.

The intention behind the transitional provisions encapsulated in item 9 was established in Standard Bank of SA v R-Bay Logistics CC. The court held that "[i]t is therefore clear that item 9 is intend- ed to serve only as a stop gap, until such new legislation is passed." No legislation has been passed to this effect and accordingly item 9 and, therefore, s424(1), remain extant. In summary, s424(1) is retained by the 2008 Act and applies during the winding-up and liquidation of solvent and insolvent companies.

Scope and application of s22(1)

Section 22(1) prohibits reckless trading, gross negligence and fraudulent trading, and a creditor may harness the s22(1) prohibition by making use of s218(2) of the 2008 Act. Section 22(1) is commonly assumed to be reserved for a company that is still trading. However, this assumption ignores the wide ambit of the provision. Section 22(1) will find application when a company is trading and during its winding-up and liquidation, whether solvent or not.

Its scope is substantially broader than that of s424(1) in that s22(1) is not confined to the winding-up and liquidation of a company. Notably, s22(1) applies notwithstanding the operation of s424(1). The broad scope of s22(1) fosters an overlap in application with s424(1), which allows for the two provisions to apply simultaneously during the winding-up and liquidation of a company. Reckless trading during the winding-up and liquidation of a solvent and insolvent company is, therefore, regulated by both s 424(1) and s 22(1).

Albeit beyond the scope of this article, the question that remains is why Chapter XIV of the 1973 Act was preserved in its entirety, thereby retaining s424(1) in the face of the ubiquitous ambit of s22(1)?

The s424(1) preference

When dealing with a claim for reckless trading against a director, I propose that a creditor of the company that is being wound up would invariably prefer to pursue s424(1) proceedings against the directors of the company for the following reasons:

  • Causation

A creditor pursuing a s424(1) claim would not have to allege or prove a causal nexus between the harm suffered by the creditor and the reck- less conduct of the director concerned. By contrast, s218(2) imposes a statutory requirement of causation. It has been argued that the inclusion of a causative requirement in s22(1) eliminates the punitive character associated with the reckless trading remedy shaped by s424(1).

  • No requirement to prove that actual harm or loss was suffered by the claimant

A s424(1) claim merely requires proof of the existence of a debt that a company is unable to pay to impose personal liability on a director. Actual harm or loss need not be proved. However, and in contradistinction, s218(2) requires actual harm or loss to be proved by a claimant for a claim for s22(1) reckless trading to be successful against a miscreant director.

(i) A simplified evidentiary burden

Section 424(1) operates to "supplement the common law and simplify the evidential requirements of a delictual claim which might be difficult if not impossible to prove." Bearing this in mind, it is arguable that s424(1) is designed to be easier to prove than a s22(1) claim instituted in terms of s218(2), particularly because a claimant is not required to prove causation and actual harm or loss.

Whilst s424(1) adopts a penal attitude towards reckless trading, s22(1), when read with s218(2), is comparatively lenient. The overlapping application of s424(1) and s22(1), coupled with the contrasting manner in which these two provisions regulate reckless trading, may foster an incentive for a creditor to elect the punitive s424(1) remedy as opposed to its s22(1) counterpart when a claim for reckless trading is pursued against a director during the winding up and liquidation of a company,. N

Gray is an Associate, Corporate Commercial and Litigation, VDMA.