LEGAL EAGLE | 'Must I tell on my company?'
“I am a director of a computer hardware company. Sales have been going steadily down the last few months, and we are concerned about whether we can pay our suppliers and staff. I’m not sure whether this situation will change, and rather expect it to worsen, but it could change. What are my responsibilities towards the business and our shareholders under these circumstances?”
Directors of a company are in a fiduciary position and have to exercise care, skill, and diligence in the performance of their duties. Directors occupy a position of trust and are therefore obliged to display the utmost good faith towards the company in any dealings on behalf of the company. This raises an important question, namely to what extent is a director required to disclose that a company is in financial distress. Here the Companies Act 71 of 2008 (the “Act”) gives guidance and defines “financial distress” as:
- circumstances where it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months; or
- circumstances where it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months.
In such an event, the board of directors of the company may resolve that the company voluntarily starts with business rescue proceedings to try and rehabilitate the company and place the company under the supervision of a business rescue practitioner.
Notice of such a resolution and its effective date must, within five business days after the company has adopted and filed a resolution, be provided to all affected persons (such as creditors) and the company must then also appoint a business rescue practitioner under the requirements of the Act.
Where the board of directors elects not to commence with business rescue proceedings, the board must still deliver a written notice to each affected person, informing them that the company is financially distressed, as well as their reasons for electing not to commence with business rescue proceedings.
The Act, therefore, places a duty on the board of directors of a company to inform affected persons when the board becomes aware of or reasonably believes that the company is in financial distress. Any failure by a board to report the financial distress of a company could, therefore, amount to reckless trading and conducting the company’s business to defraud creditors.
Directors of a company can also be held personally liable in terms of the Act for any loss, costs or damages sustained if directors permitted the carrying on of the company's business knowing that such carrying on of business is done recklessly, with gross negligence, and/or with intent to defraud any person.
If your company distress falls within the financial distress test of the Act, you will have an obligation to notify affected parties of this status. It would be advisable to contact your attorney to help assess your options and assist with any reporting obligations you may have.
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