Directors’ liability and the section 218(2) civil action – in whose hands is the claim?

The action was brought by two shareholders of African Bank Investments Limited (ABIL) against ABIL’s directors for an order in terms of section 218(2) of the Act, holding the directors jointly and severally liable for damages suffered as a result of the diminution in the value of their shares in ABIL, on account of the directors’ alleged misconduct in relation to the affairs of the company.

Section 128(2) of the Act provides that any person who contravenes any provision of the Act is liable to another person for any loss or damage suffered by that person as a result of that contravention. Section 128(2) essentially provides a claimant with a civil claim against a person who has contravened the Act and thereby caused the claimant to suffer damages.

The shareholders alleged that, in breach of section 76(3) of the Act, the directors had failed to exercise their powers in good faith and in the best interests of ABIL, which resulted in the business of ABIL being carried out recklessly or with gross negligence in contravention of the provisions of section 22(1) of the Act. The shareholders further alleged that this caused ABIL to suffer significant losses, which in turn caused the ABIL share price to drop.

The shareholders alleged that the damages they suffered were a direct consequence of the directors having acted in bad faith, for ulterior purposes and without the requisite degree of care, skill and diligence as expected of them in terms of the Act, particularly in terms of section 76(3) of the Act.

The High Court findings

One of the pertinent issues which was largely debated by the court a quo was whether or not the shareholders could use the mechanism as provided for in terms of section 218 of the Act to bring such a claim against the company directors for their loss suffered as a result of the diminution of the shares.

The High Court stated that the section requires for a particular person to have suffered damage as a result of a particular contravention. What this means is that the particular person who has suffered damage must be a person who is able to invoke a claim for damages as a result of a particular contravention of the Act.

The court stated that a claim that alleges that directors are liable for damages as a result of a breach of section 76(3) must be brought in terms of section 77(2), which specifically creates the liability for a breach of section 76(3). The court went on to state that, where a statute expressly and specifically creates liability for the breach of a section, then a general section in the same statute cannot be invoked to establish a co-ordinate liability. It was emphasized that section 77(2) required claims for a breach of section 76(3) to be brought in accordance with the principles of the common law. A reflective loss claim cannot be brought under section 77(2) because the common law does not permit such a claim.

The High Court concluded that the shareholders could not rely on section 218(2) of the Act for their reflective loss claim. The shareholders’ action was dismissed and the shareholders took the matter on appeal.

SCA findings

The SCA accepted that there was a diminution in value of the shares held by the shareholders, that losses were caused to ABIL and that these losses were due to the alleged misconduct on the part of the directors.

The SCA however indicated that the issue to be considered was whether section 218(2) of the Act provides for a basis for a claim by the appellants, in their capacity as individual shareholders in ABIL, against the directors based on contraventions by the directors of section 22(1), 45 and 74 and breaches of section 76(3) of the Act.

The SCA stated that, where a wrong is done to a company, only the company may sue for damage caused to it. This does not mean that the shareholders of a company do not consequently suffer any loss, for any negative impact the wrongdoing may have on the company is likely also to affect its net asset value and thus the value of its shares. The shareholders, however, do not have a direct cause of action against the wrongdoer. The company alone has a right of action.

What a shareholder cannot do is to recover damages merely because the company in which he is interested has suffered damage. Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss.

The SCA went on to state that the principle is that, where harm is wrongfully caused directly to a company and indirectly to its shareholders, the law gives the right of action to claim compensation to the company. It does so because if, instead, the right were given to the shareholders, then the company and its creditors would be prejudiced. If both the company and the shareholder were given the right to recover, the wrongdoer would suffer “double jeopardy”.

Our law recognises the rule against claims for reflective loss, more particularly in respect of claims by shareholders for compensation for a diminution in the value of their shares due to loss occasioned to the company by a wrongdoer. The shareholders’ claims against the directors in this case are quintessentially reflective loss claims. Based on the the shareholders’ version of events, ABIL has a claim against the directors.

The court came to this conclusion on the premise that the shareholders presented no independent cause of action against ABIL. The alleged claim for wrongdoing in fact resonated with the company and not that of the shareholders.

The SCA stated that the common law position is that a director has to act bona fide and in the best interests of the company. The duties owed by the directors in terms of section 76(3) are owed to the company, not to individual shareholders. The company, in the event of a wrong done to it in terms of any of the provisions of that subsection, can sue to recover damages. The company would be the proper plaintiff. It is no coincidence then that section 77(2)(a) provides that a director of a company may be held liable for breaches of fiduciary duties resulting in any loss or damage sustained by the company.

The SCA concluded by stating that there must be a link between the contravention and the loss allegedly suffered. In the present case, loss was occasioned to the company and the company is the entity with the right of action. The SCA dismissed the shareholders’ appeal with costs.

Conclusion

Section 218(2) of the Act deals with liability to third parties (i.e. not only the company) and is very far-reaching in its ambit.

When it comes to directors’ liability, creditors and/or shareholders must ensure that they have a separate and distinct cause of action against the directors of a company when bringing claims against them. They must also ensure to rely on the correct provisions of the Act when instituting civil action, depending on the facts and circumstances of the specific case.

In terms of section 424 of the Act, and in a winding up of a company, directors can be held personally liable for the debts of the company where the business is or was being carried on recklessly or with intent to defraud creditors of the company. This is a remedy that is utilised quite a lot in practice and it is one of the most important mechanisms invoked by creditors and/or liquidators of companies during liquidations of companies unable to pay their debts.

It must be noted that liability under section 218(2) is not limited to situations where the company is placed in liquidation; it applies at all times, unlike section 424. Another difference is that section 218(2) read with section 22 does not make the director personally liable for the actual debts of the company, but instead he may be held liable for any “loss or damages” suffered by the third party as a result of the relevant contravention of the Act.

If a creditor or shareholder of a company is thinking about bringing legal action against the directors of a company to hold them liable for misconduct, we suggest that you first consult our Business Rescue, Restructuring and Insolvency team at CDH in order for us to guide you regarding directors’ duties and obligations under the Act, as well as which provisions under the Act you should be relying on for a claim against a director of the company.