Hypothetical scenario:

A company’s board of directors consists of three directors.

Two of the three directors are the sole shareholders of the company.

The two directors which are shareholders wish to declare and pay a distribution (a dividend).

The third director which is not a shareholder does not believe that the company has sufficient finds to declare a dividend.

Question:

What should the third director do?

Applicable Law:

Section 46(1) of the Companies Act No. 71 of 2008 (“the Companies Act”), provides that a company must not make any proposed distributions unless –

  1. the distribution is pursuant to an existing legal obligation of the company or the board of the company has authorised the distribution by a directors resolution;
  2. it reasonably appears that the company will satisfy the solvency and liquidity test  immediately after completing the proposed distribution; and
  3. the board has acknowledged that it has applied the solvency and liquidity test and reasonably concluded that the company will satisfy such test immediately after completing the proposed distribution.

Section 46(6) provides that a director of a company is liable to the extent set out in section 77(3) if such director was present at the meeting when the board approved such distribution, or participated in making the decision and failed to vote against the distribution, despite knowing that the distribution did not satisfy the requirements of section 46(1).

Section 77(3)(e) holds a director liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director having been present at or participated in a meeting and failing to vote against a resolution approving a distribution, despite being aware that the distribution was contrary to section 46.

Section 77(4) (a) limits the liability in terms of section 77(3)(e) and provides that such liability arises only if immediately after making all of the distribution contemplated in such a resolution the company does not satisfy the solvency and liquidity test and it was unreasonable at the time of the decision to conclude that the company would satisfy the solvency and liquidity test after making the relevant distribution.

Section 77(4)(b) furthermore limits the liability of a director to the difference between the amount by which the value of the distribution exceeded the amount that could have been distributed without causing the company to fail to satisfy the solvency and liquidity test and the amount recovered by the company from persons to whom the distribution was made.

 

dividend

Conclusion

On the assumption that the two directors which are also shareholders of the company vote in favour of the resolution to make the distribution and further resolve that the company satisfies the solvency and liquidity test the third director may take the following course of action: 

  1. 1.    Director failed to vote against decision

If the third director was present at or participated in the resolution authorising the distribution that director can be held liable in terms of section 77(3)(e), however such director may apply to a court for an order setting aside the decision of the board in terms of section 77(5).

In terms of section 77(5)(b) the court may make an order that is just and equitable in the circumstances, including an order to rectify the decision, reverse any transaction, or restore any consideration paid or benefit received by any person in terms of the decision of the board and requiring the company to indemnify any director who has been or may be held liable in terms of this section, including indemnification for the costs of the proceedings under section 77(5) of the Companies Act.

  1. 2.    Director voted against the decision

It the director voted against the decision the director will not be held liable in terms of section 77(3)(e) and therefore it is of paramount importance that directors who find themselves in such situations ensure that they expressly vote against such decisions and ensure that their objections are duly recorded in the minutes of the meeting.

If the distribution has not yet been paid to the shareholders, a director may in terms of section 20(4) apply to the High Court for an appropriate order restraining the company from doing anything inconsistent with the Companies Act.

Alternatively once the distribution has been paid the director may either:

  • in terms of section 165(2), serve a demand upon the company to commence legal proceedings in terms of section 77(5) (see above);
  • in terms of section 165(6) (in exceptional circumstances), apply to a court for leave to bring proceedings in terms of section 77(5) (see above) in the name and on behalf of the company without first making a demand as contemplated in section 165(2); or
  • to file a complaint in writing with the Commission in terms of section 168.