Breach of Directors’ duties – how damaging are they to shareholders?

Breach of Directors’ duties – how damaging are they to shareholders?

On 3 July 2020, the Supreme Court ofAppeal ("SCA") delivered a significant judgment on the interpretation of the Companies Act relating to the liability of directors and auditors for claims by shareholders in Hlumisa Investment Holdings (RF) Ltd v Kirkinis 2020 JDR 1284 (SCA).

The High Court decision

The plaintiffs case was that from 2012 to 2014, the directors conducted the business of the Bank recklessly and in contravention of section 22(1) of the Companies Act 71 of 2008  as amended (the " Act"). In terms of hereof, a company must not carry on its business recklessly, with gross negligence, with the intent to defraud any person or for any fraudulent purpose. Under section 76(3), a director must exercise his/her power, he/she must do so in good faith and the best interests of the company. Also,  with the degree of care, skill and diligence that may be reasonably expected of a person carrying out the same functions, and having the general knowledge, expertise and experience of that director.

The plaintiffs alleged that these breaches resulted in significant losses on the part of the Bank, which in turn caused the share price of ABIL to fall from R28.15 per share to R0.31 per share. The plaintiffs' claims, which were jointly more than R2 billion, were based on the total diminution in the value of their ABIL shares.

The plaintiffs' relied on a statutory cause of action rooted in section 218(2) of the Act, which states: "Any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention."


The SCA decision

At the heart of the SCA's decision is the concept of separate legal personality, which is fundamental to company law. A company is an entity separate and distinct from its members. The loss sustained by a shareholder in the value of his/her shares is reflective of the loss suffered by the company. The shareholder does not bear any personal loss, but rather a decline in the value of the company.

The SCA affirmed that it is not merely the company's existence as a separate legal person that deprives the shareholder of action against the wrongdoer. What denies the shareholder of a right of action is the fact that the company has a right to recover damages for its loss.

The SCA agreed with the High Court's finding that, "where a wrong is done to a company, only the company alone may sue for damage caused to it" and that "shareholders … do not have a direct cause of action against the wrongdoer". 

The fiduciary duties owed by directors which are codified 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 section 76(3), can sue to recover damages under sections 77(2)(b) and 77(3)(b), meaning the company would be the “proper plaintiff”. 

For purposes of sections 218(2), the person who can sue to recover loss is the one to whom harm was caused. There must be a link between the contravention and the damage allegedly suffered. In this case, the alleged loss was occasioned to the company, and the company is the entity with the right of action.

Conclusion

This judgment is ground-breaking in affirming that under the Act:

  • directors do not owe fiduciary duties to shareholders, but to the company itself;
  • shareholders cannot claim from directors for their reflective loss suffered, save in very limited circumstances;
  • section 218 of the Act was not intended to alter the common law position that a shareholder cannot claim against a director for reflective loss;
  • an appropriate remedy for claimants in the position of the plaintiffs may be to pursue a derivative action under section 165 of the Act.

 

Joy-Marie Lawrence CD(SA) PCC (ICF)

Founder | Chartered Director | Leadership Coach |

4 年

Important lessons for all directors to remember. Thank you for sharing Nicolene Schoeman – Louw #boardofdirectors #shareholderactivism

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