THE MILD, MILD WEST: A horse named Crypto

THE MILD, MILD WEST: A horse named Crypto

Space: the final frontier. Not too long ago, the expanse of central North America was seen as such a frontier line. In time, railroads, telephone wires and highways sketched their lines across its unspoiled canvas, setting the stage for future generations to draw poor analogies about the connectivity of Western society from a computer down in Southern Africa. After getting acquainted with our place amongst the stars, we set our sights outwards for new analogies to butcher.

The American frontier. The Wild West. It immediately conjures up imagery of saloon shoot-outs, train robberies and cowboys. Perhaps a result of indulging in too many Westerns, but nevertheless a consequence of doting on the subject. Harsh, untamed and seemingly lawless, the Wild West was, well, wild.

With cleaver in hand, let’s compare this to South Africa’s crypto asset regulations. This analogy has done the rounds quite a bit and I’m definitely not breaking new ground in following suit. Its aptness remains evident (new territories; unexplored opportunities; the dangers that insufficient infrastructure and ill-willing individuals may pose – you get the picture) and doesn’t really need these explanators to drive the point home. But seeing as there are new developments happening in crypto here in South Africa, it may just be excusable to give this analogy one more spin.

South Africa has been cautious to try and tame crypto for quite some time now. Over several years, its nature and mannerisms were scrutinised and we have finally, it would seem, come to a conclusion – albeit being in draft format and only hinting at things to come: late in November of 2020, a draft declaration delineating crypto assets as a financial product was issued. Public comments closed near the end of January 2021. The wheels are in motion.

Backing the right horse: Assets and Currency

The draft declaration provides for a “crypto asset” definition as well, which emphasises South Africa’s continued aversion to seeing crypto assets as crypto “currency”. Although the average consumer would view these as synonymous terms and reference them interchangeably, there’s meticulous reasoning behind viewing crypto assets as crypto assets rather than crypto currencies. Although it may just be semantics for some, considering crypto assets as a currency is not something South Africa seems to be ready for yet.

Divergence exists the world over as to what legal status crypto assets should be given, and pinning a “currency” tail to something has more implications than its colloquial usefulness where it isn’t recognised as readily exchangeable. So although South Africa isn’t requiring your local saloon to accept Bitcoin in lieu of ZAR just yet, it’s at least come to terms with the fact that crypto may be here to stay.

It should be noted that the declaration is most likely only the tip of the iceberg of crypto regulations in South Africa. The press release following the draft declaration states that “[t]he draft Declaration is merely intended to be an interim step in mitigating certain immediate risks in the crypto assets environment pending the outcome of broader developments currently taking place through the [Crypto Asset Regulatory Working Group] which will inform future policy interventions to be implemented across a variety of regulators and laws.

Blazing new trails with trusty horseshoes: Financial products and FAIS

Slotting crypto assets into the “financial product” definition cannot be said to be surprising – there’s already massive differences between the different financial products that are currently being combed with the same brush. In addition, when considering Conduct of Financial Institutions Bill’s (COFI) expansion on the financial product definition, this approach in a regulatory sphere that is progressing towards streamlining regulatory authorities, is almost expected.

While some are strong advocates of cryptocurrency being used as a form of, well, currency, others treat crypto assets in a way that can somewhat be compared to trading in stocks. Whether these positions are two sides of the same coin or not (pun intended), the treatment of crypto assets, at least more recently, has resulted in extreme fluctuations in large amounts of value. With a two-day window allowing for double-digit percentage fluctuations, one can hardly say that changes are negligible.

It is within this tumultuous, new and exciting yet confusing environment that consumers are at risk of running into trouble. Only days after comments on the draft regulations were closed, the FSCA issued a press release stating that it is receiving a large number of complaints from consumers aggrieved with losing savings to scams premised in crypto assets or through crypto investments they did not fully understand.

The statement goes on to say that “[c]rypto-related investments are not regulated by the FSCA or any other body in South Africa. As a result, if something goes wrong, you’re unlikely to get your money back and will have no recourse against anyone.” It is this exact position that is sought to be changed by including crypto assets within the FSCA’s ambit by denoting it as a financial product.

Accordingly, South Africa has taken an approach that, in comparison to the current position, will essentially herald the FSCA’s arrival as sheriff to the scene. FAIS is a battle-hardened piece of sectoral legislation, so having crypto assets included in its ambit is a big step forward for consumer protection. And with promising prospects of further regulation on the horizon, the corralling of crypto assets into the financial product pen is just the start. Putting the reigns on crypto assets through directly involving the FSCA may be just the thing that is needed to bring some order to the wild.

Minimal Mercy for Miscreant Marauders: Delinquency Orders for Directors and the Effects in terms of the Companies Act

Minimal Mercy for Miscreant Marauders: Delinquency Orders for Directors and the Effects in terms of the Companies Act

One of the most significant innovations of the Companies Act No. 71 of 2008 (“Companies Act“) includes an order declaring a director a delinquent in terms of section 162 of the Companies Act. This powerful protective remedy “ensure[s] that those who invest in companies are protected against directors who engage in serious misconduct of the type that violates the ‘bond of trust’ that shareholders have with the people they appoint as directors” (Gihwala and Others v Grancy Property Limited and Others, 2017).

Recent articles on our blog discuss director duties as set out in the common law and section 76 of the Companies Act. What this should make you recognise is that this represents the one side of the coin, being the duties that are owed to the company and its true stakeholders. On the other side of the coin, however, are the consequences of such actions. One is a declaration of delinquency or probation in terms of section 162.

The object of this section clearly establishes such an order as a protective remedy in the public interest. The remedy provides an applicant with protection from a director that proves unable to manage the business of a company or has failed or neglected their duties and obligations owed to a company. In other words, the remedy not only protects the applicant but serves to protect other companies from the delinquent director’s conduct as well.

This remedy takes the form of a court application for an order declaring a director a delinquent, the result being a prohibition on being a director for any company for seven years, or even indefinitely in serious cases, being placed on a register of delinquent directors and, as an “automatic inherent effect of such a declaration” (Kukama v Lobelo, 2012), a director found guilty of such conduct shall automatically be removed from any current board seat held.

What is interesting to note is that this amounts to an indirect manner for the removal of a director from a company and it does not matter what the subjective motive of the applicant is; if there is objective merit for delinquency this may be a viable way to remove a director, even if the sole motive of the applicant is to have the director removed by a court (Msimang NO and Another v Katuliiba and Others, 2013).

Following from the above, it is, of course, important to recognise who can bring an application for delinquency. Quite a wide net is cast in this regard, which may include the company itself, a director, shareholder, company secretary or a prescribed officer of a company. The right to initiate such an application goes even further and includes a registered trade union that represents the employees of the company or another employee representative, the Companies and Intellectual Property Commission, the Takeover Regulation Panel and, to a limited extent, an organ of state responsible for the administration of any legislation.

There is a distinction in the application of Section 162 as it relates to an order of delinquency and an order for probation. Whereas an order for probation requires a court to apply its discretion, an order of delinquency does not require such discretion, meaning that, for purposes of an order of delinquency, a court must declare a director delinquent if one of the following grounds are established as provided in the Companies Act, this being considered by the courts as a substantive abuse of power (in terms of sections 162(5)(a),(b),(d),(e) and (f)):

  • consenting to serve as a director, or acting in the capacity of a director or prescribed officer, while ineligible or disqualified in terms of the Companies Act;
  • while under an order of probation, acting as a director in a manner that contravened that order;
  • repeatedly being subject to a compliance notice or similar enforcement mechanism;
  • being convicted twice personally of an offence or being subject to an administrative fine or penalty in terms of any legislation; or
  • within a period of 5 years, being a director of one or more companies or being a managing member of one or more close corporations, or controlling or participating in the control of a juristic person (irrespective of whether concurrently, sequentially or at unrelated times) that was convicted of an offence or subjected to an administrative fine or similar penalty in terms of any legislation.

The Companies Act, furthermore, provides for more substantive abuses under section 162(5)(c) of the Companies Act, the confirmation of which will result in an order for delinquency as well and includes:

  • gross abuse of the position, while acting as a director;
  • taking personal advantage of information or an opportunity, or intentionally or by gross negligence inflicting harm on the company or a subsidiary of the company, contrary to section 76(2)(a) of the Companies Act; or
  • acting in a manner that amounts to gross negligence, wilful misconduct or breach of trust or in a manner contemplated in sections 77(3)(a), (b) or (c) of the Companies Act (unauthorised acts, reckless trading or fraud).

Of interest is the repetition of sections 76 and 77 of the Companies Act in the above-mentioned grounds, which refers to the fiduciary duties of directors and their personal liability. What this means is that, in addition to personal liability, it is possible for a director to also be declared delinquent. This remedy takes the common law duties of directors, which have been codified in section 76 of the Companies Act, and gives them teeth – quite significant teeth.

Regarding the grounds recorded in section 162(5)(c), case law has provided a significant amount of guidance and it is clear that the common law principles codified in sections 76 and 77 of the Companies Act continue to steer the courts’ approach, these being regarded as substantive abuses of office, leading to a lack of genuine concern for the prosperity of a company (Grancy Property Limited v Gihwala, 2014).

Regarding gross abuse of the position of director (see section 162(5)(c)(i) of the Companies Act), a court will have to use its discretion as to whether a gross abuse is present, this term not being defined in the Companies Act. However, an abuse must relate to the use of the position as director and not relate to the performance of the director. An example of such an abuse would include the usurping of confidential information or a corporate opportunity meant for the company and using this for the director’s personal advantage, whether for another company or personally (Demetriades and Another v Tollie and Others, 2015), this amounting to a breach of a director’s fiduciary duties, irrespective of whether the actions undertaken by the director have caused harm to the company or not. This seems to overlap closely with the common law corporate opportunity rule (which has been codified to a certain extent in section 76 of the Companies Act) and which dictates that any contract, opportunity or information that arises for a company, irrespective of whether it could be taken up or used by a company or not, belongs to the company and a director is prohibited from usurping the aforementioned for him or herself.

Taking personal advantage of information or an opportunity meant for a company (see section 162(5)(c)(ii) of the Companies Act) is a ground similar to the above-mentioned ground of abuse, however, it is narrower in that it applies only if a director usurped information or an opportunity meant for a company, for the personal advantage of the director as a natural person. To date, courts have found this ground to be present for two dominant types of conduct, one being the appropriation of a business opportunity that should have accrued to the company and secondly, insider trading.

The grounds established in terms of sections 162(5)(c)(ii) and (iv) of the Companies Act, being the infliction of harm intentionally or by gross negligence and/or breaching trust, whether directly or indirectly places an element of discretion on the court. In effect, conduct aimed at harming a company or recklessness while aware of the harm that certain conduct may cause, will be used by the court to navigate the relevant questions in this regard. Actions which could result in the presence of these grounds could include the conducting of a business by a director in competition with a company that he or she is also a director of, the misappropriation of company funds, the failure to keep proper accounting records and possibly the appropriation of financial benefits for certain directors to the exclusion of shareholders. What is important to note is that the court will take into consideration holistically the actions undertaken by a director and will have to establish whether or not such action amounts to wilful misconduct or gross negligence, thereby intimating of course that a bona fide mistake or error will not automatically result in an order for delinquency. What is required is more, namely gross negligence, wilful misconduct or a breach of trust.

Further common law rules that may influence the above-mentioned grounds (in addition to the corporate opportunity rule) may include the common law no-conflict rule and no-profit rule. In terms of the no-conflict and no-profit rule, which to an extent overlaps, a director owes a company a fiduciary duty not to place themselves in a position in which there may be a conflict between their personal interests and the interests of a company. Furthermore, profits made by a director acting in that capacity are for the company and cannot be retained by him or her, resulting in those profits having to be disgorged. It is important to note in such circumstances that ‘profit’ is not only limited to money but could be any advantage or gain experienced by a director and, furthermore, it is irrelevant whether a company could have secured the particular profit for itself.

This discussion should clarify that a director acts as an extension of a company and therefore has more strict obligations placed upon his or her shoulders when compared to an agent, for example. It goes further in that a core misuse of this position for his or her own benefit or a serious conflict can be responded to with severe consequences. Many individuals think that they can use a company and play the victim card thereby side-stepping personal liability, in legal terms, hiding behind the corporate veil. However, you can note from the above that the Companies Act does indeed have some teeth and, depending on the veracity of the grounds, a court will not and, to a certain extent, cannot hesitate when relevant grounds for delinquency are proven and if they do, may a Judge have mercy on your miscreant soul.

What’s up with the WhatsApp hysteria?

What’s up with the WhatsApp hysteria?

I recently asked my teenage daughter whether she has accepted the new WhatsApp terms. Her answer: “Not sure. Probably.” In response, I asked whether she at least read the terms and conditions. “What’s the point Mom? You HAVE to accept them if you want to use the service.” So much for having a privacy lawyer as a mother.

Since the announcement of the changes to the terms, we have read lots of articles and, literally, thousands of users have expressed their views on various platforms – to such an extent that WhatsApp postponed the implementation of the new rules to a later date. Our own Information Regulator has also indicated that discussions with Facebook SA would be required to consider the changes against our own Protection of Personal Information Act requirements, which will take effect on 1 July 2021.

What are the facts?

  • WhatsApp currently makes use of end-to-end-encryption, which means that only the recipient of a message can actually read the content of the message. If the message somehow gets intercepted on the way to the recipient, the interceptor will not be able to read the message. This will not change under the new terms.
  • WhatsApp will not share the content of user messages with Facebook (or any other party for that matter).
  • Under the current terms, WhatsApp already shares some user information (not message content) with Facebook, unless the user opted out during a short period allowed for in 2016. This means that if you did not use this opt out in 2016, the information has already been and can still be shared in terms of the current privacy policy.
  • Under the new terms, users will still have some choices around privacy setting. For example, location data will only be shared if you agree to it.
  • If you do not agree to the changes before the implementation date, you will not be able to continue using WhatsApp.

What are the learnings?

  • WhatsApp took an approach of transparency and disclosure to inform users of the coming changes. Being transparent about the use of data is a general privacy law requirement.
  • Lots of users, however, responded negatively to the announcement – almost as if they realised for the first time that their data is being used in some way or another.
  • Following from this, it is probably fair to say that users have and are becoming more aware of their privacy rights.
  • It can therefore be expected that users will consider privacy policies and statements more carefully in the future when deciding whether or not to sign up for a service.
  • It is likely that users will have more questions around privacy matters than in the past.
  • Companies should gear themselves toward full compliance with applicable privacy law requirements and have the necessary resources available to deal with privacy matters raised by their customers.

The discussions also raise interesting questions around consent to use personal information:

  • What does consent really mean?
  • Can a company force me to give consent if I don’t want to?
  • What happens if I don’t give consent?
  • What does consent really entitle them to do with my information?
  • Is it possible for them to use my information if I don’t give consent?

We will delve more into the topic of consent in a future article.

In the meantime, make sure you read and understand the privacy terms of the services you sign up for. If you cannot live with it, just don’t sign up – simple as that.

If you would like to receive a document indicating the changes from the current to the new WhatsApp privacy policy, you can email us on info@dommisseattorneys.co.za.

Part 3: My general knowledge, skills and experience of running a company need work, but I’m already in the hot seat making decisions…

Part 3: My general knowledge, skills and experience of running a company need work, but I’m already in the hot seat making decisions…

This article is the last in our three-part series on company directors.  As we’ve discussed in the previous articles, directors have several duties, namely:

  • to act in good faith;
  • to avoid conflicts of interests;
  • to act for a proper purpose; and
  • to act in the best interests of the company.

In this article we will discuss how each of these duties are qualified by the fact that directors, in the course of carrying out their duties, can only be expected to act with similar care, skill and diligence that would reasonably be expected of a person carrying out the same functions in relation to the company as those carried out by that director, having a similar level of general knowledge, skill and experience of that director.

The starting point is that all directors are expected to carry out their duties honestly, in good faith and for a proper purpose, without exception. However, the yardstick used to assess whether each duty was carried out effectively will differ on a case by case basis. This assessment will be dependent on the general knowledge, skill and experience of that particular director. This means that your actions as a director will effectively be tested in light of your ability and your knowledge of the company and how it operates.

On that basis, it is accepted that not all directors have the same skills and experience, and not all directors have the same understanding of how companies function. Naturally, this raises the question as to what can be expected of different directors (who have different backgrounds and experience) when it comes to determining whether they have acted appropriately in any given circumstance.

In the case Fisheries Development Corporation of SA Ltd v AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W), the court clarified that the test is applied differently to different directors, stating that the “extent of a director’s duty of care and skill” depends on the “nature of the company’s business and the particular role played by the director”. There is a different expectation between the so-called full-time or executive director, who participates in the day to day management of the company’s affairs, and the “non-executive” director who is not an employee.

In other words, a different expectation will be applied to each of these categories of directors. A non-executive director is not expected to give continuous attention to the affairs of the company and has an intermittent (even part time) relationship with the company. Therefore they would not be expected to have the same level of knowledge as the executive director, who is involved in the day to day operations of the company, and so more is expected of them.

Courts have acknowledged that directors do not have to have special business acumen in order to be a director, highlighting the subjective nature of the test. In carrying out a director’s duties, directors may assume that employees, professional advisors, and company officials acting under the board’s instruction will perform their duties honestly unless they have proper reasons for querying this.

If a director takes a decision which, in hindsight, turns out to have been a poor decision, directors can rely on the “business judgement rule” which provides directors with protection from liability to the company incurred as a result of a poor decision, provided that the director:

  • took reasonably diligent steps to become informed about the matter;
  • had no personal financial interest in the subject matter of the decision (and had no basis to know that any person/entity related to the company had a personal financial interest in the company); and
  • had a rational basis for believing that the decision was in the best interests of the company at the time.

If there is a dispute over whether the decision taken by the director was in the best interests of the company, the courts will apply the “business judgement rule” by considering what the director believed at the time in light of their general knowledge, skills and experience.

With this in mind, directors will be protected by the law if, relying on their skills and experience, they approach company related decisions by taking intentional steps to become properly informed about a matter, remain aware of and avoid any conflicts of interest, and ensure that there is a rational basis for believing that their decisions are in the best interest of the company at that time.

Your service agreements, The CPA and ECTA

Your service agreements, The CPA and ECTA

Following on from a previous article on service agreement essentials, this article considers some of the important provisions of the Consumer Protection Act 68 of 2008 (“CPA“) and the Electronic Communications and Transactions Act 25 of 2002 (“ECTA“) that will likely apply when your customer qualifies as a ‘consumer’ (in terms of consumer laws). These should be carefully considered when preparing your service agreement, customer policies or terms and conditions.

A CPA ‘consumer’ is an individual or juristic person (company or CC) with an asset value or annual turnover that does not exceed R 2 000 000 and usually applies to all transactions between suppliers and consumers. ECTA applies to electronic transactions and does not differentiate between individuals and juristic persons, so applies to both. Unless an agreement is specifically excluded from the ambit of the CPA and/or ECTA, these acts will apply wherever the customer is a ‘consumer’. In our view, some of the important provisions of the CPA and ECTA to bear in mind when contracting with consumers and preparing your service agreements, are sections 14 (Expiry and renewal of fixed-term agreements) and 17 (Consumer’s right to cancel advance reservation, booking or order) of the CPA, and sections 42 (Scope of application) and 44 (Cooling-off period) of ECTA.

If a transaction is concluded electronically, and ECTA applies, the supplier will also need to comply with other ECTA obligations. These include providing the consumer with certain information set out in section 43. This calls for the disclosure of certain information about the supplier and requires the supplier to provide the consumer with an opportunity to review the entire transaction and costs and withdraw from the transaction before placing the final order. For online transactions, systems therefore need to enable this.

Returns and cooling off rights (for non-defective goods and services)

A cooling off right allows a consumer to return goods or cancel an order for services without reason where the consumer has simply changed his/her mind. Consumers have a “cooling off” right, but only in the following circumstances:

  • For sales that are not concluded online, there is a 5 day cooling off period for sales resulting from direct marketing. This means that the supplier directly approached the customer to sell him/her the goods and the customer bought the goods as a result of the direct marketing. This is a right in terms of section 16 of the CPA and allows the consumer to return the goods within 5 business days of delivery or cancel the transaction 5 business days after it was concluded.
  • If an online sale, ECTA provides a 7 day cooling off period (and there is no direct marketing requirement as per the CPA), but there are some exceptions to this cooling off right and not all goods/services can be returned. For services, the cooling off right lapses as soon as the services are used, and certain other transactions are also excluded from the cooling off right including certain financial services, auctions, consumable foods, customised goods, software that has been unsealed by the consumer, newspapers, periodicals, magazines and books, gaming and lottery transactions (see section 42(2) of ECTA).

In these cases, the customer has the right to a full refund when returning the goods within the prescribed period, but the customer will have to pay the costs associated with returning the goods to the supplier.

It is important to remember that the return policies of suppliers and retailers generally provide extended rights to consumers. If the consumer is returning goods outside his/her CPA/ECTA rights, then the terms of the return policy of the supplier will apply and both the consumer and the supplier will need to comply with those terms. This means that if, as the supplier, you offer better return rights than those provided for in the CPA/ECTA, you will be bound by the more generous terms offered in your returns policy.

Cancellation fees and deposits 

Section 17 provides that a supplier may require a deposit to be paid for an advance booking, reservation or an order for goods or services that will be supplied at a future date, and furthermore that a supplier may charge a reasonable cancellation penalty if the consumer cancels the advanced booking, reservation or order.  What is reasonable depends on the circumstance, but the cancellation penalty will be unreasonable where it exceeds a fair amount. To determine what is fair in the circumstances, the supplier must consider the nature of the booked goods or services, the length of notice, the potential to find an alternative customer and general industry practice.

Fixed term agreements

Fixed term contracts are very common and often a valuable mechanism that can be used by a supplier to ensure guaranteed income for a minimum period. These agreements are subject to the terms set out in section 14 of the CPA, which requires both suppliers and consumers to comply with specific requirements regarding the maximum term of the agreement, termination (before the agreed term ends), notice periods and cancellation fees.

The maximum duration of a fixed term agreement is 24 months, however this term can be extended where the additional period is to the consumer’s financial benefit. A common example of this is a cell phone contract that extends over 36 months, thereby allowing the consumer a longer period to pay for the device.

A consumer may cancel a fixed-term agreement on the expiry of the agreement without penalty (the consumer will remain liable to the supplier for any amounts owed to the supplier under the agreement until the date of cancellation), or at any other time (during the fixed term) by giving the supplier 20 business days of notice. Where the agreement is cancelled before the end of the fixed term, the supplier may charge the consumer a reasonable cancellation penalty. A cancellation penalty must be reasonable and must not have the effect of negating the consumer’s right to cancel the fixed term agreement. The regulations to the CPA have set out a list of aspects that must be considered when determining what a reasonable cancellation penalty would be.

A supplier may also cancel a fixed term agreement, but only if the consumer has breached the agreement. If the agreement has been breached (for example, the consumer hasn’t paid the monthly fee), the supplier must give the consumer written notice that the agreement will be cancelled if the consumer does not remedy the breach (pay the monthly fee) within 20 business days. In that case, the consumer will still be liable to the supplier for any amounts owed to the supplier at the date of cancellation.

If you have a fixed term agreement, you will also need to consider section 14 if your agreement automatically renews for additional fixed terms or continues on a month to month basis after the initial fixed term ends.

*Importantly, section 14 of the CPA does not apply to fixed term agreements where the consumer is a juristic person, regardless of the annual turnover or asset value of the juristic person.

Conclusion

The above sections of the CPA and ECTA are only a few of the important aspects to consider when preparing your service agreement, and the pertinent sections will differ depending on your specific business and industry. It is important to make sure that your policies on returns, booking fees and deposits (and when these would be forfeited) are set out clearly and that your customer is aware of and understands these policies. If entering into fixed term agreements, you need to ensure that your cancellation penalty is reasonable and that your customer understands both the implications of them cancelling the agreement prematurely and what will happen at the end of the fixed term.

Get in touch to discuss these aspects and other important CPA and ECTA provisions that may be applicable to your business.

Part 2: Directors – the duty to act in good faith and in the best interests of the company

Part 2: Directors – the duty to act in good faith and in the best interests of the company

Directors of companies have a unique “fiduciary” role. A fiduciary, acting on behalf of stakeholders and in relation to a company, is in a position of power, trust and confidence with respect to the company and is required to act solely in the interests of the company, whose rights it must protect.

As mentioned in the first article of our series, the fiduciary is a concept developed in law as having the following duties (set out in the Companies Act):

  • the duty to act in good faith;
  • the duty to avoid conflicts of interests;
  • the duty to act for a proper purpose; and
  • the duty to act in the best interests of the company.

It is helpful to understand each of these concepts by looking at how they are tested when a director’s actions are measured by a court.

The first element of good faith is quite subjective. This means that the courts will go through a process of enquiring whether the director genuinely believed that his/her conduct was in the best interest of the company. When making this decision, courts will take into account:

  • the relevant facts available to the director at the time;
  • his/her level of skill;
  • the expected level of diligence and care in such a situation; and
  • whether their actions were reasonable.

A proper purpose is not defined in the Companies Act, however the courts’ approach is to test whether the directors exercised their powers for an objective purpose. The court will first look for factual evidence (i.e. objective evidence) for the purpose of the director’s appointment. This will largely involve understanding the purpose of the company by looking at its Memorandum of Incorporation, shareholders agreement and historical decisions by shareholders and the board (through written resolutions). Once the courts understand the purpose of the company, and how the director’s appointment was intended to further that purpose, they can then test the director’s actions against this.  If the director’s actions do not have any rational link to furthering the company’s purpose, their actions may be considered to have been for an improper purpose.

A director’s fiduciary duties extend to the duty not to place themselves in a position where their personal interests conflict, or may conflict, with their duty to act in good faith. An obvious and important element of this duty is the obligation not to compete with the company and to avoid a conflict between a director’s interests and the interests of the company.  Effectively, this means that every director has an automatic non-competition obligation with the companies that they serve.

Acting in the best interests of the company means to act for the benefit of the company as a whole. There has been much debate as to what this means. However, this does not mean just acting in the best interest of the shareholders. Rather, this can also mean acting in the interests of “stakeholders” including employees and creditors.

There are various approaches to determine what directors should take into account when making decisions on behalf of the company, and whether the factors taken into account should have regard only for the benefit of shareholders or for the benefit of all stakeholders. The King Code, which is only mandatory in respect of listed companies, has attempted to clarify this by promoting the principles of corporate social responsibility, which require companies to act in a socially responsible manner by making decisions which will benefit both the company and other stakeholders.

If there is a dispute around whether a decision taken by a director was in the best interests of the company, the courts will apply the “business judgement rule”. They will consider what the director believed at the time in light of their general knowledge, skill and experience. The director will have satisfied the duty to act in the best interests of the company if s/he:

  • took reasonably diligent steps to become informed about the matter;
  • had no personal financial interest in the subject matter of the decision (and had no basis to know that any person/entity related to the company had a personal financial interest in the company);
  • had a rational basis for believing that the decision was in the best interests of the company.

It has been acknowledged by the courts that companies should not be over-regulated, and that directors should have the legal authority to run companies as they deem fit, provided that they act within the legislative framework. In other words, the Companies Act tries to ensure that it is the board of directors, duly appointed, who run the business rather than regulators and judges, who are never best placed to balance the interests of shareholders, employees, creditors and the larger society within the context of running a business. Accordingly, the business judgement rule could be used to absolve directors from liability, if:

  • they acted in good faith; and
  • adopted a course of action which they honestly and reasonably believed would benefit the company.

However, any director who fails to act in the best interests of the company with intellectual integrity, honesty and independence of mind and without any conflict of interest could not rely on the business judgement rule.

In the next article, we will dive into the qualification that applies to directors in the course of carrying out their duties. Specifically, that they should, and can only be expected to carry out their duties, with the degree of care, skill and diligence that may reasonably be expected of a person carrying out the same functions in relation to the company as those carried out by that director; and having the general knowledge, skill and experience of that director.

Part 1: I’ve just incorporated a company. Suddenly I’m a director and I’ve got duties. So, what next?

Part 1: I’ve just incorporated a company. Suddenly I’m a director and I’ve got duties. So, what next?

“I’ve just started a company. I’m the director and must comply with a number of directors’ duties. I’m not sure what this means, where to find them, or what I’m supposed to do to actively uphold them…”

This is how a lot of people feel when incorporating a company for the first time. There’s often a lack of conceptual clarity around the significance of the commercial vehicle that’s been created by simply filling out the suite of documents provided by the Companies and Intellectual Properties Commission (“CIPC”).

In this series on a director’s duties, we’re going to look at what a company is, and the roles of the people involved in maintaining its existence. Specifically, we’ll discuss what it means to be a director of a company by describing a director’s duties as they apply to ordinary business.

To start with, what is a company? A company is a legal entity formed by one or more individuals to engage in business. There are various types of companies (private, profit, non-profit, public, foreign), and the duties which the directors owe in each case are much the same across the board. For the purposes of these articles, we’ll be referring to private companies only.

Conceptually, a company is an artificial person, and is a separate entity from the individuals who own, manage, and support its operations. Companies have many of the same legal rights and responsibilities as a person, such as the ability to enter into contracts, own assets, hire employees, pay tax and incur liability. The main benefit of incorporating a company is limited liability. This means that the shareholders can separate themselves from the company. This is a huge factor, as it limits the risk involved because the liability of a company cannot pass to the shareholders or directors (except in certain exceptional cases which we’ll dive into later on).  However, given the separate and unique nature of a company, a human is required to direct its actions, make strategic decisions and ultimately shape its identity in accordance with the purpose for which it was created. This task is undertaken by the appointed directors, who are empowered by the Companies Act 71 of 2008 (the “Companies Act”) and Memorandum of Incorporation (“MOI”) of the company.

Directors are identified and appointed at the incorporation of a company, and can also be appointed afterwards by shareholders or any other persons designated with that right.  In the vast majority of cases, only shareholders appoint directors. However, the company’s MOI can give this right to other parties, such as investors or creditors who insist on the right to appoint a director on the board.  Once a person accepts their appointment as a director, they become a “fiduciary” in relation to the company and are obliged to display the utmost good faith towards the company. To explain this very simply, the fiduciary duty means that the director must act in the best interests of the company when dealing on the company’s behalf. This means placing the company’s interests ahead of the director’s own interest in many instances.

Nowadays, there are three main sources of information which describe and inform the duties, expectations and standard of conduct for a director: the common law (historical practice of our courts), the Companies Act and the King Code on Corporate Governance.  The most recent version of the Companies Act (2008) helpfully “codified” these duties and should be the first port of call for information in this regard. These duties are summarised in section 76(3) of the Companies Act which requires that directors, acting in such capacity, exercise the powers and perform the functions of a  director “in good faith and for a proper purpose, in the best interests of the company, and with the degree of care, skill and diligence that would reasonably be expected of someone carrying out the same function with similar experience and skill.”  The King Code of Corporate Governance is a valuable tool for describing how those duties are to be applied in practice. Compliance with the “King Code” is not mandatory except for companies listed on the JSE. It is also exhaustive and not really applicable to small and medium sized enterprises, but it does add color and context to the duties set out in the Companies Act.

In the remaining articles of this series we will explore and explain the duties listed above, to bring clarity and simplicity to your role as a director.

Closing Shop: The in-case ins-and-outs of getting out

Closing Shop: The in-case ins-and-outs of getting out

The harsh reality is that the majority of start-ups do not succeed. The economic effects brought about by the COVID-19 pandemic may be felt for a long time yet – on a global scale. Considering this, it cannot be said that the business climate is currently particularly advantageous to a fledgling business which, statistically speaking, was far from a guaranteed success story even before the national lockdown.

Just like you, we hope that your business will defy the odds and succeed. We have written plenty of articles spanning a wide range of topics that may prove helpful and remain available to offer legal assistance in this regard. But what do you do if your business is failing and it can no longer sustain its operations?

Consider this: your business is in financial distress and you have considered all the possible options including business rescue. You have reached the point where the only option is to liquidate the company. What now? What are the legal processes you should follow to efficiently wrap up your business affairs to avoid further unnecessary expenses?

This article will deal with such questions so that you can be aware of the appropriate course of action as well as the possible legal pitfalls when you choose to close up shop due to insolvency.

The test for insolvency:

A company is said to be insolvent in two circumstances:

(1) when its liabilities exceed its assets (what is known as factual insolvency); or

(2) when it cannot pay its debts as and when they fall due (what is known as commercial insolvency).

When your company faces either of these two scenarios, then it means that the company is no longer able to trade and may need to consider insolvency proceedings should all the other available possibilities (for example business rescue) be exhausted.

The liquidation process:

In South Africa, insolvent companies are liquidated in terms of Chapter 14 of the Companies Act 61 of 1973 (“the Old Act“), whereas solvent companies are liquidated in terms of the new Companies Act, 71 of 2008 (“the New Act“). For the purposes of this article, we will only be dealing with the winding up of solvent companies – which is dealt with under Part G of Chapter 1 of the New Act.

Another distinction to draw here, and something that will have to be ascertained beforehand due to them being subject to different legislative processes, is whether the (solvent) entity will be undergoing winding-up proceedings on a voluntary or involuntary basis. These will be discussed in turn below. Finally, the deregistration of your company with the Companies and Intellectual Property Commission (“the CIPC“) will also be briefly considered.

Voluntary:

Voluntary winding-up of a solvent company is regulated by section 80 of the New Act, prescribing an elective process through the adoption of a special resolution by the shareholders of the company. However, simply passing this resolution will not be enough to wind up the company.

It is only when this resolution is filed with the CIPC (which is to be accompanied by a CoR 40.1 and a filing fee of R250) that the voluntary winding-up process can be said to have begun. The CIPC will then deliver a copy of the resolution to the Master of the High Court. However, before the resolution can even be filed, the company must arrange for satisfactory security of the company’s debts (or obtain consent to dispense with such security) to be lodged with the Master.

Involuntary:

It would perhaps be more accurate to refer to involuntary winding-up as court-ordered winding up. A court may order a solvent company to be wound up if the company resolved by special resolution that it would be wound up by the court or the company itself applied to the court to have its voluntary winding up continued by the court.

One or more of the company’s creditors may also apply to the court for an order to wind up the company on the grounds that business rescue proceedings have been unsuccessful or that it is just and equitable for the company to be wound up.

Exactly when the winding up of a company by means of a court order starts will depend on who requests it. If it is the company itself, then it will be when the application to court is made (as mentioned above, this can be done either directly or by moving from the voluntary process to the court-ordered process). If an application for winding up by means of a court order is brought by a creditor, a director, a shareholder or the CIPC itself, then the process will only begin once the order is granted.

The deregistration process:

Although the above outlines how the winding-up process starts through either the voluntary or involuntary process, it is also important to know when this all comes to an end – which will be with the deregistration of the entity with the CIPC.

Formally, after the Master of the High Court has filed a winding up certificate with the CIPC, the CIPC has a duty in terms of section 82(2) of the New Act to remove the company’s name from the companies register. What this means is that once its confirmed that the affairs of the company have been completely wound up, the CIPC is obligated to record the dissolution of the company in the prescribed manner and deregister the company forthwith.

It is possible for the CIPC to deregister the company in other circumstances (for example failure to pay annual returns for 2 consecutive years).

Now, you may be thinking: why not just skip to the whole liquidation process, abstain from filing annual returns and the company will just be de-registered eventually? The deregistration of the company with the CIPC does not affect the liability of any former director or shareholder of the company and continues to be in force and effect as if the company had not been removed from the register. It is only through a liquidation process that the affairs of the company can be legally and factually wound up.

In short, we’re hoping you’re reading this as a time-filling light read – but if you were brought here out of necessity, we’ll be happy to assist you in considering all your available options.

Direct and indirect share ownership on asset protection

Direct and indirect share ownership on asset protection

Generally, buying shares means buying fractional ownership of a company. The reality is that the shares you hold do not entitle you to financial returns unless certain liquidity events occur or as otherwise agreed upon. The most common example of a liquidity event is when directors of a company declare dividends to the shareholders. Assuming such dividends are financial in nature, you will be paid a monetary amount equivalent to your shareholding percentage. If you hold shares directly in your personal capacity, your portion of the dividends will be paid into your estate. Similarly, if a company is liquidated, after the debts and other liabilities of the company are paid in full, your shares would entitle you to a portion of the residual assets of the company. These proceeds would also be paid into your estate.

Alternatively, upon a dividend liquidity event when you hold your shares indirectly through another entity such as a trust or holding company, your portion of the returns will be paid into the estate of a trust or holding company. Such proceeds will not form part of your personal estate until, as a beneficiary of the trust in question, you succeed in your claim against the trust. At this point you will receive such payment into your personal estate. The same is true if you have shares through a holding company. The directors of that company must first declare dividends, if no other agreement exists, before you will be entitled to access the company funds.

The structure through which you hold your shares is crucial in protecting your assets. In this article, we focus on some basic legal outcomes that a direct and indirect shareholding structure have on protecting your assets from unforeseen risks such as debt, death, divorce and sequestration.

Direct share ownership: personal capacity

Holding your shares in a company directly does not mean that your estate will be responsible for the debts and other liabilities of the company (unless otherwise agreed in the shareholders’ agreement or surety agreements). This is stated in section 19 (2) of the Companies Act 71 of 2008 (as amended) (“the Act“), in terms of which a direct shareholder has limited liability. This means that a direct shareholder will only be liable for company debts to the extent of his or her investment in the company or through another agreement.

However, returns paid into the estate of a direct shareholder will always be exposed to personal liability claims as they remain in the direct shareholder’s personal estate. The shares held may be protected against attachment, unless pledged or subject to attachment through other processes such as the procedural workings of insolvency law (at which point most company’s founding documents will trigger forced sale events). However, the returns generated from the shares are susceptible to risk as they form part of the personal estate. For purposes of wealth creation, it is important to diversify your assets and not put all of your eggs in one basket. This can be crucial for individuals who are involved in business ventures which may leave them financially exposed.

Indirect share ownership: trust

As a point of departure, you will need to consider if the company’s founding documents allows for a trust to hold shares in the company. If this is provided for, a trust will enable an indirect shareholder, in the capacity of a trustee, to manage shares, as well as the proceeds thereof, to the benefit of the trust beneficiaries. Any returns received as a result of shareholding will vest in the estate of the trust and not in the personal estate of the trust founder. This position is confirmed in section 12 of the Trust Property Control Act 57 of 1988. The result of the separation of estates is that any claims brought against the personal estate of an indirect shareholder cannot be recovered from the estate of the trust, as this a distinct and separate estate.

As with various special purpose vehicles, there are exceptions. The above stated section 12 excludes beneficiary claims. If you have a claim against a trust (i.e. you are also a beneficiary of the trust through which you hold shares) creditors holding claims against your personal estate may succeed in attaching your claim to the trust using appropriate legal procedures. Furthermore, any financial returns suddenly transferred into a trust when a trustee is declared insolvent can set aside the trust transaction, subject to insolvency laws. Generally, creditors might find it difficult to set aside trust transfers if an indirect shareholder is solvent and you can present an honest record of using the trust. Therefore, sudden or suspicious transfers of shareholding returns into a trust to extricate an indirect shareholder from liability will fail at protecting your returns, as this may constitute a sham or alter ego trust.

Indirect share ownership: holding company

The Act allows for another special purpose vehicle, a holding company, to hold shares in another company. Usually, a holding company will not conduct any business of its own (although it can) as the purpose is normally restricted to creating wealth. Again, it is necessary to have sight of the founding documents of the company to ensure that a holding company is authorised to be a shareholder. As in the case of an individual shareholder, a holding company will not be liable for the debts and other liabilities of the company beyond the share capital contribution as it is regarded as a separate juristic person (except in instances of fraud or as otherwise agreed).

Upon the happenings of any liquidity event, if a holding company is a shareholder the proceeds will not accrue to a personal estate. Instead, payment will be made into the estate of the holding company. The indirect shareholder will not be authorised to access funds from the estate of the company for personal use unless dividends are declared, or through another arrangement in law.

Likewise, any claims against the personal estate of the indirect shareholder cannot be extended to the holding company, as such estates are separate. If the indirect shareholder’s shares in the holding company are attached through proper legal proceedings, the estate of the company will still be protected, and the founding documents of the holding company might enforce a forced sale event upon successful attachments. An exception here is if the company is being used inappropriately to divert funds solely for the frustration of claims from creditors. This conclusion is reached on a case-by-case basis.

Conclusion

There are many complexities to protecting shares or the value generated from such shares against external claims. Careful consideration must be given to the terms in the founding documents of the company, relevant legislations, transactional documents, the shareholding structure and personal circumstances of each client. With an experienced commercial attorney on your side, you can structure your shareholding with ease to protect your assets and ensure other desired outcomes.

Trade Secrets: What’s the fun in keeping a secret… ask your lawyer what will happen if you don’t

Trade Secrets: What’s the fun in keeping a secret… ask your lawyer what will happen if you don’t

Benjamin Franklin professed that “three may keep a secret, if two of them are dead”. The same principle bodes well for trade secrets.

Do you have any idea of the practical lengths that Coca Cola goes to in order to keep its recipe for its coca cola beverage secret? For starters, the recipe is locked up in a vault, which can only be opened by a hierarchy of company resolutions and only two individuals at one time may know the actual recipe of the unmistakable flavour combination, who may never board a flight at the same time and whose identity is never made known. Although it sounds absurd, it makes absolute sense once we consider the significant value of trade secrets, as well as the brittle nature thereof.

A trade secret is seen as an asset, which falls under the umbrella of intellectual property. However, there is no distinct body of law that regulates this form of intellectual property and instead, it is enforced by means of unfair competition law, contract law and criminal law. This nomad nature of trade secrets makes it a high risk, high reward asset. The benefit in retaining the secret means infinite and unfettered use, however the concept does not prohibit a third party from unravelling the trade secret, reverse engineering it or stumbling upon it through honest means. Unlike patents, where the proprietor has an absolute right to prevent a copycat, even if the copycat stumbles on it or reverse engineers a product, a trade secret is fair game to those willing to crack the code, provided that the trade secret has not been acquired by deceptive measures.

A violation of a trade secret will be present where a competitor has been shown to have misappropriated a trade secret, that there has been a misuse of the information obtained and that the trade secret proprietor had taken all reasonable steps to maintain the secrecy of the information.

So far trade secrets seem like a viable strategy, especially seeing that it could relate to almost any information, such as source code, formulas, marketing and sales strategies, proprietary recipes, technical drawings, business plans and test data, to mention a few, however a trade secret must meet three universal requirements in order to be protectable:

  • the information must not be known in the general business circles to which it relates , or the general public for that matter;
  • the confidentiality of the relevant information must represent an economic benefit; and
  • the information must be subject to reasonable efforts made to maintain its secrecy.

In order to show that reasonable efforts have been made to maintain secrecy, consider introducing certain checks and balances to ensure that there are proactive steps being taken in this regard. Internally, you should be considering appropriate document marking and management, ensuring that employment and partnership agreements create confidentiality obligations and that your company follows clean desk and secured system policies. When dealing with external third parties, your efforts should extend a little further. Aim to include confidentiality notices on important documents which record trade secrets or confidential information, conclude non-disclosure agreements (where necessary) and confidentiality agreements with relevant parties who may have access to such information and ensure that all agreements make sufficient provision for confidentiality obligations.

Lastly, consider clear definitions in all agreements as to what is included as confidential information and ensure that each agreement provides for protective obligations as it relates to confidential information.

Trade secrets are high risk, high reward, especially seeing that the lifespan of a trade secret is as long as you can keep it out of the public, unlike patents or copyright, which offer a limited protection lifespan. In order to ensure successful retention of trade secrets, it will be important to take stock of internal and external processes used by you to protect confidential information and to include appropriate checks and balances, where necessary. As can be seen, it’s not that easy to protect a trade secret, but when it works the benefits truly outweigh the effort. If you don’t believe me, try finding the recipe for coca cola.