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.

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.

So, you created some IP, now what?

So, you created some IP, now what?

Irrespective of whether you support the overzealous protection of intellectual property (“IP“) or believe in a more open-source world, one thing is certain in the world of technology and IP – the greatest economic value of IP stems from its use in licensing arrangements. Whether for commercial or development reasons, the concepts remain the same. The registration of IP is only your first step in a long and complex dance with any entrepreneur, service provider or developer who you wish to collaborate with.

The unique thing about IP is that it is subject to constant development. This means that new stand-alone IP can develop from base IP, thereby attracting unique and new avenues to attract its own separate IP.

This starts to blur the lines of ownership when more than one party is involved and the failure to properly regulate these relationships can mean the death of innovation; as the once exciting venture is distilled down to a playground battle with the participants’ crying over sand in their eyes.

This blog post serves to touch on the basic legal concepts which form part of standard commercial agreements involving IP. It also highlights what you need to start thinking about to ensure that the boundaries of ownership and use are clearly set out from the get-go.

In most licensing agreements there is a distinction between ‘Background IP’ and ‘Foreground IP’. Background IP is the term used to define that IP which the respective parties own prior to performing under an agreement, or IP that is developed or conceived independently of the agreement. ‘Foreground IP’, on the other hand, is usually used to define new IP developed in terms, and during the subsistence, of an agreement. An important element of these distinctions is that not only does Background IP lead to the creation of Foreground IP, but Background IP is often linked to Foreground IP and the ability to exercise it.

These concepts exist to protect and regulate one of our most basic human tendencies derived from those even our most primary of conquerors practiced, think “Veni, Vidi, vici”. Basically, what’s mine is mine and in some cases (especially where you fail to regulate your IP properly) what’s yours is mine too.

So to avoid being the subject of someone’s Odyssey, standard agreements usually start off with a definition of these two terms, thereby creating a split between each party’s IP prior to entering the agreement and the IP created from the agreement. This allows for the protection of each party’s previously developed IP and ensuring that any new IP is regulated by the terms of the agreement.

Regarding ownership of Foreground IP, different models will be appropriate in different sets of circumstances. For example, where an agreement opts for Foreground IP to be jointly owned, administration becomes a problem as every party must be consulted and agree on any further use, development or commercial exploitation of such IP. Further frustration can be present where an agreement doesn’t regulate a breakdown, as this could in effect mean that one party could potentially hold ransom the further exploitation and commercialisation of the IP.

Another ownership option could be that such IP is rather outrightly owned by one of the parties (by means of assigning the IP rights over to one party) and for that party to grant access to the other, which may include terms of use, extent of exploitation, as well as compensation. For the more seasoned entrepreneur, the possibility exists that this model could be used to strategically transfer IP into a new entity, by means of building and developing Foreground IP in a newly established entity, based on a Background IP licencing agreement with an older entity. This, however, is a topic for another day.

This second aspect in the above examples highlights the use component of IP licensing. Irrespective of whether you are licensing your Background IP to a partner or joint venture so as to create the Foreground IP, or whether you agree that one of the parties owns the Foreground IP so as to licence it to the other, the extent of a party’s use or participation in the particular IP is regulated by a use license.

The most renowned types of licenses which you should start to become familiar with include exclusive and non-exclusive licenses. From a high level, a non-exclusive licence will potentially grant a licensor the unfettered freedom to exploit the IP without giving the other party any say, as well as the ability to allow other licensees to exploit the same IP. Whereas an exclusive licence could potentially limit both licensor and licensee from exploiting the IP.

It is crucial to understand that your unique circumstances will guide which licence is the best option for you and the onus will be on you to ensure that you are aware of the effects of such a license. Inevitably, you will have to ensure that the licence reflects what was in fact agreed to and that you are not the recipient of a very attractively constructed Trojan Horse.

This blog post was only intended to open your mind to concepts tied to the complex nature of IP. It also provided some insight into how various commercial and licensing arrangements can impact on both ownership and use of your own Background IP, as well as any Foreground IP, which you may have had a hand in creating. A competent practitioner who can truly understand your offering and your vision for the future can make this process a breeze. With years of academic and practical experience in both IP and commercial law, our team here at Dommisse Attorneys is well placed to assist you with developing your IP strategy and to translate this into a clear and succinct agreement, thereby avoiding the exchange of any unruly phrases like “Et Tu, Brute?”.