Ex parte De Villiers and Another NNO: In re Carbon Developments (Pty) Ltd (In Liquidation)

• Jurisdiction: South Africa
• Judge: Stegmann J
• Judgment Date: 08 October 1991
• Court: Witwatersrand Local Division
• Citation: 1992 (2) SA 95 (W)

Ex parte De Villiers and Another NNO: In re Carbon Developments (Pty) Ltd (In Liquidation)
1992 (2) SA 95 (W)

1992 (2) SA p95

Citation	1992 (2) SA 95 (W)
Court	Witwatersrand Local Division
Judge	Stegmann J
Heard	August 27, 1991; September 2, 1991
Judgment	October 8, 1991

Flynote : Sleutelwoorde

H Accountant — Auditor — Public Accountants' and Auditors' Act 80 of 1991, s 20(5) — Section 20(5) requiring auditor to intervene if satisfied or has reason to believe that 'material irregularity' has taken place in conduct of affairs of undertaking causing or likely to cause financial loss to undertaking, its members or creditors — In absence of lawful authority, causing of company to engage in risk-taking I activity once its capital exhausted, ie causing company to trade in insolvent circumstances, amounting to material irregularity contemplated by s 20(5), such conduct being likely to cause loss to company's creditors.

Accountant — Auditor — Public Accountants' and Auditors' Act 80 of J 1991, s 20(5) — Section 20(5) requiring auditor to intervene if

1992 (2) SA p96

A satisfied or has reason to believe that 'material irregularity' has taken place in conduct of affairs of undertaking causing or likely to cause financial loss to undertaking, its members or creditors — Guide issued by South African Institute of Chartered Accountants (SAICA) entitled 'Audit and Accounting Guide: Trading when the liabilities of an B undertaking exceed its assets' — Guide recommending that one of means by which auditor may be persuaded that continuing to trade in insolvent circumstances not likely to cause loss to undertaking, its members or creditors is conclusion of subordination contract with one or more major creditors — Guide recommending that auditors 'give full weight' to such C contract, provided only that it remains uncancelled — Guide also suggesting that, on winding up, 'a properly worded' contract would be one which 'creditors (would be) able to enforce without reference to the liquidator' — Court holding that subordination contract cannot restore solvency to an insolvent company — Very step of subordinating certain D claims to others proclaiming insolvency — Subordination contract may be cancelled — Furthermore, no procedure devised to ensure that present and future creditors would know of contract, thus defeating its purpose since none who had not accepted its benefits could enforce its benefits — Statutory ranking of claims on insolvency cannot be altered by E contract — No sound legal basis for idea that recommended subordination contract able to eliminate inevitable risk of loss to creditors from whom goods and services obtained on credit when company's liabilities exceed its assets — Also no sound legal basis for idea that such contract could, for purposes of s 20(5) of Act, prevent likelihood of loss to creditors in such circumstances. F

Company — Compromise — Scheme of arrangement in terms of s 311 of Companies Act 61 of 1973 — Scheme in terms of which creditor invited to cede claim against company in liquidation in return for right of payment — Such creditor ceasing to qualify for benefit of rights under s 424(1) G when he ceases to be creditor of company by virtue of Court's sanctioning scheme.

Company — Directors and officers — Liability of for debts of company — Generally — Company trading while liabilities exceed assets — Other than provisions in Companies Act 61 of 1973 providing for judicial H management, no source of lawful authority for anyone to cause company to trade in insolvent circumstances — Causing company to trade in insolvent circumstances in absence of lawful authority amounting to material irregularity as contemplated by s 20(5) of Public Accountants' and Auditors' Act 80 of 1991 — Such conduct might also lead to directors being held personally responsible for company's debts on basis I of common-law liability for negligence or fraud, or on basis of statutory declaration of liability in terms of s 424(1) of Companies Act — Guide issued by South African Institute of Chartered Accountants (SAICA) recommending that one of means by which auditor may be persuaded that company's continuing to trade in insolvent circumstances not likely J to cause financial loss to company, its members or creditors

1992 (2) SA p97

A is conclusion of subordination contract with one or more major creditors — Such subordination contract cannot restore solvency to insolvent company — Risk of loss to creditors not eliminated thereby — Such risk inevitably present when goods and services obtained on credit at time when liabilities exceed assets — Plain, honest common sense of reasonable man in position of director of insolvent company would B recognise subordination contract as no more than device used as window-dressing to distract attention from unauthorised and therefore irregular conduct of directors in causing or allowing company to trade and incur debts while liabilities exceed assets — Reliance upon advice contained in guide not sufficient excuse for reckless or dishonest C conduct by company directors — Fact that directors acting on auditor's advice and that auditor acting in terms of SAICA guide not an insuperable obstacle to success of proceedings to have directors declared personally responsible for debts of company — No one can escape responsibilities by abandoning common sense and claiming to rely D on advice which flies in face of anyone's sense of right and wrong.

Headnote : Kopnota

In terms of s 20(5) of the Public Accountants' and Auditors' Act 80 of 1991 (which replaced s 26(3) of the Public Accountants' and Auditors' Act 51 of 1951) the auditor to an undertaking is required to intervene if he 'is satisfied or has reason to believe that in the conduct of the E affairs of such undertaking a material irregularity has taken place . . . which has caused or is likely to cause financial loss to the undertaking or to any of its members or creditors'. An 'Audit and Accounting Guide: Trading when the liabilities of an undertaking exceed its assets' was issued by the South African Institute of Chartered Accountants (the SAICA) in May 1984 concerning the statutory duties imposed upon auditors by s 20(5) of the Act. The guide proceeds upon the premise that trading in insolvent circumstances is not necessarily a F 'material irregularity' as contemplated by the Act. It recommends that the auditor should consider whether the particular circumstances do or do not show it to be such a material irregularity; that the auditor should form a view on the question whether the insolvency of the undertaking is or is not likely to cause financial loss to the undertaking or to any of its members or creditors; and that one of the means by which an insolvent undertaking may persuade the auditor that the undertaking's continued trading in insolvent circumstances has not G caused and is not likely to cause such financial loss is to conclude a 'back-ranking' or 'subordination' agreement with one or more of its major creditors. The recommended form of subordination agreement includes provision for its own cancellation or variation, provided that written notice thereof is given to the auditor.

The Court held that, provided that a company had a risk capital appropriate to the enterprise which it was formed to undertake, and provided that the relevant risk-taking conduct which was likely to cause H financial loss (ie the company's trading within its intended field of enterprise) ceased when the company's risk capital had been exhausted, such conduct, although likely to cause financial loss to the company and its members, was not likely to cause financial loss to the company's creditors since at that stage creditors could still be paid 100 cents in the rand for their claims. Up to that stage, therefore, the risk-taking conduct involved in trading was not an irregularity, material or I otherwise, for the purposes of s 20(5) of Act 80 of 1991 because the members had, in the manner permitted under the Companies Act, authorised the directors to expose the risk capital to the loss which was likely to result from the enterprise embarked on in the hope of profit. However, once the company's risk capital had been exhausted and it continued trading, the directors would be causing the company to engage in risk-taking conduct which was likely to cause loss to the company's creditors, ie by causing the company to trade in insolvent J circumstances. Other than the provisions in the Companies Act

1992 (2) SA p98

A investing a judicial manager with the authority to conduct the business of an insolvent company (in the hope of nursing it back to solvency), there was no source of lawful authority for anyone, whether a member, a director, or a creditor of the company, to cause the company to trade in insolvent circumstances. The Court concluded that, in the absence of such lawful authority, such conduct had to amount to a material irregularity as contemplated by s 20(5) of Act 80 of 1991.

When a creditor of an insolvent company in liquidation is faced with a B proposal under s 311 of the Companies Act 61 of 1973 which involves an offer of compromise inviting him to agree to cede his claim against the company in liquidation in return for the right to a payment in terms of the compromise, such creditor should recognise the implication that, if and when he ceases to be a creditor of the company by virtue of a Court order sanctioning the compromise, he will also cease to qualify to enjoy the benefits of such rights as s 424(1) may have afforded him had he approached the Court at a time when the company owed him a debt or other C liability for a declaration that a wrongdoing representative of the company was personally responsible for the full amount of such debt or other liability of the company.

The joint...