Loans to Directors—An Analysis of Section 226 of the Companies Act

• Jurisdiction: South Africa
• Date: 25 May 2019
• Pages: 269-290
• Published date: 25 May 2019
• Author: Richard Jooste

Loans to Directors—an Analysis of

Section 226 of the Companies Act

RICHARD JOOSTE*

University of Cape Town

1 Introduction

Section 226

1

of the Companies Act

2

is a recognition by Parliament of

the powerful position which directors and managers of a company hold.

They can abuse this position for their own benefit and to the detriment of

the company and hence its shareholders. As stated by Goldblatt AJ:

'The clear purpose of s 226 of the Act is to prevent directors or managers of a company

acting in their own interests and against the interests of shareholders by burdening

the company with obligations which are not for its benefit but for the benefit of another

company and/or for the benefit of its directors and/or managers.'

3

An effective s 226 is an important cog in the corporate governance

wheel. This article seeks, in an analysis of its provisions and in the light of

recent case law, to determine its potency.

Section 226 attempts to regulate the transactions in question by

prohibiting them, subject to certain exceptions. Exceptions are provided

'presumably on the basis that in the excepted circumstances there are

sufficient safeguards to establish a likelihood that the use of the company's

assets for the benefit of its directors or managers or of companies con-

trolled by them, will also be of benefit to the company and not at its

expense'.

4

The section can be divided into three parts: the prohibitions,

5

the

exceptions to the prohibitions,

6

and the consequences of contravention.'

For ease of reference, I will quote s 226 in full:

'(1) No company shall directly or indirectly make a loan to —

(a) any director or manager of —

(i)

the company; or

(ii)

its holding company; or

(iii)

any other company which is a subsidiary of its holding company; or

* BA BCom (Hons) (Taxation) LLB (Cape Town) LLM, Diploma in Comparative Legal

Studies (Cantab). Attorney of the High Court of South Africa and Professor of Law, Department

of Commercial Law, University of Cape Town.

The forerunner of s 226 was s 70oct of the Companies Act 46 of 1926, as inserted by the

Companies Amendment Act 46 of 1952. Section 70oct was introduced on the recommendation of

the Millin Commission

(Final Report of the Company Law Amendment Enquiry Commission

(1947-1948) UG No 69-1948 paras 135-136), which took its cue from the Cohen Committee in

England which reported in 1945

(Report of the Committee on Company Law Amendment

(1945)

Comd 6659 para 94). Section 226 has been amended by s 19 of the Companies Amendment Act

111 of 1976, s 21 of the Companies Amendment Act 64 of 1977, s 5 of the Companies Amendment

Act 29 of 1985, and s 6 of the Companies Amendment Act 82 of 1992.

2

Act 61 of 1973 ('the Act').

3

Standard Bank of SA Ltd v Neugarten & others

1988 (1) SA 652 (W) at 658F.

4

S v Pourolis & others

1993 (4) SA 575 (W) at 589E (per Stegmann J).

5

Section 226(1) read with s 226(1A).

6

Section 226(1B) and s 226(2) read with s 226(3).

7

Section 226(4).

269

(2000) 12 SA Merc LJ 269

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270

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(2000) 12 SA Merc LJ

(b) any other company or other body corporate controlled by one or more directors

or managers of the company or of its holding company or of any company

which is a subsidiary of its holding company,

or provide any security to any person in connection with an obligation of such director,

manager, company or other body corporate.

(1A) For the purpose of subsection (1)

(a) "loan" includes

(i)

a loan of money, shares, debentures or any other property; and

(ii)

any credit extended by a company, where the debt concerned is not payable

or being paid in accordance with normal business practice in respect of the

payment of debts of the same kind; and

(b) one or more directors or managers of a company contemplated in sub-

section (1)(b) shall be deemed to control another company or body corporate

only if

(i)

such director or manager or his nominee is a member or such directors or

managers or their nominees are members of such other company or body

corporate and the composition of its board of directors is controlled by

such director, manager or nominee or such directors, managers or

nominees, and such composition shall be deemed to be so controlled if

such director or manager or his nominee or such directors or managers or

their nominees may, by the exercise of some power and without the consent

or concurrence of any other person, appoint or remove the majority of

the directors concerned, and such director, manager or nominee or such

directors, managers or nominees shall be deemed to have power to

appoint a director where a person cannot be appointed as a director

without his or their consent or concurrence; or

(ii)

more than one-half of the equity share capital of that other company or

body corporate or, if that other body corporate is a corporation as defined

in section 1 of the Close Corporations Act, 1984 (Act No 69 of 1984), more

than 50 per cent of the interest in such corporation is held by such director,

manager or nominee or such directors, managers or nominees; and

(c) "security" includes a guarantee.

(1B) The provisions of subsection (1) and of paragraph (b) of subsection (1A) shall not

be construed as prohibiting a company from making a loan to, or providing security to

any person in connection with an obligation of, its holding company or subsidiary or a

subsidiary of such holding company;

(2) The provisions of subsection (1) shall not apply

(a) in respect of

(i)

the making of a loan by a company to its own director or manager;

(ii)

the provision of security by a company in connection with an obligation of

its own director or manager;

(iii)

the making of a loan by a company to any other company or other body

corporate controlled by one or more of the directors or managers of the

first-mentioned company; or

(iv)

the provision of security by a company in connection with an obligation of

any company or other body corporate controlled by one or more of the

directors or managers of the first-mentioned company,

with the prior consent of all the members of the company or in terms of a special

resolution relating to a specific transaction: Provided that in respect of any such

loan made or security provided at any time before the date of commencement of

the Companies Amendment Act, 1992, such consent shall be deemed to have

been given if the transaction concerned has subsequently, whether before or after

that date, been ratified by all members of the company; or

(b) subject to the provisions of subsection (3), in respect of anything done to

provide any director or manager with funds to meet expenditure incurred or

to be incurred by him for the purposes of the company concerned or for the

purpose of enabling him properly to perform his duties as director or manager

of that company; or

(c)

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in respect of anything done bona fide in the ordinary course of the business of a

company actually and regularly carrying on the business of the making of loans

or the provision of security; or

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