The nature and extent of the obligation imposed on the board of directors of a company in respect of the solvency and liquidity test under section 4 of the Companies Act 71 of 2008

• Jurisdiction: South Africa
• Pages: 59-102
• Published date: 21 November 2019
• Author: Bidie, S.S.
• Citation: (2019) 5(1) JCCL&P 59
• Date: 21 November 2019

59

THE NATURE AND EXTENT OF

THE OBLIGATION IMPOSED ON

THE BOARD OF DIRECTORS OF

A COMPANY IN RESPECT OF

THE SOLVENCY AND LIQUIDITY

TEST UNDER SECTION 4 OF THE

COMPANIES ACT 71 OF 2008*

SIMPHIWE S BIDIE†

Lecturer, Nelson R Mandela School of Law, University of Fort Hare

ABSTRACT

The solvency and liquidity test in section 4 of the 2008 Companies

Act of South Africa is the foundation upon which the entire Act is

structured. It sets the threshold against which the ability of a company

to distribute its money or property to its shareholders should be

assessed. The introduction of the test places the 2008 Act among

some of the most progressive and liberal legislative frameworks

in the world. The test caters for various interests rather than the

orthodox approach of the capital protection principle. The inclusion

of the test into South African company law signifies a shift away

from the traditional capital maintenance doctrine and recognises

other factors that play a role in the economy of the country. From

a policy perspective, replacing the capital protection rules with the

solvency and liquidity test was a commendable step. The nature

and extent of the obligation imposed on directors as a result of the

incorporation of the test into the 2008 Act is enormous. The solvency

and liquidity test is assessed alongside the duties to which directors

must adhere. The discussion of the test and its constituent elements

* This paper was first presented at the Conference of The Society of Law Teachers

of Southern Africa (SLTSA) 6–8 July 2015 as part of my studies. See Simphiwe S

Bidie Protection of Company Capital in Contemporary Company Law: South Africa and

Selected Commonwealth Jurisdictions (unpublished LLD Thesis, University of Fort

Hare, 2016). I wish to acknowledge and thank Prof P Osode for his assistance,

excellent editing and guidance. Responsibility for any errors or omissions in this

paper is exclusively mine.

† LLB, LLM, LLD (UFH).

(2019) 5(1) JCCL&P 59

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(2019) 5 (1) JOURNAL OF CORPORATE AND COMMERCIAL LAW & PRACTICE

indicates the appropriate standard expected, and the interpretation

and application of the test as contemplated in the Act.

Keywords: solvency and liquidity test; corporate law; company law;

commercial law; distribution; dividends; duties of director

I INTRODUCTION

As a measure to safeguard the financial viability of a company, one

of the foundational changes brought about by section 4(1) of the

Companies Act 71 of 2008 (the 2008 Act; the Act)1 is the incorporation

of the solvency and liquidity test.2 Section 4(1) provides that, for any

purpose of the Act, a company satisfies the solvency and liquidity

test at a particular time if, considering all reasonably foreseeable

financial circumstances of the company at that time:

(a) the assets of the company, if the company is a member of a

group of companies, the aggregate assets of the company, as

fairly valued, equal or exceed the liabilities of the company

or, if the company is a member of a group of companies, the

aggregate liabilities of the company, as fairly valued; and

(b) it appears that the company will be able to pay its debts as they

become due in the ordinary course of business for a period of —

(i) 12 months after the date on which the test is considered;

or

(ii) in the case of a distribution contemplated in paragraph (a)

of the definition of ‘distribution’ in section 1, 12 months

following that distribution.3

1 Act 71 of 2008 was assented to by the President on 9 April 2009. It came into

operation on 1 May 2011,

GG 34239 of 26 April 2011. In terms of s 224 of the

2008 Act, it replaced the 1973 Companies Act.

2 FHI Cassim ‘The reform of company law and the capital maintenance concept’

(2005) SALJ 287; Deeksha Bhana ‘The company law implications of conferring

a power on a subsidiary to acquire the shares of its holding company’ (2006)

Stellenbosch Law Review 232; Kathleen van der Linde ‘Share repurchases and

the protection of shareholders’ (2010) TSAR 288; Kathleen van der Linde ‘The

solvency and liquidity approach in the Companies Act 2008’ (2009) TSAR 224;

Kathleen van der Linde ‘The regulation of distributions to shareholders in the

Companies Act 2008’ (2009) TSAR 484; Richard Jooste ‘Issues relating to the

regulation of “distributions” by the 2008 Companies Act: Notes’ (2009) SALJ 627;

Harvey E Wainer ‘The new Companies Act: Peculiarities and anomalies’ (2009)

SALJ 806.

3 See s 4(1)(a) and (b)(i) and (ii) of the 2008 Act; Department of Trade and Industry

‘South African company law for the 21st century: Guidelines for corporate law

reform’ at 34, GN 1183 of 2004 in GG 26493 of 23 June 2004, available at http://

www.info.gov.za/gazette/notices/2004/26493.pdf, accessed on 1 October 2017 (the

‘Guidelines for Corporate Law Reform’); Piet Delport New Entrepreneurial Law

(2014) 82. Also see s 128(1)(f)(i) and (ii) of the 2008 Act as amended under s 81

of the Companies Amendment Act 3 of 2011 (the ‘2011 Companies Amendment

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THE NATURE AND EXTENT OF THE OBLIGATION IMPOSED ON THE

BOARD OF DIRECTORS

In Canada and Australia, the Canada Business Corporations Act,

1985 (the CBCA) and the Corporations Act 2001 as amended by the

Corporations Amendment (Corporate Reporting Reform) Act 66 of

2010 (the Reform Act 2010) both respectively provide for this test.4

In all three jurisdictions mentioned, the application of the solvency

and liquidity test replaced the capital maintenance principle.5 In the

South African context this was so because this common-law principle

was labelled as ineffective as a foundation to safeguard societal and/

or stakeholder interests within companies.6 Perhaps, and probably

rightly so from an economic point of view, at the heart of the criticism

was the argument that the rules underlying the capital maintenance

principle were rigid and incoherent and as such unjustified from the

Act’). Under the 1973 Companies Act as amended by the Companies Amendment

Act, 1999 (the ‘1999 Act’) the solvency and liquidity test was provided for in

ss 85(4) and 90(2). That Act did not expressly abolish the unexpressed capital

maintenance principle contained in common law. The sections preserving the

capital maintenance principle included ss 81 and 82 of the then 1973 Act, which

prohibited the issue of shares at a discount unless certain preconditions were met,

and s 79 of the same Act, restricting a company from paying interest on shares

out of share capital; Capitec Bank Ltd v Qorus Holdings Ltd 2003 (3) SA 302 (W),

para 10; Van der Linde 2009 TSAR op cit note 2 at 224.

4 Under ss 34 and 42 of the CBCA the test is whether the corporation is: unable

to pay its liabilities as they become due (liquidity or cash flow test); and that the

net realisable value of the assets does not exceed the liabilities of the corporation

and the stated capital of all assets (net assets test). The manner in which s 4

of the 2008 Act is phrased is similar to Canadian law. See StockCo Ltd v Gibson

[2012] NZCA 330; (2012) 11 NZCLC 98-010 para 42. The wording of s 4(1) of the

Companies Act 1993 of New Zealand reflects more or less the wording under s 4

of the 2008 Act. The section states that a company satisfies the solvency test if

the company is able to pay its debts as they become due in the normal course of

business and that the value of the company’s assets is greater than the value of

its liabilities, including contingent liabilities; available at http://www.legislation.

govt.nz/act/public/1993/0105/latest/DLM319998.html, accessed on 1 February

2018. Singapore has seen some recent developments in its company law as well.

See Maisie Ooi ‘The financial assistance prohibition: Changing legislative and

judicial landscape’ (2009) Singapore Journal of Legal Studies at 135.

5 Section 254T of the Corporations Act refers to circumstances under which a

dividend may be paid. It states that ‘(1) a company must not pay a dividend

unless: (a) the company’s assets exceed its liabilities immediately before the

dividend is declared and the excess is sufficient for the payment of the dividend;

and (b) the payment of the dividend is fair and reasonable to the company’s

shareholders as a whole; and (c) the payment of the dividend does not materially

prejudice the company’s ability to pay its creditors’. The Reform Act 2010 came

into effect on 28 June 2010. In Australia the legal requirements to pay a dividend

out of profits were removed in 2010 and replaced with the solvency and liquidity

test. See Grant-Taylor v Babcock & Brown Ltd (in liquidation) [2016] FCAFC 60 paras

37–39. See also in s 95A of the Corporations Act 2001.

6 Cassim op cit note 2 at 287–293; FHI Cassim ‘Unravelling the obscurities of

section 38(2)(d) of the Companies Act’ (2005) SALJ 493; and Aiman Nariman

Mohd-Sulaiman ‘A cross-jurisdictional study of financial assistance provisions

and proposals — Convergence of concepts’ (2005) Lawasia Journal at 157.

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