The legal status of companies and the validity of company actions

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Topics Commercial & Corporate Law

09 Jun 2023

Introduction

The 2008 Companies Act brought about uncertainty – perhaps to be expected considering the significant changes that it introduced. While many provisions were identical to those of the 1973 legislation, others were quite foreign to our company law traditions. In addition, some more familiar rules and principles were drafted using unknown terms and phrases and it was not at all clear how these should be interpreted and applied.

Judgments and commentary continue to give meaning and texture to the text and build a new body of jurisprudence to guide advisors and practitioners. Key cases now illuminate matters such as:

(a) the impact and application of alterable and unalterable provisions;

(b) estoppel, corporate capacity and the revised application of the doctrine of constructive notice and the Turquand rule;

(d) the application of the newly introduced “solvency and liquidity test”.

See the short discussion below on these cases and for more detail refer to the recently published Companies title by Dr HH Stoop in The Law of South Africa (LAWSA) Volumes 6 Parts 1, 2 and 3 (3ed).

Alterable and unalterable provisions

The 2008 Companies Act (the Act) aimed to simplify the law, rejected archaic concepts and complicated language and favoured international best practice. In section 15, the Act introduces alterable and unalterable provisions and attempts to distinguish between them. It also provides for an expeditious way of resolving the question of whether, in the case of a particular company, an unalterable provision of the Act has been flouted or circumvented. The courts have had to interpret the notion of alterable and unalterable provisions.

As an example, the Act provides that at any time a shareholder of a company may appoint any individual, including an individual who is not a shareholder of that company, as a proxy to participate in, and speak and vote at, a shareholders’ meeting on behalf of the shareholder, or give or withhold written consent on behalf of the shareholder to a decision contemplated in section 60.

In Barry v Clearwater Estates NPC the court confirmed that this was an unalterable provision of the Act and aimed to give effect to the defined functions of the proxy set out in section 58(1)(a), which is a provision that “does not expressly contemplate its alteration in any way by a company’s memorandum of incorporation” (MOI).

The legislation is unambiguous in requiring all alterable provisions to be altered only through provisions in the MOI. Likewise, it is only the MOI that can introduce a requirement that is more onerous to the company than as envisaged by section 15(2)(a)(iii). In Gihwala v Grancy Property Ltd it was held that it was possible to validly qualify more general powers in a shareholders’ agreement and that the invalidity visited upon sections that fall foul of the MOI was reserved for instances of direct conflict only.

Estoppel, the revised application of the doctrine of constructive notice and the Turquand rule

Where a company’s directors or managing director, or a committee of its directors, purport to transact in the name of the company without actual authority to do so, the general rule is that the transaction is void, unless the company ratifies it. However, in certain circumstances, the company is bound in spite of their lack of authority, namely, where the agent is found to have had ostensible authority, where a company is estopped from asserting their lack of authority; where the rule in Royal British Bank v Turquand (1856) 6 E & B 327 (the Turquand rule) applies; and where the provisions of section 20(7) of the Act apply.

Doctrine of constructive notice

Before the Act came into effect, a person dealing with a company, although not under a duty to read its memorandum and articles of association, could not assert as against the company that he or she did not know the contents of the public documents of the company, of which documents the memorandum and articles of association were the prime examples.

This rule was known as the “doctrine of constructive notice” and was often expressed by saying that a person dealing with a company was “deemed to know” the contents of the memorandum and articles and the other public documents of the company, and indeed the courts frequently stated the doctrine in these positive terms. This, however, tends to disguise the fact that the doctrine of constructive notice was a negative, and not a positive, one.

The doctrine operated only in the favour of the company – and not against it so as to entitle a person dealing with it, who in fact had no knowledge of a particular provision in its articles, to be treated as if he or she had relied on that provision. The most important consequence of the doctrine was that it prevented a person who transacted with a company from asserting that he or she did not know the provisions of its memorandum and articles of association relating to the powers of its directors, managing director, and committees of directors. Where the lack of authority of the directors, or managing director, or committee of the directors, results from a failure to comply with the formalities, a person dealing with them may, in the circumstances, be able to hold the company bound on the basis of ostensible authority, an estoppel or on the basis of the Turquand rule.

The doctrine will now apply only under limited circumstances. A person must be regarded as having received notice and knowledge of any restrictive conditions applicable to the company in its MOI, if the company’s name includes the element “RF” and the company’s notice of incorporation or a subsequent notice of amendment has drawn attention to the relevant provision and must be regarded as having notice and knowledge of the liability of directors and past directors of a personal liability company.

Makate case

The Constitutional Court significantly changed generally-accepted approaches to authority in Makate v Vodacom (Pty) Ltd. Under the general law of agency, the position prior to this decision was that, where a person purported to act as the agent of another, or an agent acted outside his or her authority in purporting to bind his or her principal, the person with whom he or she transacts would nevertheless be entitled to enforce the transaction if he or she could prove that the principal was estopped from denying the agent’s authority. Where a person represents that he or she has given another authority to enter into a transaction or transactions on his or her behalf, the appearance of authority created by that representation is said to clothe that other person with “ostensible” or “apparent” authority. The concepts “ostensible authority”, “apparent authority” and “estoppel” were often used interchangeably by the courts.

In the Makate case the court criticised this and made a clear distinction between ostensible or apparent authority on the one hand, and estoppel on the other.

The legal position regarding estoppel is as follows: If a person purports to transact as agent for the representor with a third party in a matter falling within the scope of that presented authority, and if the third party transacts in reliance on such representation, the representor is estopped from asserting that the person who purported to act as his or her agent had no actual authority to do so. Thus, provisions in a company’s articles that limit actual authority also limit the ability of the third party to plead estoppel and, following the judgment in Makate, the third party’s ability to argue that the agent had been acting with ostensible or apparent authority. Where lack of authority is not apparent ex facie the MOI, the doctrine of constructive notice will not defeat an estoppel set up against the company.

In certain circumstances it is not necessary to prove ostensible authority or rely on an estoppel in order to hold the company bound, namely, where either (or both) the Turquand rule or the provisions in section 20(7) of the Act apply.

The Turquand rule provides that “persons contracting with a company and dealing in good faith may assume that acts within its constitution and powers have been properly and duly performed and are not bound to enquire whether acts of internal management have been regular”. The rule renders proof by the company that the internal formalities have not be complied with insufficient to enable it to escape liability under the contract. When the rule applies, it entitles the third party to assume that those formalities have been complied with. Thus, it does not entitle a third party to assume that the company has in fact transacted.

In terms of section 20(7) of the Act, a person dealing with a company in good faith, other than a director, prescribed officer or shareholder of the company, is entitled to presume that the company, in making any decision in the exercise of its powers, has complied with all of the formal and procedural requirements in terms of the Act, its MOI, and any rules of the company, unless, in the circumstances, the person knew or reasonably ought to have known of any failure by the company to comply with any such requirement. This provision must be construed concurrently with, and not in substitution for, any relevant common-law principle relating to the presumed validity of the actions of a company in the exercise of its powers.

This is an attempt to state, plainly and concisely, the essence of the common-law rule in Royal British Bank v Turquand. The provision is explicit that it applies “concurrently with and not in substitution for” the common law. Thus, the common-law Turquand rule is preserved. Presumably, therefore, if section 20(7) were held to be wider in scope than the Turquand rule, or vice versa, the wider version will prevail.

For more information on the role of common-law concepts (such as the rule related to the recovery of reflected losses by shareholders) and the Companies Act, see Peel v Hamon J&C Engineering (Pty) Ltd and Hlumisa Investment Holdings (RFI) Ltd v Kirkinis (sections 20(6) and 218(2) of the Act do not detract from the common-law principles).

Piercing the veil

Piercing the veil has long been a common-law concept. Section 20(9) of the Act now provides that a court may declare that a company is to be deemed not to be a juristic person in respect of any right, obligation or liability of the company or of a shareholder of the company, if it finds that the “incorporation of the company, any use of the company, or any act by or on behalf of the company constitutes an unconscionable abuse of the juristic personality of the company as a separate entity”.

There has been some confusion about the section of the Act and how it relates to the common law. Ex parte Gore has clarified this issue by holding that the statutory provision seems not to have displaced the common law and is couched in such wide terms that it is mostly possible to reconcile its provisions with the cases that preceded it. The court held:

“ . . . Having regard to the established predisposition against categorisation in this area of the law and the elusiveness of a convincing definition of the pertinent common-law principles, it seems that it would be appropriate to regard section 20(9) of the Companies Act as supplemental to the common law, rather than substitutive . . . ” [emphasis provided].

The application of the “newly introduced” solvency and liquidity test

The “solvency and liquidity test” is contained in section 4 of the Act. Its application is a prerequisite before companies may offer financial assistance for the acquisition of securities, pay dividends, and repurchase shares (to name a few).

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, as fairly valued, equal or exceed the 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 12 months after the date on which the test is considered.

The test is based on reasonably foreseeable financial circumstances and is therefore likely an objective enquiry. It must, however, be noted that this may be impacted by the section of the Act that requires the application of the test. For example, section 45(3)(b) requires that directors should be “satisfied” that the company would comply with the solvency and liquidity test following financial assistance to directors.

If the solvency and liquidity test is applied and the board determines that the company passes the test (and the criterion in this regard is subjective), the fact that the company later becomes insolvent or illiquid does not, of itself, trigger any personal liability on the part of the directors, nor does it affect the validity of the transaction. As far as the phrase “the board is satisfied” in the context of section 45 is concerned, the court in Trevo Capital Ltd v Steinhoff International Holdings (Pty) Ltd clarified matters and concluded as follows:

“[the phrase] requires something more than a purely subjective belief on the part of the directors and must be interpreted as meaning a subjective satisfaction based on reasonable grounds. This approach carries the approval of the authors of Henochsberg who reason that the expression the ‘board is satisfied’ means that the particular board is satisfied, which is a subjective test, but qualified by the objective ‘reasonably foreseeable circumstances’ in section 4. Actual (objective) solvency and liquidity is, therefore, not the test.”

Conclusion

While the Act did create a sense of uncertainty surrounding its application, its purposes (especially with regard to the novel provisions added to our company law and utilisation of unfamiliar language, the purpose of clarifying the old 1973 Act and bringing the existing law in line with the Act and Constitution) were largely fulfilled. Obfuscation can often be clarified in light of the aforementioned case law and commentary. The Act is significant in the understanding of company-law principles, particularly in terms of, inter alia, estoppel, the doctrine of constructive notice, the Turquand rule, the novel statutory piercing the veil provision and the solvency and liquidity test.

Written by Mandy Kuhne, BA LLB LLM (Cantab), Editor-in-Chief of The Law of South Africa (LAWSA), for LexisNexis South Africa and based on the text of The Law of South Africa, Companies, Volumes 6 Parts 1, 2 and 3 (3ed) by Dr HH Stoop.

Article sourced from LexisNexis.