Labour Law
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Imraan Mahomed, Vivien Chaplin and Tobie Jordaan 10 Mar 2022
Family or not - business is business: Consequences of reckless trading
Doing business with family members can be a double-edged sword. On the one end, there is shared trust and understanding which creates a strong foundation. On the other, there may be an overlap of personal and professional dynamics. This may be a fertile ground for conflict and financial risk.
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This was evident in the case of Badenhorst v De Kock 2024, wherein Janisch AJ held that the respondent, Jacobus Francois De Kock traded recklessly and was personally liable for the debt incurred by Good Hope Holdings (GHH) for the purchase of shares and loan accounts from the applicant, Mariana Badenhorst, his sister. The legal principles pertaining to reckless trading and its consequences are explored through the analysis of the case.
Family feud led to sale of shares
In or around 2009, Badenhorst purchased a minority interest in Bunker Hills Investments on recommendation by her brother, De Kock. A few years later, De Kock, on behalf of GHH, offered to purchase her shares and loan accounts in Bunker Hills. Badenhorst contended that her decision to sell her shares and loan accounts was due to lost trust in the quarry business of Bunker Hills. However, her brother contended that the decision was due to a family feud.
GHH, represented by De Kock, purchased his sister’s shares and loan accounts in Bunker Hills for R4,625,000. The purchase price was to be repaid in monthly instalments over a period not exceeding 24 months, failing which an amount of R750,000 per annum (being capital growth) would accrue. GHH was an investment holding company of whom De Kock was the sole director and shareholder.
At the outset, GHH failed to meet its payment obligations and after Badenhorst approached the court, the parties concluded a settlement agreement in terms of which the GHH would make payment of the overdue amounts in addition to the instalments due under the share sale agreement. De Kock failed to comply with the terms of the settlement agreement and after approaching the court for an order enforcing the settlement agreement, Badenhorst obtained judgment against her brother for an amount of R4,224,000 including interest.
GHH again defaulted on its obligations, and with a sum of R4,035,000 still outstanding, Badenhorst launched liquidation proceedings and accordingly obtained a provisional liquidation order in September 2021 and a final order in January 2022.
Before the dividend due to the creditors had been determined and prior to the approval of the liquidation and distribution account, Badenhorst approached the High Court again. But this time seeking an order, in terms of section 424 of the Companies Act 61 of 1973 (the “1973 Act”), that her brother be held personally responsible for the debt of GHH, contending, amongst other things, that the business of GHH was at all relevant times carried on recklessly by her brother, and that he was knowingly a party thereto.
Reckless trading
Section 424 of the 1973 Act, which still finds application despite the Companies Act 71 of 2008 (the “2008 Act”) coming into operation provides that:
“When it appears, whether it be in a winding-up, judicial management or otherwise, that any business of the company was or is being carried on recklessly or with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the Court may, on the application of the Master, the liquidator, the judicial manager, any creditor or member or contributory of the company, declare that any person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Court may direct.” [Underlining added]
Having regard to the above definition, in Philotex (Pty) v Snyman, Braitex (Pty) Ltd v Snyman (1992) SCA stated that the test for recklessness is:
objective insofar as the defendant's actions are measured against the standard of conduct of the notional reasonable person and it is subjective insofar as one has to postulate that notional being as belonging to the same group or class as the defendant, moving in the same spheres and having the same knowledge or means to knowledge.
Unreasonable vs grossly unreasonable conduct
To prevent the above test from making it impossible for directors to take entrepreneurial risk in carrying on the business of a company, the court in Philotex distinguished between unreasonable conduct and grossly unreasonable conduct. The court also noted that each case needed to be determined on its own facts and involve a value judgment.
In making the distinction, the court stated that a person’s conduct would be unreasonable where it fell short of the standard of conduct of the reasonable businessman but could not fairly be described as “gross”. The court noted that to require virtual certainty of non-payment would impose an unduly heavy burden on a plaintiff to succeed in section 424 proceedings.
In summary, the court in Philotex stated that “the incurral of debts on behalf of a company at a time when no reasonable business person would consider that the company would be able to satisfy those debts when they fall due would prima facie demonstrate reckless trading even if the directors bona fide thought otherwise.”
General manner of carrying on business
De Kock’s knowledge of the conduct of GHH was not in dispute, given that he was at all relevant times the sole director of GHH, no third parties were involved, and he did not contend that he was not knowingly a party to every act of GHH. The court focused on ascertaining whether De Kock caused the business of GHH to be carried on recklessly.
To assess this, the court considered three areas, namely the conclusion of the shares agreement and the incurral of indebtedness by GHH to Badenhorst, the conclusion of a settlement agreement, and De Kock’s general manner of carrying on the business of GHH over the period relevant to the application.
Each area is dealt with separately below.
1. Sale of shares agreement
To determine whether De Kock acted recklessly in concluding the sale of shares agreement, the court needed to establish “whether a reasonable business person in the position of De Kock would have assumed the debt and instalment payment obligations on behalf of GHH, having regard to the GHH’s ability to meet those payment terms”.
The court emphasised that the determination had to be made “on the facts and circumstances existing at the time of concluding the sale of shares agreement”.
De Kock gave evidence that GHH, as an investment holding company, did not have income, but rather assets in the form of loan accounts. As such, GHH was solely dependent on its ability to call up loan accounts with its operating subsidiaries.
De Kock stated in his answering affidavit that the money that GHH intended to use to pay the purchase price had been indirectly invested in Safepro and that as a result of Safepro not receiving payment from a joint venture partner, it was unable to fund suppliers or repay its loan account with Two Ships, resulting in Two Ships being unable to repay its loan with GHH. This ultimately affected GHH’s ability to pay the instalments in terms of the sale of shares agreement. The court found De Kock’s evidence unsatisfactory.
Given the vagueness proffered by De Kock in relation to how he considered that GHH would be able to meet its payment obligations, the court was not able to conclude, on the facts, that at the time that the sale of shares agreement was concluded, GHH had a reasonable expectation of being able to meet its payment obligations. Similarly, De Kock’s testimony in court and in the insolvency enquiry was vague, and the language used in the insolvency enquiry enunciated that of “hope” and “uncertainty”.
The court determined that nothing De Kock said confirmed that there was a reasonable prospect of GHH meeting its payment obligations. This position was reinforced by the fact that GHH failed to meet such obligations.
The court found that not only was there no concrete or reliable expectation at the time of the conclusion of the sale agreement that GHH would be able to meet the payment terms, but the asset acquired was seemingly worthless and De Kock merely used GHH as a vehicle to appease his sister amid the family tension.
The court therefore determined that De Kock took an unjustifiable risk on behalf of GHH and that he was party to the reckless carrying on of the business of GHH when committing it to acquire the Bunker Hill shares on the terms set out in the sale agreement.
2. Settlement agreement
At the time of concluding the settlement agreement, the events which resulted in Safepro being unable to repay its loan with Two Ships had occurred, and it would therefore have been clear that Two Ships would be unable to repay GHH. Despite this, De Kock committed GHH to more onerous terms contained in the settlement agreement and committed to it being made an order of court.
Other than proceeds from the sale of a property, the value of which was far below the debt owed to his sister, the court found that there was no indication of any other source of income to pay the balance of the instalments, and no source of capital should the acceleration clause be triggered, which seemed inevitable.
As a result, the court concluded that De Kock, again, showed little to no regard for the success and well-being of GHH and caused GHH to incur debts with no reasonable likelihood of being able to fulfil its payment obligations. The court was satisfied that this conduct met the requirements for recklessness set out in the aforementioned case law.
3. General conduct of De Kock
It was submitted by De Kock that GHH was an investment holding company and its ability to pay its debts was dependent on receiving repayments from its operating subsidiaries. Repayment was therefore not certain. Furthermore, GHH had little control over receiving loan repayments from its subsidiaries because repayment was dependent on the ability of the subsidiaries to repay same to GHH.
De Kock, in his evidence at the enquiry, reflected that when he made an agreement to pay a creditor, he put the underlying companies to terms and they undertook to repay same as and when they were able in terms of their own cashflows, which did not happen. The court expressed the view that this demonstrated that De Kock was prepared to commit GHH to payment terms before approaching the operating companies for the money it needed to do so and without knowing whether the operating companies were able to repay the money needed by GHH to meet its payment obligations.
De Kock expressly acknowledged that any non-payment by GHH in respect of a debt owed to loan creditors would be restructured with the particular creditor, with the knowledge, co-operation and consent of all GHH’s other creditors, other than his sister. This meant that GHH adopted a business model where its survival was dependent upon the goodwill and patience of its creditors to agree to extended payment terms, which often entailed further commitments being made by GHH.
The court was satisfied that the ongoing conduct of being financed by external debt instead of liquidating a commercially insolvent company was reckless in itself. De Kock, under those circumstances, committing GHH to substantial new and onerous obligations to his sister without any increased expectation of income only reinforced that view.
The court concluded that De Kock’s conduct in the transaction between GHH and Badenhorst and in relation to the general conduct of GHH’s business was so far removed from how a reasonable director would conduct himself, warranting the conclusion that De Kock acted recklessly.
The court found that Badenhorst, in principle, had established a basis for relief against De Kock under section 424 of the 1973 Act.
Causal link between the recklessness and the debt
The court noted that where the requirements of section 424 are met, it retains a discretion whether to declare De Kock personally liable for the debts of the company and the amount of such liability, if any.
In exercising its discretion, the court was satisfied that Badenhorst had shown a causal link between her brother’s recklessness and the debt in issue. In addition, the court found that the conduct of De Kock in relation to the Bunker Hill transaction was markedly similar to GHH’s business, and the same criticism would apply to the conduct of De Kock in relation to the Bunker Hill transaction and the general way he conducted the business of GHH.
The court found that De Kock was liable to his sister in the amount of R4,035,000 plus interest and made a cost order in her favour.
Closing remarks
Reckless trading poses significant risks. The Badenhorst case serves as a cautionary tale of the dangers thereof, and highlights that the separate personality of an entity does not guarantee the persons carrying on the business of that entity, an escape from personal liability.
Two important lessons can be learned from this case:
- Before incurring debt on behalf of an entity, it is essential to ensure that the entity is capable of repaying the debt timeously; and
- before being owed a debt, it is essential to do the necessary due diligence to establish that the debtor has the financial means to repay the debt – trust in the debtor’s ability to repay the debt is not sufficient.
Before you enter a business transaction, regardless of which side of the transaction you are on, think twice!
About the author
Lara Horne is a Candidate Attorney and Nicola Mullineux, a Senior Associate at Herold Gie Attorneys.