BCLR Step Ahead Newsletter No. 3/2012
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Personal liability of members for a CC's debts
The judgment in Airport Cold Storage (Pty) Ltd v Ebrahim (handed down by the Cape High Court on 22 May 2007) stands as a warning to any businessperson who thinks that carrying on business as a close corporation is cast-iron protection against personal liability for the debts of the business.
Section 65 of the Close Corporations Act provides that where the incorporation of a close corporation or any act by it, constitutes “a gross abuse of the juristic personality of the corporation as a separate entity” the court can declare that the CC is “deemed not to be a juristic person in respect of such rights, obligations or liabilities of the corporation” as the court specifies.
It is interesting to note that there is no exact counterpart to this provision in the Companies Act.
In the Airport Cold Storage case, the Cape High Court applied this section of the Close Corporations Act against a close corporation whose sole member had engaged in many irregular practices, including “reckless trading” as contemplated in section 54 of the Act. The member had also, said the court, ignored the separate legal existence of the close corporation when it suited him to do so.
The effect of the court order was that the CC was deemed not to exist vis-à-vis the particular aggrieved creditor, and its sole member was personally liable for the CC’s debts toward this particular creditor. Consequently, this particular creditor would be able to enforce payment of his debt from the personal money and assets of the member.
This is the first time that a court has invoked section 65 of the Close Corporations Act to make an order of this kind. Usually, aggrieved creditors choose instead to base their claim on section 64 of the Close Corporations Act which empowers a court to declare any person who was “knowingly a party” to reckless or fraudulent trading by the close corporation to be personally liable for its debts.
The general rule remains intact that, where debts are incurred by a close corporation, the corporation as a legal entity in its own right is liable for those debts, and that the members’ of the CC have no personal liability for those debts.
The mere fact that a close corporation is unable to pay its debts does not, of itself, result in the members being personally liable for its debts. It is only where the members have engaged in conduct which empowers a court (either at common law or in terms of the Close Corporations Act) to “lift the veil of incorporation” that the members will be personally liable for those debts.
In Hulse-Rutter v Godde 2001 (4) SA 1336 the Supreme Court of Appeal held that the court has no general discretion to disregard the existence of a separate corporate identity simply because it would be “just or convenient” to do so.
Indeed, the law is still far from settled as to the circumstances in which the courts will lift the corporate veil. Generally, the courts will do so only where there has been conduct which entails “some misuse or abuse of the distinction between the corporate entity and those who control it”. Fraudulent conduct on the part of those who control the corporate entity will almost always justify a lifting of the veil. But so also will “improper conduct”, though this category is somewhat vague.
The widest ground on which a court can lift the veil of incorporation is that of “reckless” conduct by the controllers of the company or close corporation.
Section 424(1) of the Companies Act and section 64 of the Close Corporations Act specifically provide that where the company or CC was carrying on business “recklessly”, those persons who were “party to” that conduct (in essence, the directors, managers and controllers) can be declared personally liable for the debts of the company or close corporation.