Is your company solvent? What are a director’s responsibilities to ensure it is?

We Build It (Pty) Ltd is a construction company managed and operated by its directors. The nature of the company’s business regularly requires that its construction projects be well advanced before payment for services rendered is received. With subcontractors and suppliers to be paid, the company often finds itself in a situation where its debts could potentially not be paid if payment from a major client is delayed.

Should such a scenario arise, the business can be at risk of falling foul of the compliance requirements of the Companies Act, 2008 (the Companies Act) by not being able to pass the solvency and liquidity test prescribed by the Companies Act. As the business is being run by its directors, the following question then arises: If the company cannot pass the solvency and liquidity test, to what extent may the directors of the company incur liability for this situation?

Sibeko is a director of the business and is primarily responsible for the finances of the business. Sibeko and his fellow directors operate the business at a constant profit and ensure that each director earns a healthy return for their efforts. However, despite the company being profitable, a delay by a major developer to pay the company for a large office development, creates a cash flow crisis for Sibeko and his directors and puts the company at risk of not being able to pay subcontractors, suppliers and possibly even their staff.

Sibeko is not overly concerned as he is used to managing these types of risks in the construction environment and knows that the company is inherently healthy. However, the Companies Act does not cater for a ‘gut-feel’ approach and provides specific tests in respect of solvency and liquidity which directors of a company are obliged to apply to the company’s financial position.

Accordingly, despite the company being profitable, the reality of the situation is that it might not be able to repay its service providers and suppliers on time for accounts due and payable within the next six months as a result of the non-payment by the client.

The Companies Act now requires of Sibeko, as a director actively involved in the day to day administration of the business of the company, to consider as a reasonable business person, whether the company will be able to pay the creditors of the company as and when payment becomes due. Sibeko must further take note that the Companies Act determines that should the directors continue running the business whilst knowing that creditors will not be able to be so paid, the company may be regarded as being operated in a reckless or negligent manner by its directors.

Should Sibeko therefore determine that the company cannot repay its debts when they become due and payable, Sibeko and his board of directors are obliged to take a decision to either place the company under business rescue or to liquidate the company. Should they decide not to follow either of these options and continue with the business as is the directors will need to send a notice of their intent to all persons that may be affected by their decision. Such affected persons could include not only the suppliers and service providers of the company, but also employees and shareholders.

On a day to day basis, the situation may be such that business rescue or liquidation is not necessary as the cash flow crisis is short and determinable. However, the responsibility for the decision remains with the board of directors, and should they fail to exercise their discretion in circumstances where it is clear that the company could be insolvent or financially distressed, each director can be held personally liable for the debts incurred by the company.

A board of directors will in such circumstances have to show that after consideration of all factors and information available to them as directors of the company, their decision was taken honestly and reasonably in the ordinary course of the business of the company. If this cannot be shown, any affected person can demand payment personally from Sibeko as director of the company, and not only from the company.

To avoid such liability accruing to him, Sibeko must ensure at all times that the company will be able to repay all monies owed to creditors of the company. This will enable Sibeko to pro-actively ensure that the company passes the solvency and liquidity test or take an informed decision regarding business rescue or possible liquidation. What is clear from the Companies Act is that directors have a positive obligation to manage the solvency status of their company with a failure to do so bringing personal liability for the company’s debts into the picture.

If you are concerned about the solvency of your business it is advisable to consult an attorney without delay to obtain assistance with possible notices to creditors and obtain advice as to the option of business rescue or the consequences of liquidation.

March 18, 2013
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