Corruption is the science of man’s own work. Further, corporate corruption has a ripple effect throughout one’s business. Directors who fall negligent in carrying out their fiduciary duties as codified in section 76(3) of the Companies Act 71 of 2008 (“the Act”) in many cases act as an instrument through which pure economic loss is suffered by shareholders due to a diminution of share value. Shareholders, in such circumstance, often seek a remedy in the nature of a personal claim against the directors. It has been debated through several legal arguments whether shareholders may institute an action for damages against the directors by holding them personally liable for a diminution in shareholding value in the company.
The concept that a company has a separate legal personality stems from the fact that a company is a separate legal person which has the capacity and powers to act on its own (South Africa, Companies Act, 2008, section 1). Numerous legal implications flow from the doctrine that a company has a separate legal personality, namely if a company sustains loss, the company itself must institute the action as it is capable of suing or being sued in its own name. A shareholder does not have a direct right of action for the loss (Cassim, 2012). Directors as fiduciaries of a company owe their fiduciary duties to the company and to act in the best interest of the company as a whole (Cassim, 2012). This is emphasised in respect of section 76(3)(b) of the Act, a director of a company, when acting in that capacity, must exercise his powers and perform his functions in the ‘best interests of the company’ (South Africa, Companies Act, 2008, section 76(3)(b)).
Section 218(2) of the Act provides that “any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention” (South Africa, Companies Act, 2008, section 218(2)). This section, prima facie, creates a means through which shareholders may have a recourse against directors for damages arising from pure economic loss. However, it must be pointed out that the decision-making of directors which results in harm to shareholders is likely to result in loss to the company (Cockrill, 2020). In such instance, the shareholders’ loss gives rise to the ‘reflective loss’ principle, barring shareholders from recovering personal damages against directors as this is a reflective loss suffered by the company (Cockrill, 2020). In respect of South African company law and common law, shareholders do not have a right of action to recover personal damages against directors, only the company suffering the loss has a right of action against the third party attributing to the loss. The Supreme Court of Appeal (“SCA”) confirmed this in the case of Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (1423/2018) [2020] 3 All SA 650 (SCA) hereinafter Hlumisa case).
In the Hlumisa case, shareholders instituted an action for an order in terms of section 218(2) of the Act for damages suffered through a diminution of share value in the company due to the directors acting in breach of section 76(3) of the Act (i.e failing to exercise their powers and perform their functions in good faith and proper purpose, in the best interests of the company and with the degree of skill, care and diligence reasonably expected of directors) (Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (1423/2018) [2020] 3 All SA 650 (SCA)). The SCA echoed that directors owe their fiduciary duties to the company itself, and not the company’s members or shareholders. Moreover, the court reaffirmed the common law position that while shareholders of a company may suffer loss by way of the negative effect on a company’s net asset value, in other words, the value of its shares, the company alone may sue for the recovery of damages and not shareholders (Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (1423/2018) [2020] 3 All SA 650 (SCA)).
The effect of this judgment instills that when shareholders suffer a reflective loss as a result of the conduct of the directors, shareholders cannot recover a sum equal to the diminution in the market value of shares, or equal to the likely diminution in dividend. This is because such a loss is merely a reflection of the loss suffered by the company (Mupangavanhu, 2019).
Although, the position in terms of shareholders holding directors personally liable for the pure economic loss suffered through a diminution of share value has been settled in our law, there are instances where shareholders are employing section 218(2) of the Act as a general remedy to hold directors personally liable for the diminution in share value. It has been argued section 218(2) is ambiguous and requires appropriate interpretation (Cockrill, 2020). This is because the current phrasing of the section leads to the assumption that shareholders have the section available to them as a remedy in the instance that they have suffered pure economic loss as a consequence of directors breach of their fiduciary duties (Mupangavanhu, 2019). However, section 218(2) does not alter the common law position. The court, in an obiter dictum, stated that the common law principle has been preserved and complemented by the Act of which was described as a “harmonious blend” (Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (1423/2018) [2020] 3 All SA 650 (SCA)). As a result of the common law position, shareholders’ appropriate remedy, in such circumstance, is to pursue a derivative action embedded in section 165 of the Act (South Africa, Companies Act, 2008, section 165).
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).