The Companies Act 71 of 2008 (“the Act”) sets out rules to ensure that companies venture responsibly when dealing with their finances, especially when giving financial assistance or making payments to shareholders. These rules are important because they protect both creditors (people the company owes money to) and shareholders. Two key provisions in this regard are the rules on financial assistance and the solvency and liquidity test, which determine whether a company is financially stable enough to proceed with certain transactions.
What is Financial Assistance?
Under section 44(2) of the Act, financial assistance encompasses matters such as giving a loan, providing security, or any similar form of financial help.
The Solvency and Liquidity Test:
Section 4 of the Act introduces the solvency and liquidity test (“the test”).[1] This test must be applied not only when a company makes distributions to shareholders, but also when it gives financial assistance for the purchase of its own shares. The test has two parts, and both must be satisfied.
The solvency component holds that the company’s assets must be equal to or greater than its liabilities, taking into account all reasonably expected financial circumstances.[2] The liquidity component holds that the company must be able to pay its debts as they become due for the next twelve months.[3]
In simple terms, the test speaks to the board of directors (“the board”) assessing whether the company is financially healthy enough for certain transactions. They must consider whether the company owns more than it owes, and whether it can continue paying its debts in the near future. The law does not require the board to be perfectly accurate in predicting the future, but it does require them to act reasonably based on the information available at the time.[4] Even if their prediction later turns out to be wrong, the requirement is still met if their decision was reasonable when made.
When applying this test, the board must rely on the company’s financial records, as required by sections 28 and 29 of the Act. These records reflect the company’s financial position and help determine whether it is solvent and liquid. The board must also consider any other relevant factors that could affect the company’s finances. The purpose of this test is to protect creditors and minority shareholders by preventing companies from making decisions that could weaken their financial position.
Distributions:
The Act defines a “distribution” in three main ways. First, it can be a payment of money or transfer of property to shareholders, such as dividends or payments when a company buys back its own shares. Second, it can involve the company taking on a debt or obligation for the benefit of a shareholder. Third, it can include forgiving a debt owed by a shareholder to the company. [5]
Section 46 of the Act sets out the requirements for making a valid distribution.[6] First, the distribution must be properly authorised, either by law, a court order, or a decision of the board.[7] Second, the board must believe, based on reasonable financial forecasts, that the company will pass the solvency and liquidity test.[8] Third, the board must formally confirm that they have applied this test and are satisfied that the company will still meet it after the distribution is made.[9]
If more than 120 days pass after the board approves the distribution and it has not yet been carried out, the board must reassess the company’s financial position (by reconsidering the solvency and liquidity test) and pass a new resolution before proceeding.[10]
Failure to comply with the abovementioned requirements renders the distribution invalid and directors may be held personally responsible[11] to the extent outlined in section 77(3)(e)(vi) of the Act.[12] For example, a director who knew the company did not meet the requirements but still supported the distribution, or failed to object or vote against it, can be held liable. Liability can be in the form of any loss, damage or costs sustained by the company due to the director’s negligence.[13] This is in line with cases such as Howard v Herrigel NO and Another[14], where the court confirmed that directors have a duty to display the utmost good faith towards the company, and, in doing so, to exercise reasonable skill and diligence… and may be held liable in damages for any loss suffered. It can then be said that section 46 ensures that company assets are not distributed in a way that harms creditors. [15]
Therefore, the Act requires companies to carefully assess their financial position before giving financial assistance or making distributions. The solvency and liquidity test plays a central role in this process, ensuring that companies remain financially stable and able to meet their obligations. By placing responsibility on the board of directors and holding them accountable for unreasonable decisions, the Act strikes a balance between allowing shareholder benefits and protecting creditors from financial harm.
[1] The Companies Act 71 of 2008 s 4. [2] The Companies Act 71 of 2008 s 4(1)(a). [3] The Companies Act 71 of 2008 s 4(1)(b). [4] Van Der Linde K ‘The solvency and liquidity approach in the Companies Act 2008’.(2009) (2) TSAR.
[5] The Companies Act 71 of 2008 s 1. [6] The Companies Act 71 of 2008 s 46. [7] The Companies Act 71 of 2008 s 46(1)(a). [8] The Companies Act 71 of 2008 s 46(1)(b). [9] The Companies Act 71 of 2008 s 46(1)(c). [10] The Companies Act 71 of 2008 s 46(3). [11] The Companies Act 71 of 2008 s 46(6). [12] The Companies Act 71 of 2008 s 77(3)(e)(vi). [13] Cassim et al Contemporary Company Law 2ed (2012) 282. [14] (130/89) 1991 (2) SA 113 (A) at 674. [15] Howard v Herrigel NO and Another (130/89) 1991 (2) SA 113 (A) at 674.Associate at Adriaans Attorneys
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