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CHAPTER 2 CONCEPTUAL JUSTIFICATION
INTRODUCTION
Many commentators, in criticising directors’ duties to creditors, advance doctrinal and theoretical objections to such a duty. These objections are often related to the view that a particular commentator has regarding the nature of the corporation and its theoretical underpinnings. As a point of departure, some of the theories underlying the concept of the corporation will thus be analysed in order to assess how these theories lend themselves to make provision for a duty to creditors.14 An extension of directors’ duties to creditors is furthermore criticised on the basis of the perceived differences between creditors and shareholders. Creditors are seen to have an exclusive contractual relationship with the company. They should therefore ensure that their interests are protected through the terms of the contract that they are free to negotiate with the company. Any breach of this contract should be addressed by way of traditional contractual remedies.15
Shareholders, on the other hand, are for various reasons assigned the position of primary, or sole, corporate constituents.16 Their interests are thus deserving of protection in other ways, for example the common law duties that directors owe to the company, but which in effect serve to protect shareholders’ interests.17 A last conceptual concern is related to possible negative consequences that directorial liability to creditors for a breach of directors’ duties could have, specifically regarding the effect on director conduct18and limited liability.19In this regard arguments such as the fact that a duty to creditors would stifle entrepreneurial spirit; that it would deter competent people from serving on the boards of companies; and that it is contrary to the fundamental principle of limited liability and would contribute to the erosion of this cornerstone of modern company law, are advanced. In this chapter an analysis of these objections is undertaken to assess whether they are insurmountable and whether an extension of directors’ duties to protect the interests of creditors could be justified on a sound conceptual basis.
THEORIES ON THE NATURE OF THE COMPANY
General
Commentators have various viewpoints on the theoretical foundations underpinning the corporation.20These viewpoints led to the formulation of different models in terms of which the corporation is defined The importance of such models should not be underestimated. It is said that The way in which an extension of directors’ duties to creditors is approached could thus be influenced to a large extent by the model favoured by a particular person. Theories that have been influential in shaping models of companies are the contractual, communitarian and concessionary theories.22 A further theory, namely the associative theory, could also play an important role, especially with regard to directors’ duties to creditors.23 In this section a closer look is taken at what each of these theories entail and how a duty to creditors could be influenced by a predisposition for a particular theory.
Contractual Theories
General
Contractarians view the company as nothing more but a number of “complex, private consensual contract-based relations, either express, or implied”,24 also referred to as a “nexus of contracts”.25The theory, while allowing that implied contracts may be incomplete and that gaps may be filled by company law principles,26 is against the mandatory application of principles and provides for parties to be free to “opt out” of rules where these do not suit their needs.27 The contractarian approach has been very influential in shaping company law doctrine and it is in fact argued by some that the contractarian paradigm developed by law and economics scholars dominates the theory of corporate law.28
Legal Contractualism
Dine distinguishes between two contractual theories, namely “legal contractualism” and “economic contractualism”.29 She explains the consequences of legal contractualism as creating an entity remote from regulatory interference and putting the corporation into the sphere of private law.30A statutory manifestation of this theory is found in section 65(2) of the South African Companies Act,31which provides:
The memorandum and articles shall bind the company and the members thereof to the same extent as if they respectively had been signed by each member, to observe all the provisions of the memorandum and of the articles, subject to the provisions of this Act. An important consequence of the application of this theory is that the primary implied “contract”32is regarded as being between the company and its members, to the exclusion of all other interested parties.33
2.2.2.3 Economic Contractualism
According to a popular economic view the company is seen to be nothing more than a “nexus of contracts”.34It is consequently regarded as a “voluntary association between shareholders”, rather than a “creation of the state”.35The nature and form of the corporation is explained on the basis of bargaining dynamics, rather than legislation, which is considered to have only limited impact on any corporation.36 In this context the function of any system of corporate law is seen merely to provide for a reduction of transaction costs, as it provides a set of “off-the-rack legal rules that mimic what [rational] investors and their agents would typically contract to do”.37 These theories thus seem to emphasise economic notions such as rationality, efficiency and information.38
Communitarian Theories
In terms of these theories the grant of company status is a concession by the state, creating an instrument for the state to utilise.39 The emphasis is thus on identification of the aims of the company with those of society, causing the loss of a strong commercial identity for the company, because it has become a political tool with diffused goals.40These theories hold the risk that sight might be lost of the commercial goal of the company.41
These theories gained prominence in the “stakeholder debate”, in terms of which directors’ duties are redefined with reference to the interests of various corporate stakeholders. This approach, also referred to as the “pluralist” approach,42asserts that “co-operative and productive relationships will only be optimised where directors are permitted (or required) to balance shareholders’ interests with those of others committed to the company”.43The “enlightened shareholder value” approach44 appears to be more moderate than the “pluralist” approach. This model permits directors to have regard, where appropriate, to the interests of other stakeholders in the company, but with shareholders’ interests retaining primacy.45 The interests of other stakeholders are thus to be considered only insofar as it would promote the interests of shareholders.46The enlightened shareholder value approach appears to be nothing more than an affirmation of the reality that directors are bound to consider various factors in ensuring achievement of the goal of wealth-maximisation for shareholders. It would not, however, seem to be indicative of a new trend in terms of which there is an increase in the number of interest groups with justiciable interests against company directors. In the end it is once again a confirmation of the fact that the only corporate constituency whose interests should be protected in terms of directors’ duties, is shareholders.47 Shareholders’ interests are interpreted on a long-term basis, however, with the emphasis on the company being managed in a sustainable manner.48
Concessionary Theories
General
Application of this theory entails that the operation and existence of the company is viewed as a concession by the state that provides the possibility to trade as a corporation, especially where limited liability is afforded in the process.49 The difference between the communitarian theories and the concession theories is that the latter accept that the state has a limited role to play in ensuring that corporate governance structures are fair and democratic, but do not force the company to realign its aims to reflect the social aspirations of the state.50
The granting of limited liability is seen as a privilege which corporators are entitled only to subject to certain terms and conditions.51
Dual Concession Theory
Dine proposes a dual concession theory, the crux of which is that the company is seen as an instrument created by the contractors, but which has a real identity separate and distinct from the original contracting parties.52The concept of the free entity entails the important consequence that the wishes of the original “owners” can no longer be considered paramount.53 This raises the question, however, as to whose interests should carry weight.54
PART I: GENERAL ORIENTATION
Chapter 1: Introduction
1.1 BACKGROUND
1.2 PURPOSE OF STUDY
1.3 EXPOSITION
1.4 LIMITATION OF SCOPE
1.5 METHODOLOGY
PART II: JUSTIFICATION OF A DUTY TO CREDITORS
Chapter 2: Conceptual Justification
2.1 INTRODUCTION
2.2 THEORIES ON THE NATURE OF THE COMPANY
2.2.1 General
2.2.2 Contractual Theories
2.2.2.1 General
2.2.2.2 Legal Contractualism
2.2.2.3 Economic Contractualism
2.2.3 Communitarian Theories
2.2.4 Concessionary Theories
2.2.4.1 General
2.2.4.2 Dual Concession Theory
2.2.5 Associative Theories
2.2.6 Application to a Duty to Creditors
2.2.6.1 Contractual Theories
2.2.6.2 Communitarian Theories
2.2.6.3 Concessionary Theories
2.2.6.4 Associative Theories
2.3 CREDITORS’ CONTRACTUAL RELATIONSHIP WITH THE COMPANY
2.3.1 General
2.3.2 Freedom to Negotiate
2.3.3 Adequacy of Contractual Protective Measures
2.3.3.1 Risk Compensation
2.3.3.2 Guarantees and Loan Covenants
2.3.4 Efficiency Concerns
2.3.5 Conclusion
2.4 SHAREHOLDERS V CREDITORS AS PRIMARY CORPORATE CONSTITUENTS
2.4.1 General
2.4.2 Owners of the Company
2.4.3 Relative Strength of Bargaining Power
2.4.4 Residual Risk-bearers
2.4.5 Efficient Monitors of Managerial Performance
2.4.6 Differences Between Equityholders and Debtholders
2.4.7 Conclusion
2.5 EFFECT OF A DUTY TO CREDITORS ON DIRECTORS’ BEHAVIOUR
2.5.1 General
2.5.2 Fragmentation of Duties
2.5.3 Increased Risk Averseness
2.5.4 Reluctance to Serve on Company Boards
2.6 EFFECT OF A DUTY TO CREDITORS ON LIMITED LIABILITY
2.7 CONCLUSION
Chapter 3: Evaluation of Alternative Remedies
3.1 INTRODUCTION
3.2 STATUTORY MEASURES PROVIDING FOR DIRECTORS’ PERSONAL LIABILITY
3.2.1 South Africa
3.2.1.1 Applicants
3.2.1.1.1 Question as to Whether Claim Should be Quantified
3.2.1.1.2 Effect of Implementation of Compromise in terms of Section 311 on
Locus Standi of Creditor
3.2.1.2 Winding-Up, Judicial Management or Otherwise
3.2.1.3 Recklessly
3.2.1.4 Fraudulently
3.2.1.5 Consequences of a Successful Application
3.2.1.5.1 Liability for Which Debts?
3.2.1.5.2 Creditors Who Are Benefited
3.2.1.5.3 Punitive Element
3.2.1.6 Evaluation
3.2.2 Comparative Study
3.2.2.1 Australia
3.2.2.2 New Zealand
3.2.2.3 England
3.2.2.4 Canada
3.3 TYPICAL INSOLVENCY REMEDIES
3.3.1 General
3.3.2 Statutory Voidable Dispositions
3.3.2.1 Dispositions Not for Value
3.3.2.2 Voidable Preferences
3.3.2.3 Undue Preferences
3.3.3 Common Law Remedy: Actio Pauliana
3.3.4 Evaluation
3.4 PIERCING THE CORPORATE VEIL
3.5 CONCLUSION
PART III: FRAMEWORK FOR A DUTY TO CREDITORS
Chapter 4: Judicial Framework
4.1 INTRODUCTION
4.2 TYPE OF DUTY
4.2.1 Introduction
4.2.2 Australia
4.2.3 New Zealand
4.2.4 England
4.2.5 Canada
4.2.6 United States of America
4.3 POINT IN TIME WHEN THE DUTY ARISES
4.3.1 Introduction
4.3.2 Australia
4.3.3 New Zealand
4.3.4 England
4.3.5 Canada
4.3.6 United States of America
4.4 BENEFICIARY OF THE DUTY
4.4.1 Introduction
4.4.2 Australia
4.4.3 New Zealand
4.4.4 England
4.4.5 Canada
4.4.6 United States of America
4.5 PROTECTED CREDITORS
4.5.1 Introduction
4.5.2 Australia
4.5.3 New Zealand
4.5.4 England
4.5.5 Canada
4.5.6 United States of America
4.6 POWER OF THE GENERAL MEETING TO RATIFY A BREACH OF THE DUTY .
4.6.1 Introduction
4.6.2 Australia
4.6.3 New Zealand
4.6.4 England
4.6.5 Canada
4.6.6 United States of America
4.7 CONCLUSION
Chapter 5: Protection Afforded by Fiduciary Duties
5.1 INTRODUCTION
5.2 SOURCES AND FORMULATION
5.2.1 South Africa
5.2.2 Australia
5.2.3 New Zealand
5.2.4 England
5.2.5 Canada
5.2.6 United States of America
5.3 RELEVANT ELEMENTS
5.3.1 Acting in Good Faith in the Best Interests of the Company
5.3.1.1 General
5.3.1.2 Requirement of Good Faith
5.3.1.3 Defining the Interests of the Company
5.3.2 Maintaining an Unfettered Discretion
5.3.2.1 General
5.3.2.2 Nominee Directors
5.3.3 Avoiding a Conflict of Interests
5.3.3.1 General
5.3.3.2 Unwarranted Personal Benefit
5.3.3.3 Contracts with the Company
5.4 CONSEQUENCES OF BREACH OF DUTY
5.4.1 General
5.4.2 Setting Aside of Transaction
5.4.3 Civil Personal Liability
5.4.3.1 Extent of Personal Liability
5.4.3.2 Basis of Personal Liability
5.4.3.3 Defendant
5.4.3.3.1 Definining “Director”
5.4.3.3.2 De Facto Directors
5.4.3.3.3 Non-executive Directors
5.4.3.3.4 Puppet, Dummy or Stooge Directors and Shadow Directors
5.4.4 Pecuniary Penalty Orders
5.5 APPLICATION TO A DUTY TO CREDITORS
5.5.1 Sources
5.5.2 Formulation
5.5.3 Relevant Elements of Fiduciary Duties
5.5.3.1 Acting in Good Faith in the Best Interests of the Company
5.5.3.2 Maintaining an Unfettered Discretion
5.5.3.3 Avoiding a Conflict of Interests
5.5.4 Consequences of Breach
5.5.4.1 Remedy
5.5.4.1.1 Personal Liability
5.5.4.1.2 Pecuniary Penalty Order
5.5.4.2 Basis of Liability
5.5.4.3 Defendant
5.6 CONCLUSION
Chapter 6: Protection Afforded by the Duty of Care and Skill
6.1 INTRODUCTION
6.2 SOURCES AND FORMULATION
6.3 RELEVANT ASPECTS
6.4 CONSEQUENCES OF BREACH
6.5 APPLICATION TO A DUTY TO CREDITORS
6.6 CONCLUSION
Chapter 7: Point in Time When the Duty Arises
7.1 INTRODUCTION
7.2 DEFINING THE TRIGGERS
7.3 FACTORS INFLUENCING PREFERENCE FOR A TRIGGER
7.4 PRACTICAL APPLICATION OF THE TRIGGERS
7.5 CONCLUSION
Chapter 8: Beneficiary of the Duty
8.1 INTRODUCTION
8.2 ORTHODOX VIEW
8.3 JUDICIAL METHODS FOR EXTENDING DIRECTORS’ DUTIES TO CREDITORS
8.4 EVALUATION OF JUDICIAL METHODS
8.5 SUGGESTED METHOD
8.6 CONCLUSION
Chapter 9: Relief from Liability.
9.1 INTRODUCTION
9.2 RELIEF BY THE COURT Introduction
9.3 INDEMNIFICATION
9.4 DIRECTOR LIABILITY INSURANCE
9.5 CONCLUSION
PART IV: CONCLUSION
Chapter 10: Conclusion
10.1 BACKGROUND
10.2 JUSTIFICATION OF A DUTY TO CREDITORS
10.3 FRAMEWORK FOR A DUTY TO CREDITORS
10.4 DEVELOPMENT OF A DUTY TO CREDITORS
10.5 CONCLUDING REMARKS
APPENDICES
Summary
Opsomming
Bibliography: Books and Theses
Bibliography: Law Journals
Bibliography: Bills and Reports
Table of Cases
Table of Statutes
