Wake up call for members of a Close Corporation

Members are personally liable for the reckless trading of their close corporation.

The misconception exists that members of a close corporation (CC) are able to trade as they please without personal liability. The courts have, however again enforced the Close Corporations Act, 1984 to make members personally liable for the reckless trading of their close corporation.

In Ebrahim v Airports Cold Storage (Pty) Limited  (485/2007) [2008] ZASCA 113 (25 September 2008), the appellants, Ebrahim junior and Ebrahim senior, appealed a judgement which declared them personally liable for the debts a close corporation incurred during its short operational life in 2005. 

For three months from March 2005, Airports Cold Storage (Pty) Limited ("Airports") supplied Sunset Beach Trading 232 CC (trading as Global Foods) with frozen meat, poultry and other comestibles.  Payment initially flowed but eventually dried up in June 2005 when invoices totalling R278 377,19 were still unpaid.  Airports then had Global Foods liquidated. Despite recorded deliveries invoiced at over R1,8m, the cash-in-hand in Global Foods only totalled to R254,99.  Global Foods had no other assets.

Airports brought an action to recover the debt personally from Ebrahim junior who was Global Foods sole member and his father, Ebrahim senior.  Airports targeted the Ebrahims personally on the basis that they were both personally liable under Section 64(1) of the Close Corporations Act, 1984 ("the Act") because during the period March to August 2005 Global Foods was conducted recklessly or for fraudulent purposes or with intent to defraud its creditors.

According to the evidence, Ebrahim senior had actively assisted his son in running Global Foods.  According to the High Court judgement, as far back as 1997 the father and the rest of the family used "a host of entities and trading names at different stages" to pursue their business interests and that in doing so they had "scant regard" for the entities' separate corporate identities. 

A considerable volume of business was transacted through Global Foods from late March until the payments faltered on 24 June 2005.  The accountant of Global Foods testified that although Global Foods had charged its customers VAT, no VAT returns were submitted to the South African Revenue Services (Sars) and no VAT payments were made.  He calculated that about R200 000 was due to Sars.  Global Foods defence was that since VAT returns were required to be submitted only every two months and VAT paid only once a year, the short operational life of Global Foods rendered the omissions insignificant.  However, this ignores the fact that not only did Global Foods fail to submit VAT returns, it failed to record anywhere that it was collecting VAT from its customers. The suggestive inference was that there was never any intention to pay VAT.

The court found that Global Foods business appeared to have been conducted with blithe disregard of statutory requirements.  There were no conventional books of account.  There was not a single record of any expense recorded in any document provided after liquidation.  Even though the employee complement numbered between 10 and 20, there was neither payslips nor PAYE returns.  This is in clear violation of Section 56 of the Act.  Further, there was no accounting officer.

Payment to creditors totalled just over R1,4m against income in excess of R1,8m.  This gave rise to two conclusions:

• Firstly, cash takings never found themselves into Global Food's bank account. Instead the greater portion found its way into another of Ebrahim's close corporations.  The reason the Ebrahims advanced that no monies were deposited into the bank account was to avoid bank charges and cash deposit fees.
• Secondly Global Foods receipts and expenditure indicated that when trading ended there should have been a positive balance of some R300 000.00 in a bank account or on hand.  Instead there was only R254.99.

Global Foods had no financial statements and there were no other management records or reports of daily sales, itemised expenses, a trial balance or balance sheet.

The court found that acting "recklessly" consists in "an entire failure to give consideration to the consequences of one's actions, in other words, an attitude of reckless disregard of such consequences".  In applying the recklessness test to the running of a close corporation, the courts will have regard to the corporation's scope of operations, the members' roles, functions and powers, the amount of the debts, the extent of the financial difficulties and the prospects of recovery, plus the particular circumstances of the claim and the extent to which the member has departed from the standards of a reasonable person. In order for persons to derive the benefit of immunity from liability of a juristic person's debts, those running the corporation may not use its formal identity to incur obligations recklessly, grossly negligently or fraudulently.  If they do so, they can be made personally liable.

The court found that the Ebrahims simply used Global Foods on an ad hoc basis and at the convenience of their trading circumstances.  They had no conception of, nor respect for the fact that Global Foods was a distinct legal entity with a separate legal existence. Further, the consistent disregard of the independent well-being of Global Foods as a separate entity constituted reckless carrying on of its business as contemplated by Section 64 of the Act.  It was clear to the Court that the manner in which Global Foods did business that left Airports out of pocket.

The Appeal Court upheld the judgment awarding R278 377,19 with interest to Airports.

Members of close corporations must therefore be aware that although the statutory requirements of a close corporation are more relaxed than that of other forms of business enterprises, the relaxation does not give members the right to trade recklessly. If a member is found to be trading recklessly, he or she will be personally liable for the debts of the corporation.

^{Source : Moneyweb}