The potential for unscrupulous conduct in the voluntary winding-up process in South Africa

Aug 5, 2021 | News

Two primary avenues exist under South African law for the liquidation of a company – voluntary winding up and winding up by way of a court order. A further distinction exists in a voluntary winding up between one by the company’s members (shareholders) and a voluntary winding up by its creditors. In this article, we interrogate the voluntary process of winding up in both instances and illustrate how the process is susceptible to abuse by unscrupulous participants in the process to circumvent and frustrate the protections ordinarily afforded to creditors and to deprive creditors of their rights.

The voluntary winding up of a company is commenced by way of a special resolution passed by the members of the company. The special resolution is then filed and registered with the Companies and Intellectual Property Commission (CIPC). This brings about the commencement of a company’s winding up. Once the resolution is registered with CIPC, a copy of the resolution must be lodged with the Master of the High Court (the Master) within 28 days. In respect of a voluntary winding up by members, the Master must, in addition to the resolution, be furnished with a copy of a resolution passed for the appointment of a liquidator and providing the Master with security for payment of debts of the company within 12 months or a sworn statement by the directors and the auditors of the company confirming that the company has no debts. In respect of a voluntary winding up by creditors, the resolution must also be accompanied by a statement by the directors concerning the affairs of the company. The Master will then give notice of the voluntary winding up of the company in the Government Gazette.

During these processes, there is very little to no involvement of the company’s creditors, especially in the case of a voluntary winding up by members. The only protection afforded to creditors in this instance is the payment of security to the Master ensuring that all creditors will be paid within twelve months or the sworn statements by the directors and auditors confirming that the company has no debts. In reality, this gives little comfort to creditors and is inadequate to satisfy their claims.

With respect to voluntary winding up, it is not until the Master calls the first meeting of creditors that the creditors are notified of the voluntary winding-up proceedings unless they examine the Government Gazettes each week which also include a great number of statutory and other notices and are voluminous. Often a creditor is only notified of liquidation proceedings long after they have commenced, and this leaves the creditor significantly frustrated with very little opportunity to take any steps necessary to protect their interests timeously. This is more often than not a calculated stratagem on the part of the insolvent company and its directors.

This loophole also opens a pathway to unscrupulous conduct and the potential for abuse in that it enables directors of companies to bypass and abuse the process and potentially misrepresent and defraud creditors. A dishonest director might not, for example, make full and proper disclosure of the company’s affairs in the statements required by the Master, resulting in a creditor not being disclosed and who is, in consequence, unaware of the winding-up proceedings. The creditor will likely not be directly notified of the first creditors’ meeting (or perhaps the second), and it will therefore not be able to prove its claims or participate in the appointment of a liquidator at these meetings. This could also result in the appointment of a liquidator who is not impartial or independent at the behest of the company or who fails to exercise their powers and functions as contemplated in the applicable legislation. In addition, where full and proper disclosure is not made, even the most honest liquidator’s findings may not indicate the true position of the company’s affairs, to the prejudice of creditors.

In contrast, where a company is wound up by way of a court order, the court has the power to grant or dismiss any application made for the winding up of a company or make any other order it may deem fit and just. The protections afforded to creditors in this process are far greater than those provided by voluntary winding up whether by its members or by its creditors. A full enquiry in terms of section 417 of the Companies Act, 2008 is readily available once an order has been granted, allowing creditors to access the affairs of the company without a lengthy procedure. In addition to the above, it is a requirement that when the application is launched, it must be served on the company, its employees and the registered trade unions representing the employees as well as the South African Revenue Services and the Master of the High Court. This gives the Master an opportunity to file a report concerning the company and its affairs. A notice in the government gazette must also be published. If the court grants a provision winding up order, the order must be served on the same parties as were cited in the application. Often, the court will also require that the order of provisional winding up is published in newspapers within the area in which the company operates and further require that the order is also served on the company’s known creditors.  The Master will appoint a provisional liquidator and once a final winding-up order is granted, the first meeting of creditors will be called where the creditors will have an opportunity to prove their claims and confirm the appointment of the provisional liquidator or nominate an independent liquidator. A second meeting also takes place, giving creditors a further opportunity to prove their claims.

Despite the predicament in which creditors of a company that winds up voluntarily might find themselves as a result, all is not necessarily lost, provided that the creditor concerned has the resources, wherewithal and appetite to litigate. Section 388 and section 417 together with section 418 of the Companies Act provide some relief to creditors. A creditor (among others) can, under section 388, apply to the High Court and request the court to exercise the powers which it would ordinarily exercise if the company were being wound up by way of a court order. Some of these powers include ordering the holding of an enquiry into the financial affairs, trade, dealings and property of a company that is winding up as contemplated in the provisions of section 417 and section 418 of the Companies Act. A creditor may also apply to Court to convert the voluntary winding-up to a winding-up by way of Court Order, and thereby bring it within the realm of the protection usually afforded under section 417 of the Companies Act.

The function of a section 417 enquiry is to interrogate the affairs and trade dealings of the Company and its directors to establish possible fraud, reckless trading and malfeasance to the detriment and prejudice of creditors with the purpose of enabling the liquidator to claw back assets or impeachable dispositions for the benefit of the general body of creditors. During such enquiry the company, directors or any person summonsed have a duty to provide all the company’s information, books and records, including that which the directors have failed to disclose, and to provide a mechanism to assist the Master, the liquidator and any other officer to perform their duties towards a body of creditors, to assist the liquidator with the primary goal of winding up by examining and identifying the assets and liabilities of a company and administering them to the advantage of creditors and, finally, to piece together information in order to assist the winding-up process. The appointment of a commissioner to conduct and administer the enquiry contemplated in section 417 is provided for in section 418. The commissioner is required to report to the Court or the Master (as the case may be) and is authorised and empowered to summon and examine witnesses; request the production of documents, books and records; punish defaulting or recalcitrant witnesses. Once the court determines that there is a need for an enquiry in terms of section 417, the court will make an order authorising the convening of the enquiry. Section 417 (7) requires the enquiry to be private and confidential so as to enable all the information required to be given freely. The application in terms of section 388 (where there has been a voluntary winding up) is therefore ordinarily made on an ex parte basis to preserve the confidentiality of the proceedings, and to prevent wayward shareholders, directors or liquidators from being afforded an opportunity to thwart the purpose of the application. The conduct of directors and shareholders is cast under the spotlight and subject to potential scrutiny, which may then pave the way for further claims by creditors against them personally, offering additional remedies and respite.

Creditors whose ability to exercise their rights in the process of a voluntary winding up is frustrated are accordingly afforded relief. Our courts have for some time been entertaining numerous applications in terms of section 388, many of which have resulted in a full enquiry being ordered, and have afforded creditors the usual protection despite a voluntary winding-up. This is particularly so where dishonesty or fraud on the part of shareholders and directors was apparent.

Darryl Reece, Matthew van der Want, Molemo Makhubedu and Thembane de Toit