Nineteenth Century corporate law principles look set once more to do battle against 21st Century corporate governance practices as the five-year old Hlumisa Investment case against African Bank directors heads to the Constitutional Court.
Last week Hlumisa director Desmond Lockey confirmed that his company has applied for leave to appeal against the recent Supreme Court of Appeal (SCA) ruling in the damages claim against African Bank directors.
One corporate law expert believes, given that the Constitutional Court has tended to have a more expansive approach to interpretation of the common law than the lower courts, that a ConCourt ruling on the Hlumisa case could have far-reaching implications for South African company law.
To recap briefly, Hlumisa had claimed damages against the directors of African Bank for the collapse in the value of their shares on the grounds that the directors had acted in bad faith, for ulterior purposes, and without the requisite degree of care, skill and diligence in breach of the provisions of the Companies Act.
The action challenges a critical aspect of South Africa’s company law – directors owe their fiduciary duties to the company and not to shareholders.
This stark reality is tied in with the concept of limited liability and the equally stark reality that shareholders’ losses are limited to the value of the equities they purchased.
Limited liability means they can walk away from potentially huge liabilities incurred by the company – suppliers can be left stranded, environments left destroyed – and the shareholders can walk away, their exposure limited to value-less shares.
The SCA was unequivocal in its decision, acknowledging that what Hlumisa wanted from the court “would be a drastic departure from a core principle of company law”.
It also seemed to dismiss any notion that Section 218(2), which was relied upon by Hlumisa, or any other section of the 2008 Companies Act, might have provided some relief. “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,” says Section 218(2), seemingly opening the door for actions such as that launched by Hlumisa in 2015 or, more recently, by Steinhoff shareholder Dorethea de Bruyn. (De Bruyn failed to get certification for her class action against Steinhoff directors in a high court decision that echoes the Hlumisa opinion.)
“It cannot be said that there is anything in s 218(2) to indicate that the legislature intended to alter the common law and allow reflective-loss claims to be brought under that section,” said the high court judge in the Hlumisa case.
Law from the 1800s
Much of that common law has been built up around an English case that dates back to 1843. In terms of the Foss v Harbottle ruling, in any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself.
If the company doesn’t make a claim, then Section 165 of the SA Companies Act allows shareholders to initiate a ‘derivative action’, which is effected through the company. Such action faces considerable challenges particularly if the directors of the company are opposed to it, which may explain why there has been no Section 165 action relating to a listed company.
For Hlumisa this means that any claims against Leon Kirkinis and his co-directors (including Nomaliso Langa-Royds, Samuel Sithole and Antonio Fourie), as well as Deloitte, must be brought by African Bank or African Bank Investments Ltd (Abil).
Unsurprisingly neither African Bank nor Abil, both of which have gone through fundamental transformations, appear in any way inclined to bring this or any action related to the 2014 implosion of the company.
Similarly, the South Gauteng High Court ruled that Steinhoff, the company, was the only party that could claim damages against the Steinhoff shareholders and its auditors, who also happen to be Deloitte. It seemed to encourage the Steinhoff shareholders to pursue a Section 165 action.
In the proper context, the Foss v Harbottle rule is appropriate.
It is intended to protect other creditors as well as shareholders who have not lodged claims against the alleged wrongdoing directors.
There’s also the issue of potential director scarcity if candidates felt they were vulnerable to multiple shareholder claims.
Essentially the theory behind the rule is that if the company successfully claims the damages then all the affected parties will benefit equally. So, if African Bank or Steinhoff was successful in its claims against former directors (and auditors) then it would receive funds which means, in theory, its shareholders and creditors would all be that much better off.
The world has changed …
So much for the theory. And it might just be that this was a realistic presumption all the way back in 1843, when companies were small and generally local affairs. In the context of 1843 there would have been a limited number of shareholders and, being reasonably local, most would have been familiar with the workings of the company in which they were invested and had a real say in its workings.
Early 21st Century represents a radically different context.
Companies are now enormous transnational entities with thousands of shareholders spread across the globe. The line of accountability – between owner and manager – is rendered even more tenuous given that the number of beneficial shareholders, as opposed to registered shareholders, can run to hundreds of thousands.
In the 21st Century, a long chain of service-providing agents lies between the beneficial shareholder and the executive agents managing the investee company. Powerful institutional players within this chain play the role of oversight-owner with varying degrees of success.
Cronyism and conflicts of interest frequently dull the oversight role that fund managers play in 21st Century corporate governance.
For the Foss v Harbottle rule to be currently appropriate it would be necessary to design a system that allows the beneficial shareholders to exert the necessary oversight rather than the institutional fund managers who are no more than paid agents overseeing other paid agents.
Resolving this 177-year old misalignment is the immense challenge facing the Constitutional Court if Hlumisa is granted leave to appeal.