Can you sue the directors and auditors as a shareholder? “Follow procedure” says the Court!

Shareholder remedies – holding directors and auditors liable for a reduction in share value

Shareholders in a registered company may be faced with situations where they would like to hold the Directors of a company liable for the actions which they take, that cause the Company to suffer financial losses, which ultimately translate into losses suffered by the shareholders when their equity in the relevant company diminishes in value. Below is a brief description of the approach adopted by the Supreme Court of Appeal in this regard in the recent case of Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (Case no 1423/2018) [2020] ZASCA 83 (03 July 2020)

The case was based on claims made by two shareholders against the directors of a listed company in which they held shares. The shareholders claimed the directors engaged in misconduct which caused the shareholders massive financial losses as their shares lost most of their value, notably hundreds of millions of Rand. A further claim was made against the auditors of the company for their failure to qualify the financial statements of the company. This, they argued, led to the publication of false financial statements which meant that the shareholders could not obtain a true picture of the performance of the company and take any necessary action.

The misconduct claims against the directors were based on an alleged failure to uphold the standard of performance that Directors should possess as per the Companies Act. There were allegations of falsifying of financial reports, publishing misleading information, procuring risky loans, effecting unjustifiable personnel appointments, making poor business decisions, reckless accounting and negligence among other infractions of the Companies Act and common law Director’s fiduciary duties.

The case was important as the Supreme Court of Appeal upheld the High Court’s decision, which had previously dismissed the shareholders’ claims. In South African law (and most common law jurisdictions), shareholders cannot sue the Directors and Auditors (or Accounting Officers) for the loss in value of their shares in those companies.

In coming to the decision, the courts extensively quoted past South African judgements, English law, and the law of New Zealand.

The discussions and reasons given by the courts for their decision included lengthy discussions on legal principles and the statutes but can be briefly summarised as follows:

  1. A company is a distinct separate legal entity with autonomy and capacity, and it is the primary entity which the Directors and the Accounting officials have an obligation to serve.
  2. The company is the entity which must sue the Directors and the Auditors for statutory misconduct, and only the company has this right, not the individual shareholders.
  3. Financial reports are prepared as a window into the company’s affairs and are not prepared to let shareholders take any particular steps. Auditors have no duty to shareholders but to the company as a distinct legal entity.
  4. The common law is adopted by statute in as far as it is not repealed by the said statute. It is not possible to use a general term in a statute to try and override a specific principle within common law, i.e. a general term in the Companies Act allowing anyone harmed by a contravention of the Companies Act, does not mean that the bar against shareholders suing directors for diminution of value in shares at common law is overridden by the statutory provision.
  5. The reason shareholders should not be permitted to sue directors and third parties contracting with the company is that it may lead to double jeopardy or double recovery, where some shareholders sue the third parties and the company itself also sues the same party on the same issue.
  6. Creditors and other shareholders may be prejudiced, if other individual shareholders sue the directors or third parties as they may then obtain value which is due to creditors.
  7. The shareholders may compel the company to sue the directors or auditor or third parties, and where this does not happen, the shareholders may sue in the name of the company under the provisions of Section 165 of the Companies Act, known as a derivative claim.
  8. Shareholders earn the right to participate in the company by obtaining shares. They may influence the direction of the company only as per the Memorandum of Incorporation (MOI), and often these MOIs indicate how irregularities and the general management of the company are to be dealt with.
  9. The courts are loathe to extend liability in respect of claims, the liability of which is potentially an indeterminate amount for an indeterminate time to an indeterminate class.
  10. Any allegation made by shareholders must properly state the facts that would bring a specific provision of law into question and, how it causes the specific damage. For example, causation must be proven when a claim is said to fall within the ambit of a particular legal provision. In the case at hand, the claims made by the shareholders were often difficult to link to the statutes and the damage caused.

The case highlights that the principles of corporate governance of a company are not just reflective of a compliance standard but need to be followed if a shareholder wants to obtain relief in a company setting. 

Disclaimer: Although Hildebrand Attorneys is committed to furnishing reliable and accurate information, this article is intended as a general reference guide only and does not constitute legal advice. Hildebrand Attorneys cannot take any responsibility for the accuracy or currency of the information and if you require particular information you are advised to consult with the article’s author or a qualified legal authority. This article may not be reproduced without the express written permission of the author and Hildebrand Attorneys accept no responsibility for any loss or damage that may be occasioned as a result of the reliance by any person on the information contained herein.

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