Important considerations before instituting legal action against a close corporation

It’s a regular occurrence for a creditor to issue summons against a debtor. Obtaining judgment against a debtor is the easy part; the problem is enforcing the debt and reclaiming the money owed to you, as a creditor. The purpose of this article is to point out a few important considerations to take into account before instituting legal action against a legal entity and in particular a Close Corporation (“CC”).

1. Do you have a legitimate claim?

Firstly you need to ensure that you have a legitimate claim against the CC, with a strong prospect of success. If not, you’re wasting your money and time by instituting legal proceedings.

2. What is the Financial Position of the CC?

Secondly, you need to ascertain what the financial position of the CC is. Once you’ve obtained judgment against a CC, what are the chances of actually enforcing your claim against the CC? What assets does the CC own? Are there any assets that the sheriff can attach to enforce your debt? Are the CC’s assets in South Africa? How many other creditors does the CC have?

These are important questions to ask, in order to evaluate the chances of success in enforcing your claim against a CC. If the CC does not have any assets it might not be worth instituting a claim against the CC, as you might not actually recover the debt.

3. Does the CC still exist?

In order to institute/enforce a claim against a CC it has to have a legal personality i.e. the CC must be registered. If a CC is deregistered then it ceases to exist and one cannot institute action against a deregistered CC. This does not mean that you will never be able to recover your debt against a CC which has been deregistered as the debt of a deregistered CC is not extinguished, but is rather rendered unenforceable. In order to recover your claim against a deregistered CC, the CC will have to be re-registered.

Our law allows for the possibility to re-instate a CC, but it is a difficult, expensive and timeous process that isn’t very practical. Even if a creditor has successfully re-instated a CC, more often than not the same problem as listed above arises i.e. the CC does not have any money or assets and it is impossible to actually enforce your claim against the CC and recover your debt.

4. The Members’ liability

The general rule is that the members of a close corporation are not liable for the debt of the CC. Fortunately for the creditors, in some circumstances (some of which are explained below) it is possible to hold the members personally liable for the debt of the CC.

4.1 Reckless or fraudulent carrying on of business

According to Section 64 of the Close Corporation Act if “…(the) business of a corporation was or is being carried on recklessly, with gross negligence or with intent to defraud any person or for any fraudulent purpose…” the members of the close corporation can be held personally liable for the debt of the CC.

4.2 Abuse of separate juristic personality

Section 64 of the Close Corporation Act also states that if a Court finds “… a gross abuse of the juristic personality of the corporation as a separate entity, the Court may declare that the corporation is to be deemed not to be a juristic person in respect” and a court can order that the members be liable for the debt of the CC.

4.3 Members’ personal liability

The difficulty with holding the members personally liable for the debt of the CC is that the creditor would have to approach the Court and the onus would be on the creditor to prove that the members have committed the acts set out in section 64, given that our courts are guided by the principle that a member of a CC should not be found to have traded recklessly lightly, reckless/ fraudulent carrying on of business or the abuse of the separate juristic personality could be difficult to prove as a business is allowed to take risk and the fact that a CC cannot fulfil its obligation, does not necessarily mean that the members acted recklessly.

In order to hold the members personally liable for the CC’s debt, it has to be clear from the facts that the members acted recklessly/fraudulently or abused the separate juristic personality of the CC. Therefore one must carefully consider the facts, as there is no guarantee that the courts will hold the members personally liable for the debt of the CC.

5. The Members’ financial position

Even if the creditor successfully holds the members liable for the CC’s debt, it does not mean that the creditor will be able to actually enforce its claim. The same questions must be asked as with the financial position of the CC, in order to evaluate if the creditor would be able to enforce the claim against the members.

6. Conclusion

Enforcing a debt against a CC is not a slam dunk affair. It is therefore important for parties contracting with a CC to ensure that the members of the CC sign surety of the debt/obligations of the CC in order to protect their interests. Also, before deciding to institute a claim against a CC it might be a good idea to first conduct a financial investigation into the financial position of the CC/members to ensure that you will be able to recover the debt due to you and to avoid the situation of throwing good money at bad debts.

Contemplating instituting a legal action against a CC? Contact MRF for professional advice and assistance.