The content of a recent Companies and Intellectual Property Commission (CIPC) practice note in which the CIPC committed not to exercise its powers relating to temporarily insolvent companies must not be confused with the solvency and liquidity test. The board of a company is still obliged to fully apply the solvency and liquidity test wherever required by the Companies Act 2008 (Act). Failing to do so could potentially have both disastrous results for the offending transaction, as well as attracting personal liability to each implicated director. This is especially relevant at a time when companies may be looking for ways to mitigate the economic effects of the COVID-19 pandemic, by for example, providing loans outside the ordinary course of business, or even waiving them.

In practice note GNR 351 (Practice Note) the CIPC committed to not exercising its powers in terms of section 22 of the Act in certain circumstances. These powers include obliging a company to show cause why it should be permitted to carry on business or trade where the CIPC has reasonable grounds to believe that it would be unable to pay its debts as they become due and payable in the ordinary course of business. If the notified company fails to satisfy the CIPC of this ability within 20 business days it may be issued a compliance notice requiring it to stop carrying on business or trading.

The CIPC has stated that it will not invoke the above powers in circumstances where the temporary insolvency is due to business conditions caused by the COVID-19 outbreak. This commitment will remain in force for the duration of the declared national state of disaster, as well as for sixty days thereafter.

However, applying the solvency and liquidity test is a separate obligation of the board, still applicable, under the Companies Act. This test asks, at the time of its application and considering all reasonably foreseeable financial circumstances of the company:

  • whether the assets of the company equal or exceed its liabilities, both fairly valued; and
  • whether it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months.

It is the similarity between this second leg of the test and the wording of section 22(2) of the Act that is likely to cause the greatest confusion. The application of the solvency and liquidity test, including this leg, has not been altered by the Practice Note.

The provision of both financial assistance and distributions in terms of sections 45 and 46 of the Act respectively require a board to be satisfied that the company would pass the solvency and liquidity test immediately after the provision of the financial assistance or distribution. The company in question’s memorandum of incorporation (MOI) may also lay out requirements for the provision of financial assistance or the making of a distribution.

Financial assistance in terms of section 45 of the Act includes lending money, guaranteeing a loan or other obligation and securing any debt or obligation. The provision of any of these to a wide array of individuals and entities, including entities ‘related or inter-related’ to the company in question, would qualify the transaction as financial assistance. Distributions, on the other hand, are made to the shareholders of the company in question or a company within the same group of companies. It includes the incurrence of a debt or other obligation for the benefit of one or more of these shareholders as well as the forgiveness or waiver of such a debt or obligation. Companies may be more inclined than ever to provide financial assistance or make distributions, in the terms described above, in an effort to try mitigate the effects of the current economic climate.

There can be serious consequences if the requirements for the provision of financial assistance and making of a distribution, including fully applying the solvency and liquidity test, are not complied with. Section 45(6) of the Act explicitly states that the provision of financial assistance in terms of, but inconsistent with, that section is void. Further, sections 45 and 46 of the Act render directors personally liable for the non-compliant provision of financial assistance or distribution in terms of section 77(3)(e) in the following circumstances:

  • the director was present at the meeting when the board approved the resolution or agreement, or participated in the making of the decision in terms of a written resolution; and
  • failed to vote against the resolution or agreement, despite knowing that the provision of financial assistance / distribution was inconsistent with the relevant section of the Act or MOI.

The knowledge required to attract personal liability is broader than one might expect, and includes:

  • having actual knowledge of the matter; or
  • being in a position in which the person reasonably ought to have:
    • had actual knowledge;
    • investigated the matter to an extent that would have provided the person with actual knowledge; or
    • have taken measures which, if taken, would reasonably be expected to have provided the person with that knowledge.

We do not think that misunderstanding the application and effect of the Practice Note would be a strong argument for not knowing that the solvency and liquidity test needed to be fully applied in order to provide financial assistance or make a distribution.