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[2013] ZASCA 26
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Cheng-Li Tsung and Another v Industrial Development Corporation of South Africa Ltd and Another (173/12) [2013] ZASCA 26; 2013 (3) SA 468 (SCA) (25 March 2013)
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THE SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Case no
: 173/12
Reportable
In the
matter between:
Robert
Cheng-Li Tsung
...................................................................................
First
Appellant
Robert
Hsu-Nan Tsung
..............................................................................
Second
Appellant
and
Industrial Development Corporation of South Africa Limited
................
First Respondent
Findevco (Proprietary) Limited
.............................................................
Second
Respondent
Neutral citation:
Tsung v IDC
(173/2012)
[2013] ZASCA 26
(25 March 2013)
Coram:
Lewis, Cachalia, Theron JJA and Schoeman and Van der Merwe AJJA
Heard:
20 February 2013
Delivered: 25 March 2013
Summary:
Directors of a company held liable under s 424(1) of
the Companies Act 61 of 1973 for conducting the business of the
company at
a time when it was insolvent, and knowing that the company
would not be able to pay its creditors, by concluding transactions
for
their own gain.
ORDER
On
appeal from: Western Cape High Court, Cape Town (Davis J sitting as
court of first instance)
The appeal is dismissed with costs including those of two counsel.
JUDGMENT
LEWIS JA (CACHALIA AND THERON JJA AND SCHOEMAN AND VAN DER MERWE AJJA
concurring)
[1] The appellants, father and son, Robert Cheng-Li Tsung and Robert
Hsu-Nan Tsung, were the directors of Dynasty Textiles (Pty)
Ltd
(Textiles) which ran a textile factory in Atlantis, Cape Town. The
respondents, the Industrial Development Corporation of South
Africa
Ltd (the IDC) and its financial arm, a wholly owned subsidiary,
Findevco (Pty) Ltd (Findevco), instituted action against
both
appellants in the Western Cape High Court, claiming some R35 million
(rounded off) in terms of s 424 of the Companies Act
61 of 1973, on
the basis that the business of Textiles had been carried on by them
recklessly or with the intention to defraud
creditors of Textiles, in
particular the IDC and Findevco. The action succeeded, Davis J
declaring that the Tsungs’ conduct
fell within the ambit of s
424(1) and that they were personally liable for an amount agreed
(during the course of the trial) to
be the quantum of their
liability, R32 340 346. Leave to appeal against that decision
was given by this court.
[2] Section 424(1) reads:
‘
When
it appears, whether it be in a winding-up, judicial management or
otherwise, that any
business
of the company was or is being carried on recklessly or with intent
to defraud creditors of the company or creditors of
any other person
or for any fraudulent purpose
,
the Court may, on the application of the Master, the liquidator, the
judicial manager, any creditor or member or contributory
of the
company, declare that any person who was knowingly a party to the
carrying on of the business in the manner aforesaid, shall
be
personally responsible, without any limitation of liability, for all
or any of the debts or other liabilities of the company
as the Court
may direct.’ (My emphasis.)
(The other subsections of s 424 deal with the kinds of order that a
court may make when a person is found to be liable for the
reckless
or fraudulent conduct of the business of a company, and with criminal
liability. When I refer to s 424 alone it should
generally be read to
mean s 424(1).) Davis J found that the Tsungs had, on the
probabilities, concluded three transactions that
brought their
conduct within the ambit of s 424. He declared them jointly and
severally liable to Findevco for the sum agreed –
R32 340 346.
I shall deal with each of the three transactions in turn. But first
the factual background must be explained:
the context within which
the Tsungs conducted the business of Textiles is all-important.
[3] Tsung senior (to whom I shall refer as Robert) established a
textile factory in the former ‘homeland’ Ciskei in
the
early eighties. He wished to take advantage of the tax incentives
offered to businesses which were set up in the area. For
this purpose
he formed a company, Dynasty Garments (Pty) Ltd (Garments), which
manufactured woven shirts and exported them, mainly
to America. The
business flourished and by 1985 employed some 850 people. But
sanctions against South Africa, instituted in 1986,
had a seriously
adverse effect on the business and Garments changed its market and
began to manufacture knitwear for the domestic
market, selling to the
South African clothing retailers.
[4] The factory was located in an area that was in economic and
political turmoil, and so the Tsungs decided to reduce their reliance
on the local labour force and to produce cotton yarn instead.
Garments ceased effectively to be operational by 1990 and Textiles
was established to produce the yarn. The sole shareholder in Textiles
was Lio Ho International Co Ltd (Lio Ho), a company incorporated
in
Hong Kong. The Tsungs were both directors of Textiles. (I shall refer
to Dynasty Textiles as Textiles so as to distinguish it
from Dynasty
Garments. In passages quoted later in this judgment reference is made
simply to Dynasty. It is the same entity as
Textiles.) The
shareholders in Lio Ho were the Tsungs and Robert’s wife, Lucy
Tsung.
[5] The production of yarn required major capital expenditure for
plant and equipment, and the Tsungs (Tsung junior, to whom I
shall
refer as Bobby, having joined his father Robert in the Ciskei)
decided to purchase the building in which the factory was
operated.
In order to fund this Textiles borrowed funds (about R5 million) from
the IDC, and repaid it by 1998.
[6] In that year too a bill – the African Growth and
Opportunity Bill – was passed in the United States Senate to
promote exports to America by African countries. The Tsungs wished to
take advantage of the proposed benefits that the legislation
(which
did not ever materialize) would have. Textiles needed easy access to
a large international port for that purpose and the
Tsungs decided to
relocate the factory to Atlantis in Cape Town.
[7] In order to set up the factory in Atlantis, Lio Ho lent some R80
million to Textiles. Textiles approached the IDC for further
funding,
this time for R40 million. It was IDC’s requirement that the
ratio between what Lio Ho invested in the company,
and what it would
invest, would be 2:1. Findevco then purchased plant and equipment
from Lio Ho and sold it on to Textiles. The
agreement was dated April
1997. It was labelled a ‘suspensive sale agreement’,
although I fail to see what was suspensive
about it. It was a sale
with a reservation of ownership until the full purchase price and
interest had been paid by Textiles to
Findevco. The invoice from Lio
Ho to Findevco in respect of the plant and machinery purchased was
for US$7.84 million. The invoice
was dated 30 November 1996. Lio Ho
apparently left this sum in South Africa, on loan account, as working
capital for Textiles.
Findevco advanced R25.9 million to Textiles in
respect of the machinery reflected on the invoice.
[8] The Tsungs arranged for Tung Hung International Trading Company
Ltd (Tung Hung) to transport the machinery from Hong Kong and
to
commission it in Atlantis. Tung Hung was not only a broker in this
type of machinery but also a mover and installer of such
plant and
machinery. Its director, Mr Stephen Yang, himself visited the factory
in Atlantis in 2000 and provided a valuation of
it then of $10
million. (A great deal of the evidence led at the trial related to
this valuation. I shall not deal with it for
reasons that I shall
explain.) The invoice in respect of the plant and machinery, as I
have said, was some $7.84 million.
[9] In November 1997 more equipment was purchased by Findevco and
sold in turn to Textiles under a second ‘suspensive sale
agreement’. The purchase price was R5.9 million. And as
security for Textiles’ indebtedness to Findevco, Textiles
registered a collateral mortgage bond over immovable property owned
by it in Dimbaza in the Eastern Cape in favour of Findevco,
and a
notarial covering bond over its movable property – the
machinery.
[10] Textiles did well financially in 1998 and 1999. But in 2000 it
started to struggle financially and did not meet all its payment
obligations to Findevco. It was affected by the downturn in the
global economic markets and by the crisis in the Asian economies
in
particular. Accordingly, when payments were not made to Findevco
timeously, or at all, Textiles’ account was handed over
to Mr
Christo Fourie who headed the restructuring department of the IDC.
Bobby testified that as early as 2000 he and Fourie had
discussed the
possibility of a debt-equity swap, but that Fourie had not been
interested in it at that stage. However, in an effort
to resolve the
issue of non-payment, the IDC and Findevco concluded a debenture deed
with Lio Ho in late 2000. What Bobby had had
in mind instead was that
Lio Ho would swap its equity in Textiles in reduction of its debt to
Findevco, as the IDC had done with
a competitor of Textiles, Prilla
2000 (Pty) Ltd (Prilla), to which the IDC had also lent money.
[11] Bobby testified that although Textiles had still been profitable
in 2000, the payments of interest to Findevco made it unable
to meet
its repayment of capital. Thus throughout 2001, 2002 and most of 2003
he had continued to negotiate with Fourie about a
debt-equity swap.
His view was that Prilla was able to compete against Textiles because
the IDC had acquired, first, 70 per cent
of Prilla’s equity,
and subsequently all the shares in the company. Prilla’s
interest obligations were thus reduced
and then disappeared which
meant that it could undercut Textiles’ prices.
[12] Eventually, in August 2003, Fourie agreed that Findevco would
swap Textiles’ debt to it for 80 per cent of the equity
in
Textiles, Lio Ho retaining the balance of 20 per cent. A draft
agreement reflecting this was prepared in October or November
of
2003, and a copy sent to Bobby for his comment. The proposed
agreement was never concluded. But in anticipation of it Bobby
agreed
that the IDC, acting for Findevco, could perfect its notarial bond
over the plant and machinery (by taking possession of
it) which it
did in November 2003. Bobby considered that the agreement was in
effect concluded. And that appeared to be the view
also of the
Executive Policy Committee of the IDC which met on 6 November 2003.
The minutes of the meeting record the following:
‘
IDC is
already effectively acting as a shareholder of Dynasty [Textiles] as
it has not taken any legal action against Dynasty in
spite of its
non-payment, as Dynasty always kept IDC up to date with the status of
the business and IDC’s recovery in a forced
sale situation
would be very low. However, IDC is not currently receiving any
benefit for acting as a shareholder and it does not
have any control
over Dynasty’s operations. Converting IDC’s debt to
equity will provide IDC with control over the
business and the
ability to determine decision-making and the future direction of the
company. The existing shareholder [Lio Ho]
is willing to give IDC
management control of Dynasty, if required.’
[13] In the same report the IDC referred to the various factors that
had led to Textiles’ inability to meet its commitments
to
Findevco – the collapse of the Asian economy, illegal
importation of cheap textiles and clothing from East Asia, high
local
interest rates and the appreciation of the Rand in early 2003. It
referred also to the retrenchment of half the workforce
of Textiles
in that year, and a scaling down of production. The report stated
also that should Textiles not survive, the IDC would
lose
approximately R30 million. To avoid this, it would explore the
possibility of a merger between Prilla and Textiles.
[14] Once the IDC had perfected its notarial bond over the machinery
of Textiles, it sold it to Prilla for R19 075 million.
It is
noteworthy that the machinery had been valued for substantially more
than that by Yang in 2001, at R79 494 287,
and that was
reflected in the financial statements of Textiles.
[15] In fact Bobby left South Africa with his family in December
2003. He advised Fourie at a meeting shortly before he left that
he
was going to live in Australia and that Robert would attend to the
formalities for the debt-equity swap to be concluded. The
events
leading to their departure will be discussed later as the IDC argued
that the Tsungs had an ‘exit strategy’,
intending to
strip Textiles of its funds, divert them to repay the Lio Ho loans,
and then leave the country and the shell of the
company behind.
[16] Mr Jorge Maia, an economist employed by the IDC, was seconded to
Textiles in January 2004 to facilitate the handover of the
management
of the company to the IDC and to prepare for the proposed merger
between Textiles and Prilla. The former financial officer
of
Textiles, Mr Donald Campbell, left the company and went to work for
Prilla in January 2004.
[17] On 2 February 2004 Maia and Ms Angela Mhlanga, the financial
manager of Textiles seconded by the IDC, wrote an ‘interim
status report’ on the operations of Textiles and its financial
status. For the sake of convenience I shall refer only to
Maia when
dealing with the report. Maia made some damning comments about the
quality of the yarn produced, and the financial position
of Textiles.
He said, apropos shareholders’ loans:
‘
These
comprised ordinary shareholders loans and a loan from the Bank of
Taiwan to Mr RCL Tsung and secured by family members, on
behalf of
Dynasty. Quoting from a statement made by Mr Donald Campbell on 23
January 200[4]: “from around March to May last
year, Bobby
Tsung realised that the business was going nowhere and decided to
cash in.” What followed reflected a deliberate
attempt by the
shareholders assisted by the former management to repay shareholders’
loans and reduce their exposure to company
risk by various means.
Shareholders’ loans were
repaid to the tune of R7,6 million over the ten-month period ending
31 December 2003. These repayments
were effected through:
cash payments made to Mr Tsung
or Lio Ho . . . including an amount of R1.6 million in May 2003
(pushing the FNB and Bank of Taiwan
overdraft facilities towards
significantly higher negative balances) as well as a total of
R908 000, mostly in cash, paid
during the last quarter of
calendar 2003 . . .
recurring monthly payments,
either through debit orders or direct settlement of personal
liabilities; and
the outstanding balance on Mr
RCL Tsung’s loan facility with the Bank of Taiwan (on behalf
of Dynasty), but secured by personal
unlimited guarantees and
stand-by letters of credit opened by the Tsung family), was reduced
by R3 million to R1 million during
the course of December 2003. The
overdraft facility had been stable throughout the previous nine
months at a level of R4 million.
This payment was made possible by
significant receipts from debtors during the month of December.’
Maia continued:
‘
In the
opinion of the new management . . . no further repayments of
shareholders loans should be effected until the company is in
a
position to do so.’
[18] Most damning of all is the following narration in the report:
after being requested by Campbell on behalf of Robert to transfer
some R200 000 overseas through Textiles’ bank account, and
being told that such transactions had been done in the past,
Maia
investigated such previous transactions. He stated:
‘
It
became evident that one such transaction was effected through
Dynasty’s FNB banking account towards end-December 2003 for
the
purpose of transferring USD 1 500 000 (R10 373 500)
to the account of Lio Ho . . . at the Hong Kong and
Shanghai Banking
Corporation in Hong Kong.’
Maia noted that the following movements were recorded in the bank
account: Two deposits on 23 December 2003 of R4 million each;
a
deposit on 24 December of R2.5 million; a withdrawal on 29 December
2003 of R3 412 500 and another the following day
of
R6 969 000. The sum withdrawn was paid to Lio Ho in Hong
Kong.
[19] This was the most controversial of the acts complained of by the
IDC and I shall return to the evidence of Maia, Bobby and
Campbell in
this regard when considering whether the payment out of Textiles’
account constituted conduct falling within
the ambit of s 424.
For now, it is sufficient to note how Maia understood the transaction
based on what Campbell had told
him. He noted that the deposits
emanated from the proceeds of the sale of properties by the Tsung
family. The funds were channelled
through the Textiles bank account,
and the document presented to the bank (FNB) to support the transfer
of what amounted to $1.5
million was an invoice from Lio Ho
reflecting the sale of second-hand spinning mill machinery and
equipment to Textiles in December
1996. The invoice had been stamped
for exchange control approval of payment in 1997. The payment to Lio
Ho, said Maia, resulted
in a reduction in the shareholders’
loans by R10 372 500, and a corresponding credit to
Garments for R10 500 000
(the amount of the deposit). The
foreign liability was thus converted to a domestic liability. The
inference that Maia drew in
this regard was from entries in Textiles’
books of account which reflected that the deposits were made by
Garments, and the
credit was reflected against a Garments
shareholder’s loan account.
[20] Maia referred also to the overvaluation of the machinery by Yang
which resulted in an inflation of the value of Dynasty’s
assets. He concluded that the conduct of the Tsungs (to
whom he referred as shareholders) reflected a ‘clear exit
strategy’. This was evidenced by the following conduct (I
do
not refer to all the acts complained of): they had deliberately wound
down the company’s operations; accelerated repayment
of their
shareholders’ loans; and used the company’s bank account
for sending money overseas under false pretexts.
Both Tsungs had left
the country, Robert going to Hong Kong and Bobby to Australia.
[21] The report referred further to a legal opinion that had been
written at Maia’s request by the IDC’s attorney on
the
legality of the payment of R10.3 million to Lio Ho as well as to a
pending forensic audit. He recommended that the signing
of the
debt-equity swap agreement be delayed and possibly reconsidered.
Acting on his advice the IDC did not sign the debt-equity
swap
agreement and eventually instituted action under s 424 of the Act
against the Tsungs.
[22] I do not propose to traverse the evidence of the expert
accountants who testified for both parties about the financial health
of Textiles in the years leading to 2003 and in that year in
particular. It is not disputed, at this stage, that Textiles was both
factually and commercially insolvent by the end of 2003: its
liabilities exceeded its assets by some R5.9 million at the beginning
of the year, and it was unable to pay its creditors, principally
Findevco, for most of that year. Many of Textiles’ employees
had been retrenched during the course of the year, and by the end of
it only a small part of the factory was operative. About ten
workers
were still employed. It had ceased trading in the ordinary course; it
was in fact insolvent and it could not pay its creditors.
On 17
December 2003, Fourie wrote to Campbell instructing that no payments
should be made to Lio Ho or to the directors –
the Tsungs. The
payment of R10.3 million to Lio Ho was thus directly contrary to
Fourie’s instruction.
The reach of s 424(1)
[23] The purpose of the section is to prevent the business of a
company from being carried on in a reckless or fraudulent manner.
The
complaint of the IDC and Findevco (I shall refer mainly to the IDC,
but such references, where appropriate, include Findevco
as well)
was, in essence, that the Tsungs had deliberately and fraudulently
embarked on a strategy to ensure that they were able
to take as much
money as possible from Textiles when they left the country. They did
this at a time when the company was unable
to meet its financial
commitments and did not advise the IDC of the transactions complained
of, which were contrary not only to
the instruction from Fourie on 17
December 2003, but also in breach of the suspensive sale agreements.
The Tsungs denied any deliberate
or reckless wrongdoing, but also
argued that there was no causal link between the acts in issue and
the inability of the company
to pay its debts.
Causation
[24] Until recently it was clear from a series of decisions in this
court that a plaintiff need not prove that the defendant’s
conduct was the cause of the company’s inability to pay its
creditors. This was affirmed in
Howard v Herrigel and another NNO
1
and
Philotex (Pty) Ltd v Snyman
.
2
But in
L & P Plant Hire BK v Bosch
,
3
Brand AJA pointed out that if a company was able to pay its debts,
even if there was reckless conduct on the part of a person conducting
the company’s business, the intention of the section (in fact
the equivalent section dealing with close corporations)
4
was not to create a joint and several liability with the company.
[25] That statement was interpreted to mean, in
Saincic v
Industro-Clean (Pty) Ltd
,
5
that causation was a requirement to found liability under s 424. That
would have been a deviation from
Howard
and from
Philotex
.
However, Brand JA has recently explained what he intended in
L &
P Plant Hire
. In
Fourie v Firstrand Bank Ltd
6
Brand JA said that he had not suggested that a causal requirement be
introduced to found liability under the section: he had said,
in the
context of the
L & P Plant Hire
case, where the close
corporation was able to pay its debts, that the reckless actors were
not jointly and severally liable. If
the company or close corporation
were able to pay then no prejudice would be suffered by creditors.
[26] In a case where a company was ‘hopelessly insolvent’,
as was the case in
Fourie
, a causal link between the
fraudulent or reckless conduct, and the company’s inability to
pay its debt, does not have to
be established. Counsel for the Tsungs
argued that this court in
Fourie
nonetheless approved the
judgments in
Saincic
to the effect that although causation as
it is understood as a requirement for delictual liability is not
required for liability
under s 424, a causal link is somehow required
as in the example given by Harms JA in that case in his separate
concurring judgment.
Harms JA suggested that where the reckless or
fraudulent conduct occurs at a time when company A owes a debt to B,
which does not
affect A’s solvency at the time, but
subsequently A incurs a debt to C when the affairs of A are being
properly conducted,
and A, for some reason, cannot then pay its debt,
C would not be able to rely on s 424. The example, he said,
illustrated that
there must be some causation in order to found
liability under s 424.
[27] However, the passage does not suggest that there must be a
causal link between the improper conduct and the inability of the
company to pay its debt. It seems to me to hold no more than that
there must be some link or connection
in time
between the
conduct complained of and the company’s inability to pay. Brand
JA went on to say, in
Fourie,
7
that
Saincic
recognized ‘an exception to this general
principle where the converse had been positively established, namely
that there was
plainly no causal connection between the relevant
conduct and the debt’, as in the example given by Harms JA.
But, he said,
even if the company’s financial downfall resulted
from the behaviour of other parties, if that was facilitated by the
reckless
or fraudulent conduct of the defendant, the latter would be
liable under s 424, as Fourie was held to be.
[28] Moreover, this court was careful to point out in
Fourie
that
L & P Plant Hire
had not changed the law. After citing the
passage from Harms JA’s judgment
8
Brand JA said
9
that
L & P Plant Hire
was not authority for the
proposition that where a company is insolvent ‘the
plaintiff-creditor is required to establish
a causal link between the
fraudulent or reckless conduct relied upon and the company’s
inability to pay its debt. On the
contrary,
L & P Plant Hire
was never intended to deviate from those decisions of this court . .
. [such as
Howard
and
Philotex
] which expressly laid
down the general principle that s 424 does not require proof of a
causal link between the relevant conduct
and the company’s
inability to pay the debt.’
Disregard of the corporate identity
[29] Another important consideration in determining whether conduct
falls within the ambit of s 424 is the separate legal identity
of a
corporate entity. In dealing with a close corporation, Cameron JA
said this in
Ebrahim v Airport Cold Storage (Pty) Ltd
:
10
‘
It
need hardly be added that the function of the statutory provision
also shapes its application. Although juristic persons are
recognised
by the Bill of Rights – they may be bound by its provisions,
and may even receive its benefits – it is an
apposite truism
that close corporations and companies are imbued with identity only
by virtue of statute. In this sense their separate
existence remains
a figment of law, liable to be curtailed or withdrawn when the
objects of their creation are abused or thwarted.
The section
retracts the fundamental attribute of corporate personality, namely
separate legal existence, with its corollary of
autonomous and
independent liability for debts, when the level of mismanagement of
the corporation’s affairs exceeds the
merely inept or
incompetent and becomes heedlessly gross or dishonest. The provision
in effect exacts a quid pro quo: for the benefit
of immunity from
liability for its debts, those running the corporation may not use
its formal identity to incur obligations recklessly,
grossly
negligently or fraudulently. If they do, they risk being made
personally liable.’
[30] In that case, a shelf close corporation was used in order to
provide the delinquent member’s (A) creditor (B) with a
VAT
number. B had for some time supplied A with ‘comestibles’
(poultry, fish and the like) through a different entity,
C. A
transferred the entire debt owed by C to B to the new close
corporation. It received no consideration for taking over the
debt. A
regarded the transfer as a formality. Cameron JA found that A had ‘no
conception of, nor respect for, the fact that
the CC was a distinct
legal entity with a separate legal existence; that to sustain its
separateness the law exacts compliances
and formalities; and that it
could not be used at will as the receptacle of another entity’s
accumulated debts’.
11
The section (64(1)) ‘targets just such heedlessness of
corporate autonomy and form’, where the transfer of the debt
showed reckless disregard for the solvency of the CC.
12
This court upheld the finding of Griesel J in the Western Cape
High Court that the Ebrahims had used the corporate entities
concerned to pursue their own interests, having ‘scant regard’
for the separate identities of the various corporate
entities and
thus acting recklessly. Various acts, Griesel J found, formed ‘part
of one composite complaint of abuse of the
separate juristic
personality’ of the close corporation.
13
[31] It is clear, then, that if the IDC can show (and of course it
bears the burden of proof) on the probabilities that the Tsungs
acted
recklessly or fraudulently in conducting the business of Textiles,
and that Textiles was unable to pay its debts, they would
be liable
to it under s 424.
Henochsberg on the Companies Act
14
states that the carrying on of the business of a company recklessly
means ‘carrying it on by conduct which evinces a lack
of any
genuine concern for its prosperity’. A fortiori if one
deliberately depletes the company’s assets, or misuses
its
corporate form for one’s own purposes, then that conduct will
fall within the ambit of s 424.
Henochsberg
states also:
15
‘
Ordinarily,
if a company while carrying on its business incurs debts at a time
when to the knowledge of its directors there is no
reasonable
prospect of the creditors’ ever receiving payment, there is a
carrying on of its business with intent to defraud
those creditors.’
Textiles’ inability to pay its debts
[32] I turn then to the question whether the Tsungs knew that
Textiles could not pay its debts and knowingly concluded transactions
that exacerbated its inability to meet its obligations. I have
already said that by the end of 2003 Textiles had retrenched all
but
ten of its staff and was operating only a very small part of its
former business. Indeed, Bobby said, in his affidavit in support
of
an application for the liquidation of Textiles, deposed to in July
2006, that Textiles in 2003 was unable to pay its debts,
was dormant
and not trading. When testifying he insisted that he did not know
what ‘dormant’ meant: that the company
had indeed been
carrying on business. But the fact is that the reason for the
attempts to conclude the debt-equity swap agreement
was precisely
because Textiles could not pay the IDC what it owed. And Campbell
confirmed that by November 2003 only a handful
of staff were still
employed and there was limited production. The expert witnesses for
the Tsungs and the IDC considered that
the company was factually and
commercially insolvent.
The fraudulent conduct of the Tsungs
[33] As indicated earlier the IDC and Findevco relied upon several
transactions in which they alleged that the Tsungs had acted
recklessly or fraudulently. I shall deal only with those in respect
of which Davis J in the high court made findings.
Payment of R10.372 million to Lio Ho
[34] I shall first discuss the payment into the Textiles bank
account, and then the almost immediate transfer out to Lio Ho. I
have
already referred to the payment into the account of Textiles and the
way in which it was reflected in the books. The assumption
made by
Maia, on which the IDC relied when it instituted action under s 424,
was that the source of the payment to Textiles was
Garments: that
there had been a sale of property by a Tsung company, and that by
paying into the account of Textiles the loan account
of Garments to
Textiles was extinguished (so it ceased to be a debtor and instead
Textiles became Garments’ debtor). But
Bobby testified that the
payment was made not by Garments to Textiles but by another entity.
In fact, Robert’s bank records
reflect that he made the payment
to Textiles from his personal account.The source of the funds, Bobby
testified, was compensation
for the expropriation of a golf course in
the Eastern Cape. Since the owner of the golf course, Alexander
Properties (Pty) Ltd
(usually referred to as Xander Properties), had
no bank account, and neither did Garments, it was channelled to Lio
Ho through
the Textiles account. On the Tsungs’ argument that
account was used as a ‘conduit’.
[35] The fact of Xander Properties’ ownership was not put to
Maia when he was cross-examined. And his testimony that Campbell
told
him that he was instructed by the Tsungs to enter the transaction as
a credit to Garments’ account was not challenged.
But there is
no evidence of any particular loan by Textiles to Garments and the
entries in the books of account of Textiles are
not supported by any
documentation. Bobby’s evidence was of no help. He agreed that
the payment was credited to Garments’
loan account.
[36] The IDC argued that correspondence between Fourie and Bobby
reflected that Bobby saw the transaction as one where Garments
was
repaying a loan to Textiles. In a memorandum to Bobby dated 12
February 2004, Fourie asked Bobby to respond to a number of
queries,
but in particular, for present purposes, to the comment that Textiles
bank account was being used ‘for the transfer
of funds of
“affiliated” companies overseas, with such companies
having no relation to Dynasty Textiles. The funds
were channelled
overseas utilising import documentation of Dynasty Textiles for
exchange control purposes’. Bobby’s
response, written on
15 February 2004, was that:
‘
The
affiliated companies repay the loan from Dynasty Textiles or lend to
Dynasty Textiles to repay LIO HO. The net shareholder’s
loan
has not changed. This has been common practice throughout the years
between 1990 and 2003. The IDC is aware of all these types
of
transactions in the past and had not found them to be improper.’
[37] This showed, argued the IDC, that the payment into Textiles was
regarded as repayment of a loan to Textiles, but because it
was in
excess of what was apparently owed to Textiles, Garments became a
creditor and Textiles a debtor, thus reducing its ability
to pay its
debt to the IDC. It is, however, hard to see how this construction is
supported by the evidence, given that there is
nothing to tell us
what Garments in fact owed Textiles, if anything, and given also that
we do not know on what basis the funds
had become those of Garments.
[38] The high court concluded that because of the payment of the
funds into Textiles’ account, the ‘funds became the
property of Dynasty Textiles’, converting Garments to a
creditor. Textiles’ property was thus used to repay a
shareholder’s
loan ‘at the time when Dynasty Textiles was
factually and commercially insolvent and in flagrant breach of
contractual obligations,
which defendants owed to plaintiffs in
respect of payments for example, to Lio Ho’.
[39] I do not accept the finding that the R10.3 million became the
property of Textiles (although technically the money was owned
by the
bank, which had a contractual obligation to pay Textiles if required
to do so).
16
The indiciae are that the compensation for expropriation was paid to
Robert, who used the Textiles bank account as a conduit to
send money
to Lio Ho in Hong Kong. But that is not the end of the matter.
[40] The next question is whether the Tsungs fraudulently (or
recklessly) used the document issued to Textiles in 1997, reflecting
the sale of equipment by Lio Ho to Textiles, and in respect of which
exchange control approval for payment was granted. Clearly
the
payment was made contrary to the instruction of Fourie to which I
have referred.
[41] Much was made in argument before us of the misuse of the invoice
from Lio Ho issued in 1996 for equipment that had been sold
to
Findevco. The invoice was issued by Lio Ho to Textiles on 30 November
1996. It was in respect of machinery, the price being
$7 844 million.
Treasury approval for payment was given in May 1997. When Campbell,
acting for Textiles and on the instructions
of the Tsungs, remitted
R10.3 million to Lio Ho in Hong Kong in December 2003, this elderly
invoice with its foreign exchange approval
was used to facilitate
that payment. The invoice was stamped by ‘FNB Forex’ on 2
January 2004.
[42] When Maia discovered this he consulted the IDC’s attorney,
Mr David Anderson, about potential liability for exchange
control
contravention. Maia informed Anderson that the payment into Textiles’
bank account was repayment of a loan by Garments.
The advice sought
was whether IDC had an obligation to disclose to the Reserve Bank
that the payment to Lio Ho was ‘ostensibly’
made in
relation to exchange control approval granted for imports in 1997.
Anderson advised that the regulations did not require
a creditor to
advise the Reserve Bank of a contravention by a debtor. He said in an
email following a consultation that:
‘
Textiles
obtained exchange control approval for the repayment of the debt
owing by Textiles to Lio Ho in relation to the Imports.
Any payment
made by Textiles in December 2003 to Lio as repayment of the Imports
is legitimate and not contrary to the Regulations.
The fact that the
funds were raised by means of a loan from Garments . . . is generally
not problematic . . . .’
[43] Reliance on this advice by the Tsungs, in arguing that the IDC’s
attorney had considered the transaction as one that
was not in
contravention of exchange control regulations, is misplaced. The
opinion was based on the information that Garments
had repaid a loan
to Textiles, which the Tsungs now argue was not the case. If the
Tsungs’ argument that the Textiles bank
account was used as a
conduit is correct, then clearly there was a misuse of authority
given to Textiles some years previously.
Indeed, Bobby stated that
when the IDC advanced funding to Textiles it was advised that there
would be ‘channelling through
Dynasty Textiles and its invoices
through the approved exchange controlled invoices back into Lio Ho
International over to overseas’.
[44] The gravamen of Bobby’s evidence in this regard was that
IDC was not deceived. Fourie knew that money was channelled
‘in
and out, sometimes not for the purpose of Dynasty Textiles’.
When cross-examined he said that ‘I knew the
money that did not
belong to Dynasty Textiles was being put into Dynasty Textiles and
will eventually exit via Dynasty Textiles.
I was aware of that, yes.’
He conceded also that the payment to Lio Ho in December 2003 in
reliance on the 1996 invoice and
1997 Treasury approval actually had
nothing to do with Textiles itself. He testified that the process,
and previous use of the
account as a channel, had been approved by
the company auditors. But he could not name the auditor who had given
such approval
and it is improbable that any auditor would have
sanctioned the misuse of exchange control approvals in this way.
[45] In my view the Textiles account was indeed used as a conduit:
but in making use of the account in that way the Tsungs were,
at the
least, recklessly carrying on the business of the company by using
its bank account as a channel for payments and making
false entries
in the books of account. More significantly they were dishonestly
using foreign exchange approval given to Textiles
in remitting funds,
unrelated in any way to Textiles, to Lio Ho. They were deliberately
using documents of Textiles for a purpose
that was not intended.
While Textiles may not have suffered any actual loss as a result of
this transaction (no causal connection
is required), it in fact could
not pay its debts in December 2003 and the Tsungs knew this full
well.
[46] The payment to Lio Ho did not cause the company to fail. But at
a time when it had failed they falsely used an invoice provided
to
Textiles, and Treasury approval given to Textiles, to remit what was,
on their version, Robert’s money to Lio Ho. They
put Textiles
at risk of prosecution. In my view, their conduct showed not just a
reckless, but a deliberate, disregard for the
prosperity of Textiles.
The Tsungs treated Textiles’ bank account as their own,
ignoring the corporate entity and making
themselves vulnerable to
having the benefit of immunity from its liabilities removed. The
statements from Cameron JA’s judgment
in
Ebrahim
cited
above are particularly apposite here.
[47] I consider that the Tsungs used a Textiles document and bank
account for a fraudulent purpose and brought themselves within
the
ambit of s 424. The inference is inescapable that they were using the
Textiles account as a conduit – part of their strategy
to get
money (in this case, on their version, compensation for the
expropriation of a golf course) out of the country falsely using
Textiles’ invoice for plant and equipment bought from Lio Ho. I
shall return to this conclusion after examining the other
transactions for they all show a pattern of conduct.
The Bank of Taiwan repayments
[48] One of the matters on which Maia reported in February 2004 was
the payment by Textiles to the Bank of Taiwan of some R3 million
over
the period from 3 to 17 December 2003. At the time Textiles’
account with FNB was overdrawn. The payments were made
into Bobby’s
account with the Bank of Taiwan, and had the effect of reducing the
overdraft in that account from R4 million
to R1 million, that is, by
R3 million. The reason advanced by Bobby for the payment was so
that combing machines in the Atlantis
factory could be released from
the security held by the Bank of Taiwan over the machines in order to
facilitate the debt-equity
swap. However, when Textiles purchased the
combing machines they had been specifically excluded from the embrace
of the general
notarial bond in favour of Findevco or the Bank of
Taiwan would not have agreed to advance funds to Textiles.
[49] Fourie of the IDC did not know of the payments made in December
2003, and had in fact prohibited payments to the shareholders
and
directors of Textiles on 17 December 2003, as has been discussed.
Indeed a year before then, on 13 November 2002, Fourie had
written to
Bobby saying that during ‘a period that a company is facing
financial difficulty and especially when a company
is not able to
honour its commitments to its lenders one would expect the company’s
shareholders to inject additional funding
and to restrict their
withdrawals and therefore not to repay shareholders’ loans
before honouring commitments to its lenders’.
[50] Indeed it was a term of the suspensive sale agreement that
Textiles would not repay any shareholders’ loans or make
payments to its directors without the written consent of Findevco.
However, the prohibitions were subject to thresholds and it
was not
proved that those threshholds were reached. So it is not entirely
clear that these payments were made in breach of contract.
[51] However, the effect of these payments was to reduce Bobby’s
liability to the Bank of Taiwan and to reduce the assets
of Textiles.
The payments were made when the Tsungs knew that Textiles was
insolvent and when both were planning to leave South
Africa. The
Tsungs also knew that the payments were made contrary to Fourie’s
instruction. While Bobby testified that Fourie
had known about these
payments, this is contrary to the written comment of Fourie and to
his instruction, and it was never put
to him that he had known of,
let alone authorized, these payments. Again, the inference is
inescapable that the Tsungs deliberately
diminished Textiles’
ability to repay its debts, thus bringing their conduct within the
ambit of s 424. It is no defence
to say, as counsel for the Tsungs
did, that the payments were made to a legitimate creditor of Textiles
and that they were thus
neutral. The payments had the effect of
reducing the Tsungs’ personal liability, and aggravating
Textiles’ inability
to pay its creditors.
[52] While I accept that the preference of one creditor over another
does not in itself amount to reckless or fraudulent carrying
on of a
business, I consider that this conduct, examined in context, and
coloured by the exit strategy, was a deliberate means
of reducing the
Tsungs’ personal liability at the expense of Textiles’
creditors.
Payment of the Tsungs’ personal expenses
[53] Garments did not have a bank account. But it did have a Diners
Club credit card. Textiles paid the credit card account. The
Tsungs
paid for their very lavish lifestyle on the Diners Card. The
statements from the bank reflect vast sums spent on clothing,
golf
courses and restaurants, among other things. None of this is
disputed. Nor is it disputed that in 2003, the year of Bobby’s
departure from South Africa, he bought a new vehicle in Australia,
paid emigration consultants and a furniture removal company
and
bought air tickets for himself and his family to leave for Australia,
all on the Diners Club card.
[54] The Tsungs contended that since the inception of Textiles their
expenses had been paid in this way: it was in lieu of payment
as
directors, had been sanctioned by their auditor, and was in the
normal course set off against their shareholders’ loans
at the
end of every financial year. Campbell said that this was the
procedure followed, and that the IDC conducted internal audits.
He
testified that there was a clause in the IDC agreements that limited
what the Tsungs ‘could draw out’ each year.
[55] It would have been apparent from a glance at the Diners Club
statements that the card was used for personal purposes, given
the
nature of the expenditure. Thus the IDC must have sanctioned payment
by Textiles of the account, it was argued. Moreover, the
contention
went, the amounts were nominal. However, the total expenditure on
what were clearly lifestyle expenses in 2003 exceeded
R1 million. In
addition, school fees for one of Bobby’s children had been paid
out of the Textiles account.
[56] Moreover, Lio Ho had ceded (in February 1997) to the IDC, as
security for the performance of its obligations under the suspensive
sale agreement, its right to all amounts standing to the credit of
its loan account in Textiles. And Bobby could not say which
auditor
had sanctioned such book entries. Although the practice may have been
to debit the shareholder’s loan account at
the end of each
financial year to offset these personal expenses, in fact for the
2003 year no such transaction was effected. Textiles’
insolvency was exacerbated.
[57] As argued by the IDC, payment by a company of a director’s
personal costs is a breach of a fiduciary duty, and is unlawful.
In
S
v De Jager
17
this court held that De Jager was guilty of theft because he had paid
personal expenses from a company’s account. The defence
that
his conduct was justified because his loan account was in credit was
rejected on the facts. In that case too the director
charged with
theft argued that his conduct was not unlawful because the company’s
shareholders (of whom he was one) had agreed
that the company’s
funds be used to pay his debts. Holmes JA held that this contention
could not succeed: it entailed the
consequence that a shareholder
could agree to the company being ‘despoiled’ by a
director, and offended also against
the basic principle of limited
liability.
[58] Counsel for the Tsungs argued that
De Jager
is
distinguishable because there the accused’s loan account was
not in credit. I see no distinction. And even if the Tsungs’
conduct in this regard did not amount to theft (on which I make no
finding) it certainly amounted to the dishonest use of Textiles’
funds at a time when Textiles was unable to pay its debts – not
only to the IDC but to other creditors as well. This conduct
too
falls within the ambit of s 424.
The exit strategy
[59] I have found that each of the three transactions or courses of
conduct which the high court considered gave rise to s 424
liability
was in itself sufficient to warrant that the Tsungs be held liable
under the section. It is important, however, additionally
to place
their conduct in context to show that they did not intend to rescue
Textiles by concluding the debt-equity swap: they
knew that the
equity would be substantially diminished when they left the country.
They deceived the IDC.
[60] I have already referred to Maia’s description of their
conduct as an ‘exit strategy’. He said in evidence
that
while the Tsungs had appeared to be working with the IDC to conclude
the debt-equity swap agreement, such that the IDC (Findevco)
would
acquire 80 per cent of Textiles, they had at the same time planned
their emigration, and to take with them as much money
from Textiles
as they could. The IDC had negotiated in good faith, assuming that
the Tsungs also wished to save Textiles, when
in fact they were
‘doing exactly the opposite’.
[61] In his affidavit in support of an application to attach the
Tsungs’ property in 2004, Maia referred to Bobby’s
admission to him early in December 2003 that he was emigrating to
Australia. Robert told him in January 2004 that he too was leaving,
going to Hong Kong. During the course of 2003 Bobby had (with the
Garments Diners Club credit card) paid for flights to and from
Australia, paid school fees in Australia, bought a car, paid
emigration consultants, and the furniture removal company. Indeed
it
is probable that he had planned the move in the previous year: the
Diners Club statements for 2002 reflected payments for flights
and
expenses in Australia. And in evidence Bobby acknowledged that he had
bought a house in Australia in 2002.
[62] In the face of all this, Bobby maintained when testifying that
he made the decision to emigrate only in December 2003. He
waited, he
said, until the debt-equity swap was finalized and only then did he
decide to leave. His evidence was rightly disbelieved
by Davis J.
[63] The Tsungs did not advise the IDC of their intention to leave
South Africa while they negotiated the transfer of their equity
to
it. Despite meetings with IDC staff and Fourie in the course of the
year they made no mention of their plan. Only in December
2003, when
transactions that fell foul of s 424 had already been concluded, did
Bobby advise the IDC that he was going. And after
he went Robert paid
the R10.3 million into Textiles and Campbell was instructed to pay
that sum to Lio Ho, using an old invoice
and old Treasury approval to
remit the funds.
[64] If one has regard to these facts it is plain that the payments
made to Lio Ho, to the Bank of Taiwan and in respect of the
Tsungs’
personal expenses, were for their personal gain and not for the
benefit of Textiles or its creditors. They deliberately
eviscerated
the company. They used the corporate shell not for its prosperity but
to recover their personal investment.
[65] As I have said, when instituting action and running the trial
the IDC relied on several additional acts to show that the Tsungs
should be held personally liable for Textiles’ debt. I have
dealt with only three, as did Davis J in the high court. In view
of
the conclusion to which I have come, I consider that there is no need
to consider the other conduct.
Costs of postponement
[66] At the end of the trial the Tsungs asked for the costs of a
postponement requested by the IDC and Findevco. The parties had
agreed that the question of those costs would stand over for
determination when judgment was given. But the high court made no
mention of these costs ‘seemingly per incuriam’,
according to counsel for the Tsungs. The reason for the postponement
was that the IDC and Findevco made discovery of an additional 600
pages of documents shortly before the trial was due to commence.
They
had also filed an expert report out of time. The Tsungs required time
to consider the documents and report. They argued that
the wasted
costs occasioned by the postponement should be borne by the IDC and
Findevco.
[67] The response of the IDC and Findevco is that the documents and
the report related to the extent of the liability, and had
become
irrelevant once the parties had agreed on quantum. The report was
itself a response to the Tsungs’ expert’s
report, and the
late filing had caused no prejudice. I consider that the claim for
wasted costs is accordingly not founded.
Order
[68] In the result, the appeal is dismissed with costs including
those of two counsel.
--------------------------
C H Lewis
Judge of Appeal
APPEARANCES:
For
appellant: J Muller SC (with him J Miller)
Instructed
by: Spencer-Pitman Inc
Rondebosch
Lovius
Block
Bloemfontein
For
Appellant: M Fitzgerald SC (with him C Buikman)
Instructed
by: Bowman Gilfillan
Cape
Town
Matsepes
Inc
Bloemfontein
1
Howard
v Herrigel and another NNO
[1991] ZASCA 7
;
1991 (2) SA 660
(A) at 672C-E.
2
Philotex
(Pty) Ltd v Snyman
[1997] ZASCA 92
;
1998 (2) SA 138
(SCA) at142G-I.
3
L
& P Plant Hire BK v Bosch
2002 (2) SA 662 (SCA).
4
Section
64
of the
Close Corporations Act 69 of 1984
.
5
Saincic
v Industro-Clean (Pty) Ltd
2009 (1) SA 528
(SCA).
6
Fourie
v Firstrand Bank Ltd
2013 (1) SA 204
(SCA) paras 27, 28 and 29.
7
Para
31.
8
Para
29 in
Saincic
quoted in para 27 of
Fourie
.
9
Para
30.
10
Ebrahim
v Airport Cold Storage (Pty) Ltd
[2008] ZASCA 113
;
2008 (6) SA 585
(SCA) para 15,
dealing with
s 64(1)
of the
Close Corporations Act 69 of 1984
.
Footnotes are omitted.
11
Para
17.
12
See
also
Fourie v Newton
[2011] 2 All SA 265
SCA.
13
Para
4 of the SCA judgment.
14
Edited
by J A Kunst et al, service issue 33, 916(1), approved in
Ebrahim
para 18.
15
At
916(2) -916(3).
16
See
in this regard
First National Bank of Southern Africa Ltd v Perry
NO
2001 (3) SA 960
(SCA), confirming what has long been trite.
17
S
v De Jager
1965 (2) SA 616
(A) at 624H-625A.