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[2010] ZASCA 150
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Fourie NO and Another v Newton (562/09) [2010] ZASCA 150; [2011] 2 All SA 265 (SCA) (29 November 2010)
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THE SUPREME COURT OF APPEAL OF
SOUTH AFRICA
JUDGMENT
Case No: 562/09
In the matter between:
JOHN
LOUIS CARTER FOURIE NO
...................................................
First
Appellant
JOHANNES
FREDERICK KLOPPER NO
......................................
Second
Appellant
JUANITO
DAMONS NO
......................................................................
Third
Appellant
KAREN
KEEVY NO
..........................................................................
Fourth
Appellant
and
JOHN
DENIS NEWTON
...........................................................................
Respondent
Neutral
citation:
Fourie NO v Newton
(562/09) [2010] ZASCA150 (29
November 2010).
Coram:
CLOETE, PONNAN, MHLANTLA and LEACH JJA and
EBRAHIM AJA
Heard:
1, 2 NOVEMBER 2010
Delivered:
29 NOVEMBER 2010
Summary:
Companies ─ s 424 of Companies Act
61 of 1973 ─ reckless
trading ─ personal liability of directors.
______________________________________________________________
ORDER
______________________________________________________________
On appeal from:
Western Cape High Court (Cape
Town) (Desai J sitting as
court of first instance):
The appeal is dismissed with costs, including the costs
of two counsel.
_____________________________________________________________
JUDGMENT
______________________________________________________________
CLOETE JA (PONNAN, MHLANTLA and LEACH JJA and EBRAHIM
AJA concurring):
Introduction
[1] The CNA became an iconic brand in South Africa after
it was established in 1886. It came to have an enormous national
'footprint'
and an annual turnover exceeding a billion rand. In
mid-2002 companies in the CNA group were liquidated. One such company
was Consolidated
News Agencies (Pty) Ltd ('Consolidated'), the
liquidators of which are the present appellants. The liquidators
brought an action
in the Western Cape High Court based on s 424 of
the Companies Act 61 of 1973 in which they sought to hold the
respondent, Mr Newton,
who was on the board of Consolidated, liable
for Consolidated's debts and liabilities without limitation The
amount in issue is
about R256 million. Desai J dismissed the claim
but subsequently granted leave to appeal to this court.
[2] I wish to emphasise at the outset that the reason
why the liquidators have proceeded only against Newton is not because
there
is any suggestion that his conduct was any different from the
remainder of the directors of Consolidated, but (apparently) because
he was the only director that carried director's and officer's
liability insurance. There is nothing improper in such a course:
s
424 empowers a court to declare any person, who was knowingly a party
to the carrying on of the business of a company recklessly
or with
intent to defraud creditors, personally responsible for the debts of
the company. The persons who have locus standi to
bring s 424
proceedings (who include liquidators) can therefore choose whom they
wish to sue.
Chronology of Principal Events
[3] The record and the heads of argument exceed 10 000
pages. It would therefore be convenient to give an overview of the
important
events before analysing in detail the law and evidence
relevant for the determination of the appeal.
[4] In about 1997 the Gallo Group of companies sold the
business of the CNA to Consolidated, the company used for that
purpose by
Wooltru Ltd. The structure adopted by Wooltru was to place
an intermediate holding company, Consolidated News Agencies Holdings
(Pty) Ltd ('Holdings'), between itself and Consolidated. Newton was
appointed a director of Consolidated and Holdings. He was also
a
director of Wooltru and the managing director of the latter's wholly
owned subsidiary, Wooltru Finance (Pty) Ltd, the internal
banker to
the Wooltru group.
[5] Consolidated's business was loss-making at the time
of acquisition. It was financed by long-term interest free
shareholder's
loans from Wooltru made via Holdings; by short-term
'bank' finance from Wooltru Finance (that was obtained from other
cash flush
companies in the group) which was repayable with interest;
and a bank facility with First National Bank.
[6] After the sale, the management of Consolidated was
instructed to adopt a ten point plan to turn its fortunes around.
Central
to the plan was an information technology (IT) system
intended to enable management to get the right stock to the right
place at
the right time ─ a management tool that, until then,
had been lacking. Another aspect of the ten point plan was that 55
new
shops, mainly in rural areas, were opened.
[7] In April 1999 Consolidated and M-Tel (Pty) Ltd
concluded a retailer agreement ('the RA') in terms of which
Consolidated was
appointed the exclusive retailer of MTN cellular
telephone products, and M-Tel warranted that Consolidated would earn
specified
minimum commissions on the sale of those products for three
years from June 1999 until June 2002.
[8] During the latter part of 2000 it became apparent to
management that two strategic mistakes had been made in the ten point
plan.
First, the IT system was far too sophisticated and expensive;
and second, many of the new shops that had been opened were not
profitable.
[9] On 15 August 2000 Newton informed
a supervisory board meeting of Consolidated
1
that the audit committee (a
sub-committee of the supervisory board) thought that Consolidated
'was not a going concern and that
the shareholder [Wooltru] kept it
going'; that Consolidated's 'viability as a going concern was a real
issue and that Wooltru needed
to address this issue as a
shareholder'; and 'that the audit committee would approve
[Consolidated's trading] results as long as
Wooltru stands behind the
business and Wooltru views [Consolidated] as a going concern'.
[10] In August/September 2000 Wooltru decided to
'unbundle', ie to dispose of its holdings in certain (but not all) of
its subsidiaries.
Wooltru retained Casenove, a leading merchant
banker based in London, to supervise the process, which became known
as 'Project
Springtime'. Newton was one of the two persons (the other
being Mr Rabb) who, at meetings of Project Springtime, represented
Wooltru,
which was assisted by a number of professional advisors:
apart from Casenove, there were firms of attorneys, being Mallinicks
and
Edward Nathan Friedland, and accountants, being Ernst & Young
and Nkonkwe Sizwe.
[11] On 22 November 2000 the board of Wooltru decided to
dispose of Consolidated as it presented an obstacle to the unbundling
process.
Casenove was given a mandate to find a buyer.
[12] On 1 March 2001 Consolidated's management
circulated to the directors of Consolidated the 100-day plan it had
drawn up. The
stated purpose of the document was to act 'as a thought
starter that should be robustly debated and changed in order to
achieve
the desired levels of commitment' and the plan was said to
identify 'those actions that are required to Stabilise and Energize
CNA prior to the implementation of a more fundamental re-positioning
exercise'.
[13] On 14 March 2001 the Wooltru board resolved to sell
Consolidated and Holdings to a shelf company, Gordon Kay &
Associates
(Pty) Ltd ('GKA') in which, as the name suggests, Messrs
Gordon and Kay owned shares. A sale of shares agreement was concluded
between these parties the following day. The relevant provisions of
the agreement were the following:
(a) the subject matter was Wooltru's shares in Holdings
and the 'sale claims' ie all amounts owing to Wooltru as at the
effective
date (1 March 2001);
(b) the purchase price was R150 million, and an
'agterskot' being the amount by which the cost of stock of
Consolidated as at 1
March 2001 exceeded its trade creditors plus
R138 250 million;
(c) the purchase price was payable as to R15,4 million
on closing date (when the conditions precedent were fulfilled) which
became
1 June 2002 (the month before liquidation) and the balance 455
days after 1 March 2001;
(d) GKA undertook to provide guarantees for payment of
R30 million and R54,6 million;
(e) GKA undertook to establish a subsidiary of Holdings
and to transfer to the subsidiary all assets and liabilities of
Consolidated
except the top performing 50 stores. (Ultimately, this
provision was not implemented. What happened was that the top
performing
61 stores were housed in a company other than Consolidated
but also in the CNA group; the approximately 110 loss-making
'entertainment'
stores were sold; and the plan was to franchise the
remaining stores);
(f) Holdings undertook to bind itself as surety for the
obligations of GKA and to pledge 25 per cent of the shares in
Consolidated
to Wooltru; and
(g) the subsidiary of Holdings would provide a
suretyship to Wooltru.
After the sale of shares agreement, Newton remained a
director of Wooltru and Consolidated.
[14] Also in March 2001, GKA and the corporate banking
division of Absa concluded a mandate agreement in terms of which Absa
Corporate
was to act as a merchant banker to GKA to advise it on the
disposal of all or part of its interest in the CNA group. The
following
month the retail banking division of Absa granted the CNA
group a general banking facility of R40 million.
[15] On 26 March 2001 an amended retailer agreement
('the ARA') was concluded by various parties, including Consolidated,
Holdings,
Wooltru, M-Tel and MTN. The effect of the agreement was
that Consolidated waived the amounts guaranteed to it by M-Tel under
the
RA; MTN agreed to provide Wooltru with the guarantees required by
Wooltru from GKA for R30 million and R54,6 million payable on
30 June
2002 for part of the purchase price of the shares of, and claims in,
Holdings under the sale of shares agreement; and Consolidated
agreed
to reimburse MTN.
[16] On 25 April 2001 the sale of shares agreement was
amended and it was agreed that as a condition precedent to the sale,
Consolidated
would become a surety and co-principal debtor with GKA.
Pursuant to the agreement, Consolidated executed a deed of suretyship
in
favour of Wooltru as surety and co-principal debtor with GKA for
payment under the sale of shares agreement.
[17] At the beginning of May 2001 GKA paid R15 million
to Wooltru as part payment of the purchase price. The payment was
made using
cash which GKA had withdrawn from Consolidated in
reduction of that part of the loan claim (R120 million) which GKA had
against
Consolidated, which was unsubordinated and which it had
acquired from Wooltru.
[18] On 30 October 2001 Consolidated sold the assets and
stock of the 112 'entertainment' stores to Biz Africa (Pty) Ltd for
what
was ultimately agreed at R50,9 million with effect from 1 March
2001. The price was to be credited by Biz Africa to Consolidated
on
loan account to become payable when Consolidated in its discretion
decided that Biz Africa was in a financial position to pay.
[19] On 8 November 2001, but with effect from March
2001, Consolidated sold its 61 top performing stores to a company
incorporated
into the CNA group which later changed its name to
Central News Agency (Pty) Ltd ('Central') for what was subsequently
fixed at
R133 million. The whole of the purchase price was to be
credited by Central to Consolidated on loan account to become payable
when
Consolidated decided, in its discretion, that Central was in a
financial position to pay.
[20] On 13 November 2001 Absa Retail Bank approved a R10
million facility to be used for letters of credit over and above the
R40
million general banking facility which had already been granted
in March of that year.
[21] On 4 January 2002 Consolidated, with the permission
of Absa Retail Bank, transferred R15 million from its bank account to
Wooltru
in further reduction of the purchase price due by GKA to
Wooltru under the sale of shares agreement.
[22] On 25 January 2002 Holdings pledged 45 per cent of
its shares in Central to Wooltru as security for GKA's obligations to
Wooltru
under the sale of shares agreement and the sale of shares
agreement was amended to provide for payment of R15 million on 31
December
2001 and R74 million on 31 May 2002.
[23] On 16 April 2002 Consolidated and Central signed an
addendum to the sale of the 61 top performing stores to provide that
Holdings
could appropriate the purchase price of R133 million by
setting it off against the shareholder's loan of R859,748 million.
[24] On 31 May 2002 GKA failed to pay Wooltru the
balance of R74 million due in terms of the (amended) sale of shares
agreement.
Newton had already been alerted to this possibility by
Gordon of GKA at the beginning of the month, and had reported it to
the
board of Wooltru.
[25] On 20 June 2002 Absa retail bank increased the CNA
group's general banking facility temporarily (until September) from
R40
million to R70 million.
[26] On 9 July 2002 Newton resigned as a director of
Consolidated. Six days later, on 15 July 2002, Absa retail bank
unexpectedly
called up the overdraft facility. On 27 July 2002,
Consolidated was provisionally wound up as unable to pay its debts,
which amounted
to some R328 million. The order was made final on 2
October the same year.
The Law
[27] Section 424(1) of the Companies Act provides:
'When it appears, whether it be
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.'
[28] The case against Newton is based
on recklessness. The test for recklessness has both objective and
subjective elements. It
is objective, to the extent that the
defendant's actions are measured against the standard of conduct of a
notional reasonable
person.
2
Accordingly, a defendant's honest but
mistaken belief as to the prospects of payment of a claim by the
company when due is not determinative
of whether he was reckless; if
a reasonable person or business in the same circumstances would not
have held that belief, the defendant's
bona fides is irrelevant.
3
The test is subjective, to the extent
that it must be postulated that the notional person belongs to the
same group or class as
the defendant, moving in the same sphere and
having the same knowledge or means of knowledge.
4
[29] Acting 'recklessly' consists in
'an entire failure to give consideration to the consequences of one's
actions, in other words,
an attitude of reckless disregard of such
consequences'.
5
In the context of s 424, the court
should have regard, amongst other things, to the scope of operations
of the company, the role,
functions and powers of the directors, the
amount of the debts, the extent of the company's financial
difficulties and the prospects,
if any, of recovery.
6
If when credit was incurred a
reasonable man of business would have foreseen that there was a
strong chance, falling short of a
virtual certainty, that creditors
would not be paid, recklessness is established.
7
[30] A s 424 enquiry is
typically one into commercial insolvency, as opposed to factual
insolvency. As it was put by Goldstone
JA in
Ex
parte De Villiers & another NNO: In re Carbon Developments (Pty)
Ltd (in liquidation)
:
8
'In short, the mere carrying on
of business by directors does not constitute an implied
representation to those with whom they do
business that the assets of
their company exceed its liabilities. The implied representation is
no more than that the company will
be able to pay its debts when they
fall due.'
And the question whether a company is unable to pay its
debts when they fall due:
'[I]s always
[a] question of fact to be decided as a matter of commercial reality
in the light of all the circumstances of the case,
and not merely by
looking at the accounts and making a mechanical comparison of assets
and liabilities. The situation must be viewed
as it would be by
someone operating in a practical business environment. This requires
a consideration of the company's financial
condition in its entirety,
including the nature and circumstances of its activities, its assets
and liabilities and the nature
of them, cash on hand, monies
procurable within a relatively short time, relative, that is, to the
nature and demand of the debts
and to the circumstances of the
company including the nature of its business, by the sale of assets,
or by way of loan and mortgage
or pledge of assets, or by raising
capital.'
9
As will appear from what is said hereunder, the passage
just quoted is of particular significance in the present case.
The Liquidators' Case
[31] The liquidators' case, in essence, was that from
the period March 2001 until the date of its liquidation, Consolidated
continued
to trade and incur debts which it could not repay and its
board, in permitting it to do so, acted recklessly.
[32] Prof Wainer was called by the liquidators to give
expert evidence on their behalf. Wainer is a chartered accountant, a
practising
accountant and auditor registered with the Public
Accountants and Auditors Board, a past member of the Auditing
Standards Board,
the chairman of the monitoring panel for the
application of Generally Accepted Accounting Principles for the
Johannesburg Securities
Exchange and a visiting professor at the
faculty of commerce of the University of the Witwatersrand. He also
undertakes forensic
work which is a major part of his practice. He
expressed the view, as an accounting expert, that Consolidated should
have been
liquidated by no later than March 2001. In argument before
this court, the submission in the alternative on behalf of the
liquidators
was that Consolidated should have been liquidated not
later than March 2002 and that the directors of Consolidated had
acted recklessly
right up until the date of its provisional
liquidation. I do not propose being detained by a debate as to
whether the alternative
contentions are open to the liquidators in
the light of the pleadings. I shall assume that they are.
[33] In his expert report, which he amplified in his
evidence, Wainer pointed out that in each month from March 2001 until
its liquidation
Consolidated recorded losses (except for December
2001 and January 2002); in general, budgeted profit (loss) had not
been achieved;
there were material negative deviations from the
budgets (even after the budgets were revised to be less optimistic in
July 2001);
and the results were as bad, or worse, than in prior
years. This appears from the following table prepared by Wainer:
Profit
(Loss)
Prior
year
Budget
March 2001
(5 788)
(6 038)
(4 917)
April 2001
(12 856)
(10 700)
(6 448)
May 2001
(9 430)
(10 564)
(5 215)
June 2001
(14 084)
(8 250)
(4 149)
July 2001
(1 356)
(11 520)
(7 746)
August 2001
(9 404)
(7 976)
(7 972)
September 2001
(10 977)
(7 829)
(6 851)
October 2001
(10 746)
(7 141)
(1 797)
November 2001
(1 196)
(1 925)
(1 309)
December 2001
17 843
38 766
26 165
January 2002
5 565
7 432
10 567
February 2002
(810)
Unavailable
Unavailable
March 2002
(2 631)
(5 789)
(7118)
April 2002
Unavailable
Unavailable
Unavailable
May 2002
(5 407)
(9 491)
(5 882)
June 2002
Unavailable
Unavailable
Unavailable
Apr – July 2002
(35 552)
(37 758)
Unavailable
[34] Wainer pointed to the fact that Consolidated made
payments totalling R31,4 million (being two payments of R15 million,
one
in May 2001 and one in January 2002, a payment of R1 million in
June 2001 and a further payment of R400 000 in September 2001)
in reduction of the purchase price due by GKA to Wooltru. But both Mr
Bird of Casenove and Newton expected GKA to do this and although
the
payments reduced the cash available to Consolidated, they were not of
themselves of particular significance. The suggestions
that GKA was
intent on an asset stripping exercise and that Newton was looking
after Wooltru's interests in breach of the fiduciary
duty he owed to
Consolidated, are both without foundation. GKA wanted to keep
Consolidated going, not strip out its assets and
leave it for dead,
and Newton's attitude towards the fiduciary duties he owed
Consolidated as a director appears from his conduct
at the meeting of
the board on 28 March 2002 which I shall deal with when I conclude
the discussion of his evidence.
[35] Wainer singled out the conclusion of the ARA for
particular criticism. He said that it 'had no real value to
Consolidated and
was clearly contrary to its interests and needs'.
The provisions of the ARA highlighted by Wainer and the liquidators'
counsel
were the following:
(a) Consolidated waived the R40 million which it
expected to earn from the RA for the second period ended June 2001.
(b) The income warranty for the third period, 1 July
2001 to 30 June 2002, was to remain in force, but the period was to
be extended
by some three months so that it would run from 1 April
2001 to 30 June 2002.
(c) MTN in its turn would provide the guarantees
required by Wooltru from GKA. The guarantees were for R30 million and
R54,6 million
respectively, and were payable on 30 June 2002.
(d) The agreement made it plain that it was the
intention of the parties that MTN would in fact be reimbursed by
Consolidated and
a company styled Newco.
(e) The mechanism by which this was to occur was via a
trust account opened by attorneys Webber Wentzel Bowens.
(f) Consolidated was obliged to pay all of its future
income earned pursuant to the ARA into the trust account. It was
allowed to
withhold only R15 million per month up to a maximum
withholding of R20 million.
(g) This meant that the shortfall under the third income
warranty, which was expected to be R40 million, would be discharged
by
M-Tel paying that amount into the trust account instead of to
Consolidated.
(h) If, by June 2002, the monies in the trust account
were insufficient to repay MTN, M-Tel would make up the difference;
but with
one crucial qualification. If what it had to pay exceeded
the amount due to Consolidated under the third income warranty, then
Consolidated would have to repay it.
(i) Consolidated's ability to find future investors, if
it ever had any such ability, was choked off by a provision that from
any
investment made the amount withheld by Consolidated from the
trust account would have to be paid into the trust account.
(j) Consolidated and Newco bound themselves as sureties
and co-principal debtors with GKA for all of the latter's obligations
to
MTN to refund to it any amount paid under the guarantees.
(The wording of the preceding sub-paragraphs is taken
from the heads of argument.)
[36] Wainer said that the ARA would have had a profound
impact upon the cash flow of Consolidated in the period from March
2001
in that the guaranteed income amount accrued up to February 2001
and further shortfalls on guaranteed income would not be received.
The anticipated further cash receipts in respect of the year ended
June 2001 (anticipated by the directors at about R14 million)
and
expected in about September 2001, would not arise at all. Moreover,
in respect of the period to 30 June 2002, a lower amount
would be
received from M-Tel in respect of the minimum income warranty as the
period for the measure of the actual income was extended
from 12 to
15 months ─ without changing the original amount of the
warranted minimum income. In addition, from 1 April 2001
cash flow
would be negatively affected in respect of actual sales of the M-Tel
products as the proceeds had to be deposited into
a trust account and
that could not be used (except to the limited extent provided for in
the agreement, ie up to R20 million) for
the business of
Consolidated. The amounts accumulated in the trust account would not
be released to Consolidated but, the commercial
reality was, these
amounts would be taken by MTN to cover the guarantees to Wooltru by
MTN of R84,6 million.
[37] Wainer calculated the negative cash flow effect of
the ARA on Consolidated at R135 million. He concluded on the ARA that
as
at the date of its conclusion and significantly as a result of it,
it was clear that the future liquidation of Consolidated was
virtually certain; and that this would or should have been clear to
any chartered accountant or 'experienced businessman'.
[38] An assumption underlying Wainer's evidence is that
but for the ARA, the RA would have resulted in the CNA receiving
payment
under the income warranties from MTN. The validity of the
assumption is, to put the position at its lowest, questionable. The
RA
required the CNA to have at least 250 stores. Management
contemplated closing stores which would put the CNA in breach of this
obligation. That apart, according to Newton, Mr Jenkins (an executive
director of Johncom which held shares in the ultimate holding
company
of M-Tel) told him and Rabb of Wooltru that M-Tel was dissatisfied
with the CNA's performance under the RA, was not intending
to pay any
money in terms of the profit warranty provisions which it contained
and was intending to litigate. Jenkins confirmed
that he had met with
Newton and Rabb to tell them that M-Tel was unhappy about the
relationship with Consolidated. I see no reason
to reject Newton's
evidence on this point.
[39] According to Jenkins, he also told Gordon that he
should not rely on receipt of a cheque for R14 million for the first
guaranteed
period under the RA. At the same time, Jenkins realised
the importance of the relationship between the CNA and companies in
the
Johnnic group. So did Gordon, who told Jenkins (according to
Jenkins): that the CNA had lost its way; that the fact that the
deficit
in the revenue margins was so large, was an indication of
non-performance in the business; that management needed a new lease
on
life and that the business needed new vision; that he understood
why MTN would be unhappy; that his position was not dependent on
extracting money for the past; that he needed customers and that he
wanted the relationship with MTN and Johncom 'because that
was the
most important and critical success factor'. This was music to
Jenkins' ears. He explained his own commercial approach
to the
breakdown of the relationship between MTN and the CNA and his reasons
for concluding the ARA as follows:
'[I]t was the right commercial
thing. There's always more value in business in the future than there
is in the past. And very often
things don't go according to plan, and
they go wrong, but the biggest question in business is: How do you
fix them? And that, you
know, for both Johncom and MTN, we needed
retail outlets, we needed channel to market, and what CNA needed, was
they needed product,
and they needed customers. They needed feet
through their stores, and that the synergistic benefits of a
co-operative relationship
between this massive retailer with 300
stores, and the might of MTN with its telecommunications product,
which was a big magnet
for customers, and, ja, the ability to expose
for sale the rest of the Johncom product, this was a very, very ─
to my mind,
a very, very good synergistic business model.'
When the view of Wainer, that the ARA had no real value
to Consolidated, was put to Jenkins, he replied: 'I think in my mind
the
agreement had inestimable value'; and when asked for his opinion
as a businessman, he went so far as to say that, from CNA's
perspective,
the conclusion of the ARA was 'probably . . . a sine qua
non for the success of CNA'.
[40] It is for these commercial reasons that the ARA was
concluded. They were ignored by Wainer and the liquidators. So was
the
co-operation agreement concluded at the same time between
Johncom, GKA and the CNA that recognised that the success of the CNA
and Johncom was intertwined, that constituted companies in the
Johncom group preferred suppliers to the CNA group and that recorded
that the purpose of the agreement was to facilitate co-operative
dealings between the Johncom Group and the CNA group to enhance
their
respective businesses. Wainer said in cross-examination that he
considered the ARA as containing 'vague-ish references to
possible
benefits', and that he found 'nothing of any moment' in the
agreement. This attitude may be contrasted with the view expressed
in
an Absa document dated 8 April 2001 recommending the granting of the
R40 million facility to the CNA which, after the provisions
of the
ARA were summarised, continues:
'The company [Consolidated] does
not have a strong holding company, however the strategic partnership
which has been formed with
Johnnic, will provide comfort to
suppliers, bankers and possible future investors.'
Despite being aware of this viewpoint, Wainer said that
he had made nothing of it.
[41] It seems to me that the evidence about the
conclusion of the ARA shows businessmen with conflicting interests
finding a mutually
beneficial commercial solution to their
differences, rather than a reckless carrying on of the business of
Consolidated. The terms
of the ARA and the co-operation agreement
also evince a genuine belief on the part of those who concluded these
agreements that
the CNA would not be liquidated. If that were not so,
the conclusion of the agreements would have been a pointless exercise
in
cynicism. More importantly, MTN would hardly have undertaken a
liability to pay R85 million to Wooltru on 30 June 2002 and nor would
Consolidated have undertaken to repay that amount, had the prospect
of an intervening liquidation of Consolidated remotely crossed
their
corporate minds. I am accordingly not prepared to find that the
conclusion of the ARA on its own constitutes, or is even
evidence in
a wider context of, reckless trading by the board of Consolidated.
[42] Another important ─ and in fact critical ─
theme in Wainer's evidence was that during the period 1 March 2001 to
the date on which Consolidated was provisionally liquidated (I quote
from his expert report):
'There was no clarity and
commitment regarding the source, extent and term of future funding
for Consolidated.'
The phrase 'clarity and commitment' cropped up many
times in Wainer's evidence. It was argued on behalf of the
liquidators as a
matter of law that absent clarity and commitment as
to future funding, it was reckless to carry on the business of a
company ─
in casu, Consolidated ─ which was predicted to
make losses in the future; and Wainer discounted much of the evidence
relied
upon by the defence as justifying the continued trading of
Consolidated, on the basis that such evidence did not measure up to
this standard. It was in these two cardinal respects, in law and in
fact, that the case of the liquidators was misconceived. I shall
deal
first with the law and then the evidence disregarded by Wainer.
[43] As far as the law is concerned,
the phrase 'clarity and commitment' is not an accounting term. It was
culled from the judgment
of this court in
Philotex
.
10
In that matter, the question was
whether directors of a company called Wolnit had carried on the
business of that company recklessly.
Wolnit was part of a group of
companies. Howie JA, writing for a unanimous court, said:
11
'Wolnit's
inability to trade and pay its debts without group support would, in
my view, have prompted reasonable businessmen standing
in the shoes
of respondents and their co-directors to obtain clarity on certain
basic questions before deciding against liquidation
and in favour of
incurring the credit necessary for the continued operation of the
business. Those questions would have been:
(a)
What
financial support will the group provide?
(b)
For how long
will that support be available? Without clarity and the group's
commitment on those crucial enquiries it was neither
responsible nor
reasonable for the Wolnit board to have taken the risk, knowingly or
not, that trade creditors might not be paid.'
It is quite apparent from the passage
quoted that Howie JA was dealing with the situation where a company
could not trade and pay
its debts without group support. It is
equally apparent from the Accounting and Auditing Guide 'Trading
Whilst Factually Insolvent'
12
referred to by Wainer that the
inquiry (clarity and commitment) arises in the context of a company
which is dependent on group support.
Para .19 of the guide says:
'Other
factors which might be considered relevant in the context
of an
entity's trading while factually insolvent and which are highlighted
in the
Philotex
judgment are:
•
in
determining whether a company can continue to trade and pay its debts
with group support, clarity should be obtained on the following
basic
questions before credit is incurred:
─
What
financial support will the group provide?
─
For
how long will that support be available?'
[44] If an essential (and I do not
mean sole) source of funding of a company is intra-group support, and
that support has been or
may be withdrawn, that would be a factor, or
it may be decisive,
13
in considering whether the actions of
the board in continuing to trade were reckless as contemplated in s
424. But where there are
sufficient other potential or existing
sources of funding it does not follow that where group support is or
may be withdrawn, the
members of the board would immediately have to
shut up shop on pain of contravening s 424. The essential question is
whether the
board would be acting recklessly in seeking to exploit
the other sources of funding. The answer to that question would in
the first
place depend on the amount of funding required, for how
long it would be required, and the likelihood of it being obtained ─
whether timeously or at all; and in the second place, on how
realistic the possibility is that the company's fortunes will be
turned around. The second consideration will materially depend on
whether there is a credible business plan or strategy that is
being
or could be implemented to rescue the company. A business that may
appear on analysis of past performance to be a hopeless
case, may
legitimately be perceived as a golden opportunity for a turnaround
strategy.
[45] In evaluating the conduct of directors, courts
should not be astute to stigmatise decisions made by businessmen as
reckless
simply because perceived entrepreneurial options did not in
the event pan out. What is required is not the application of the
exact
science of hindsight, but a value judgment bearing in mind what
was known, or ought reasonably to have been known, by individual
directors at the time the decisions were made. In making this value
judgment, courts can usefully be guided by the opinions of
businessmen who move in the world of commerce and who are called upon
to make these decisions in the performance of their functions
as
directors of companies, and by experts who advise businessmen in the
making of such decisions or who evaluate them at the time
they are
made. And that is the second and factual shortcoming in the
liquidators' case. Because of the narrow view taken of the
law, they
relied only on the evidence of Wainer. Wainer is an accountant ─
a very highly qualified and experienced accountant,
whose views have
been of assistance to many courts in the past, as the law reports
demonstrate ─ but he is nevertheless an
accountant, not a
businessman; and, as he was constrained to concede in
cross-examination, he is not an expert on what would be
obvious to a
businessman. No witness was called on behalf of the liquidators to
fill this lacuna, to say in his or her opinion
as a person of
business what the board of Consolidated was or was not able to do and
what a reasonable director might have expected
to happen given the
circumstances known or which should have been ascertained or
anticipated. Of course, the ultimate conclusion
as to whether a
director acted recklessly or not is a decision for the court.
[46] Evidence was led by the defence which supports a
conclusion that Newton did not act recklessly in the circumstances
which prevailed
from time to time after March 2001. Without going
into detail at this stage, the evidence can be summarised as follows:
(a) Mr Bird of Casenove believed that there was a huge
opportunity in Consolidated in terms of the management plan in place
at the
time GKA purchased the shares.
(b) Mr Jenkins said that the CNA was perceived by its
competitor in the Johnnic Group, Exclusive Books, as a 'slumbering
giant'.
(c) Mr Norman of Absa Corporate testified that there was
great interest in the market place both to acquire equity in the
company
Central, which housed the 61 best performing stores, and also
in the franchising of other stores.
(d) Mr Meisenholl served on a committee of Absa Retail
Bank that on 1 April 2001, after considering detailed reports in
respect
of the business of the CNA, granted the CNA a loan facility
of R40 million and in June 2002 increased the facility to R70 million
(until 1 September 2002).
(e) None of the experts retained by Wooltru to assist it
in its unbundling suggested liquidation as a serious option, and
Newton
considered that there were several funding opportunities
available to CNA once it lost the financial backing of Wooltru in
February
2001, some of which (although diluted) were still there
until his resignation from the board on 9 July 2002.
I propose now dealing in turn with the evidence of the
witnesses called on behalf of the defence.
Bird
[47] Bird was in charge of the local arm of Casenove,
the merchant banker which, as I have said, was retained to oversee
Project
Springtime, the unbundling of Wooltru. For that purpose he
and Newton met with the other professional advisors retained by
Wooltru
on a weekly basis from October 2000 to October 2001. As part
of the unbundling process the directors of Wooltru would be required
in terms of the rules of the Johannesburg Securities Exchange to put
out a circular, approved by shareholders, that there would
be
sufficient resources left behind to finance the working capital
requirements of what remained undistributed. That required
considerable work in analysing the cash requirements and cash flow
profiles of Consolidated and making recommendations as to its
future.
[48] Bird expressed the view in an internal report dated
October 2000, which was never placed before the board of
Consolidated,
in which he said (I have inserted the names of the
companies in the place of the noms de plume):
'Wooltru has
undertaken to its own shareholders, that no further cash will be
invested in Consolidated. Consolidated is regarded
as a going concern
only if Wooltru continues to provide financial support.
14
In the event
that the support for Consolidated is formally withdrawn, Consolidated
would technically be trading under insolvent
circumstances (being
both insolvent and unable to pay its debts) and this would have
severe implications on the directors of Consolidated,
who could be
prosecuted under s 424 of the Companies Act. The implications are
that the directors are not only guilty of an offence,
but also become
personally liable for the debts of Consolidated. Wooltru therefore
needs to consider its commitment to Consolidated
very carefully.'
Bird explained this passage as follows. Wooltru was owed
R290 million, which 'technically' (Bird's expression) was on call. If
Wooltru
withdrew its support, which from a legal perspective it was
entitled to do, Consolidated would have gone insolvent. The reason
why s 424 was mentioned was to focus attention on the issues and draw
the attention of his seniors in London to the statutory provisions
in
South Africa which differ from those in the United Kingdom. Bird said
that Wooltru never seriously considered liquidating Consolidated
nor
did Casenove ever propose this as a serious option, and nor did he
himself consider it ─ it was mentioned for the sake
of
completeness.
[49] It was Bird's opinion that there was tremendous
potential in Consolidated. R350 million had been invested by Wooltru
in a new
IT system to improve the problems with stock, and a lot of
inefficiency at Consolidated had been associated with stock. He had a
number of meetings with the management of Consolidated; they were
excited about the advent of the new stock control system. Bird
always
thought that the high level of stock represented an opportunity to
release substantial amounts of cash into the business.
There was also
the possibility of franchising stores. He pointed out that
Consolidated had a turnover of a billion rand a year,
which he
explained was 'a huge positive' inasmuch as small changes (for
example, the improvement of buying power by a small percentage)
would
have a substantial impact on profits.
[50] Bird said that in attempting to find a buyer for
Consolidated, he would 'very definitely' look at a private equity
investor
that, typically, would look for assets in the business to
fund the acquisition; and according to Bird, Consolidated's business
lent itself to that possibility. But he emphasised that there had to
be a credible turnaround strategy for two reasons: first, so
that a
buyer could have regard to what had been done already and come up
with further ideas; and second, as a negotiating tactic
so that a
prospective purchaser would not regard the seller as being 'stuck in
a corner' and the seller could legitimately contend
that it was
keeping the business because it was viable ─ which, Bird said,
Consolidated's business was. He was asked in cross-examination:
'Well, had you had a solvency
statement on the 1st of March 2001, what would it have looked like?
Would the CNA be insolvent, or
would it be solvent?'
and he replied:
'I have no idea, because I
haven't seen ─ you know, the new management who came in, had a
plan. They believed that they could,
amongst other things, franchise;
they could split the business, restructure the business; they could
raise equity in a new entity
which was going to hold the top 50
stores. All of those have cash flow implications and funding
implications. . . .'
He was also asked in cross-examination:
'And isn't it important to look
historically at where a company is in order to forecast a future or
do you do it in a vacuum?'
and he replied:
'I wouldn't say you do it in a
vacuum, but the past is not necessarily a good predictor of the
future, particularly where you are
in a turnaround situation. You are
changing the way in which the business was run.'
These exchanges encapsulate the difference in approach
between, on the one hand, the liquidators and Wainer, and on the
other, the
businessmen called on behalf of the defendant.
[51] Bird presented a paper to the Wooltru board at a
meeting on 14 February 2001, which represented his views and advice
at the
time. He said, amongst other things, that if Wooltru were to
continue to hold the CNA, it would have to put a further R100 million
to R150 million at risk in order to realise an amount of R135 to R150
million. But that related to the Wooltru business plan and
whereas
Wooltru had adopted what Bird termed a 'one size fits all' approach
to the stores, Bird said that GKA appreciated that
there were
differences between the three categories of stores that provided the
potential for a different strategy, particularly
franchising.
[52] On 9 April 2001 Bird drafted a document which dealt
with security for the purchase price to be paid by GKA to Wooltru,
where
the possibility that Consolidated might be put into liquidation
by, or be unable to make payment on, 30 August 2002, was mentioned.
Bird again said, however, that he did not expect Consolidated to go
into liquidation and that, although it was a theoretical possibility,
he did not consider it to be a probability.
[53] Bird dealt with Wainer's view that it should have
been obvious to a reasonable businessman that the CNA should have
been liquidated
in March 2001 and he was asked whether this was
obvious to him from Casenove's perspective. His reply was:
'Absolutely not. We thought
there was value in the business, hence our valuation. If we felt that
the business should have been
liquidated, well actually we would have
been concluding that there was little, if any, value in the business.
We had valued on
the basis of a going concern and we felt that there
was value in the business. What was clear is that the business needed
to be
run in a different way. So certainly it was never seriously
contemplated and it was not something which I expected to happen
imminently.'
In cross-examination he said:
'If you are operating a business
which is consuming cash, you have options. You can do other things.
You can change the way in which
the business is run. You can sell
down stock, reduce your stock levels. There are a number of things
which management of businesses
can do to change the path on which
they're on. They can secure additional financing, they can sell
assets. They can do all sorts
of things to help the cash flow.'
Indeed, Bird said in re-examination that given what he
himself knew about Consolidated's business, 'it might well have been
a curious
thing' for Newton to have suggested liquidation of
Consolidated in February 2001.
Jenkins
[54] Jenkins, who, as I have said, facilitated the
conclusion of the ARA, said that CNA's competitor in Johncom,
Exclusive Books:
'[A]lways perceived that the CNA
had a huge amount of, let's call it retail and buying muscle, and
that, if they were able to get
their logistics right and their
ordering right, and get their, let's call it their model right, they
would be a fearsome competitor
in the books environment . . .'.
[55] When asked the question 'did you think that CNA
should be liquidated at that time March/April 2001', Jenkins answered
with
a categoric 'no'.
Norman
[56] The evidence established that Absa is one of the
largest commercial banks in South Africa. Absa was involved with
Consolidated
on two fronts: Absa Corporate looked for an equity
partner for the CNA and the retail banking division lent money to the
CNA. Mr
Norman was employed in Absa Corporate, which was given a
mandate by GKA contained in a letter written by the latter on 26
March
2001 in the following terms:
'2. MANDATE
2.1 We are delighted to confirm
the appointment of Absa Corp. to act as merchant bank to Gordon K &
Associated (Pty) Ltd ("the
mandator") in relation to
advising on the potential disposal of all or part of the CNA Group
(Pty) Ltd ("CNA Group"),
and the structuring and strategy
of the Group going forward.
2.2 In terms of the mandate Absa
Corp. undertake to:
2.2.1 assess all available
information and produce a report outlining the various alternatives
open to the shareholders of CNA Group;
2.2.2 provide any financial and
strategic advice regarding the future disposal and/or strategy for
the CNA Group; and
2.2.3 assess and advise the
mandator on offers received by potential acquirers of all or part of
the CNA Group's operations/business
units.
2.3 The mandator, in terms of
this letter, grants to Absa Corp. (Investment Banking Department) a
call option offering it the opportunity
to acquire up to 20% of the
existing issued ordinary shareholders equity of the CNA Group at a
price of R80 million for 20%.'
Wainer said that he ignored the interest shown by Absa
in itself acquiring equity in the CNA for R80 million as it lacked
both clarity
and commitment.
[57] After the mandate had been granted, Norman met the
executive management of the CNA and attended both board and
management meetings.
Information was obtained from those meetings and
from management reports.
[58] On 23 April 2001 at a meeting held at the CNA,
Gordon presented to management a new proposed structure for the CNA.
This structure
involved separating the CNA stores into three
categories: the top 50 stores, termed the 'destination' stores; the
bottom 150 stores,
termed 'entertainment' stores which were to be
sold to a Johnnic consortium; and the remaining stores which were to
be franchised
or closed. Norman said that, as a merchant banker, he
considered this to be a viable plan. Indeed, to implement it, Absa
Corporate
prepared a detailed weekly timetable which commenced on 13
August 2001 and which was due to be completed by 31 October 2001.
Although
implementation was delayed, the sale of the top stores to
Central was concluded on 8 November 2001 and according to Norman, by
April 2002 some stores had already been franchised and there was
ongoing interaction with Absa franchise which, he said, 'I think
. .
. is the biggest franchise division of all the banks. It is their
business to really roll out these plans I think ten stores
had been
done'. According to Norman, the CNA had retained Mr Eric Parker, whom
he described as 'the guru of franchising', to assist
it in this
regard. He took issue with the suggestion in cross-examination that
the franchising was a 'hope', insisting that it
was a 'plan'.
[59] From April 2002 a document prepared by Absa
Corporate (which was continuously updated) was shown to prospective
purchasers
of equity in Central. The document showed that it was
anticipated that profit after sale of the whole CNA group would not
become
possible even in 2005. Despite that, Norman testified,
substantial interest was shown by various different parties including
Sanlam,
Old Mutual, Shoprite, Ackermans and merchant banks. The
problem, however, was that the operational separation of the top 61
stores
sold to Central had not been effected, due to the fault of a
very senior individual in the CNA group (whom it is not necessary to
name) who gave repeated assurances that everything was in hand, but
failed to perform his mandate. There is no suggestion that
Newton was
aware of this problem.
[60] In re-examination, Norman's evidence was to the
following effect:
'It was put to you that the fact
that Consolidated was losing money was none of your concern? --- None
of my concern in relation
to what we wanted to achieve. We have to .
. . put together a plan that undoes that situation. That is the whole
point of us being
involved, to come in, put in a plan, implement,
turn it around, and everybody is happy about it. That is the game. It
is of concern
in relation to the ongoing business, but it wasn't of
concern to us in relation to our strategic plan. We knew it was
making losses.
And would the prospective
purchasers or the people interested in the business, would they have
been aware of that, or not aware
of that? --- Absolutely they'd be
aware of it. That's part of the attraction. They're getting an asset.
It's going to be substantially
below what the value is. If it's a
loss making business, you can get it cheaper and you can turn it
around.
In a similar context it was put
to you that the risk of turn around was extremely high and to which
you answered, it was high. Now
be more specific? --- It's a relative
concept. I mean we did a deal where people bought 45 hospitals which
were totally in liquidation.
And that's now the Netcare Group. So who
is to say whether that was a high risk when they did it, or extremely
high risk, but they
turned 45 hospitals, which owed Absa R100
million, into the Netcare Group.
Your client is highly
successful? --- To say the least, yes.'
Meisenholl
[61] Meisenholl, a chartered accountant with over 26
years experience in banking and the managing executive of the credit
risk management
organization of Absa Retail Bank, gave evidence on
the banking facilities granted by Absa to the CNA.
[62] At the end of March 2001 the CNA group applied to
Absa for a R40 million general banking facility. In accordance with
ordinary
practice, the application was first considered by a business
banker and a business analyst in the Sandton business centre who
would
have interacted with senior personnel of the CNA.
It
was then checked by risk management and the general manager of the
business centre. From there it went to the credit department
where it
was reviewed by a credit analyst. Ultimately, because the facility
requested exceeded R30 million, it came before the
lending committee
of which Meisenholl was a member.
[63] On 30 April 2001 the lending committee declined the
application pending receipt of further information. Once the
information
had been provided, and after Meisenholl, Mr Emsley (the
managing executive of the business bank) and Mr Human (the general
manager
of credit risk at Absa) had consulted with senior management
of the CNA (Gordon and Holden), the facility was granted by the
lending
committee on 10 April 2001. Present were Mr van der Merwe,
the executive director responsible for credit; Mr Emsley; Meisenholl;
Mr du Preez, a general manager in the business bank; and Mr Human,
who dissented. I do not propose setting out the detail of the
investigations made by Absa. It suffices to say that the application
by the CNA was considered thoroughly and the recommendations
at every
level of the process were carefully motivated.
[64] The facility of R40 million was temporarily
exceeded from time to time by the CNA, the excesses subsequently
being approved
by Absa, and on 13 November 2001 it was extended to
include a R10 million letter of credit facility ─ again after a
detailed
investigation by Absa at the various levels I have
mentioned. In March 2002 the CNA applied for an additional R20
million. That
was refused by the lending committee on 30 April 2002,
but a temporary bridging facility of R10 million was allowed and
subsequently
extended to 15 May 2002.
[65] On 16 May 2002, the lending committee noted that
the R10 million had been repaid and that Absa's exposure was within
R30 million.
On 31 May 2002 Dr Booysen (the executive director
responsible for the credit risk management organisation within Absa)
and Meisenholl
met with Newton, who gave them the assurance that
Wooltru would not demand that the outstanding purchase price due by
GKA be taken
out of the CNA. It appears that the Absa representatives
understood that Wooltru might again become a shareholder of the CNA,
although
no definite answer was given as Newton undertook to revert.
At the end of May or early June 2002, a round robin resolution of the
lending committee approved a temporary increase in the general
banking facility granted by Absa to the CNA by R21,6 million to
R60
million, subject to a reduction to R38 million on 20 June; and before
20 June, the facilities were increased to R70 million
until September
2002.
[66] Newton was aware of the fact that Absa had granted
the facilities to which I referred in the previous paragraphs. The
attitude
of Absa would hardly have prompted him to consider the
liquidation of Consolidated. On the contrary, as late as 30 May 2002
he
met with Meisenholl, who said:
'So that was the discussion with
Mr Newton it was not in terms of the R70 million term facility it was
really what is the best way
to keep CNA group operating and trading
as a going concern. . . .'
[67] Meisenholl justified the extension of banking
facilities to the CNA for essentially three reasons:
(a) first, the operation made business sense: the CNA
had changed its business model from a news agent to a retail outlet
with a
diversified product and there was a demand for the product the
CNA was selling;
(b) second, the group was debt free (ie no debts were
owing outside the group), the CNA was a strong brand with over 300
branches
and a new IT system to control stock had been introduced,
with the result that 'from a whole business case perspective, we
considered
that it is viable'; and
(c) third, and most critically, Absa, having met with
top management, had confidence that management would be able to make
a success
of the group.
Therefore, concluded Meisenholl, the lending committee
'considered it a fair decision, R40 million trading facility versus
turnover
of one billion rand at that stage' ─ even although, as
pointed out in cross-examination, the risk of the CNA's inability to
repay the loan to Absa was described as 'high' to the lending
committee. Meisenholl also said in connection with the second point
to which I have just referred that although Absa would have had
regard to financial statements of the CNA, 'financial statements
. .
. reflect a picture of what happens in the past, they do not give a
view of what is going to happen in the future'. This view
stands in
stark contrast to the position adopted by Wainer, as does the
following statement, made by Meisenholl in cross-examination:
'If I knew what I knew twelve
months later, in terms of what happened with management, how the cash
flows panned out, etc we would
have said no [to the CNA's application
for credit facilities] but I haven't got the luxury when I take a
credit decision to work
on hindsight.'
Newton
[68] It is now necessary to examine the evidence of
Newton himself. Newton never seriously considered liquidating
Consolidated,
and nobody proposed this option:
(a) The merchant banker (Casenove), the firms of
attorneys (Mallinicks and Edward Nathan Friedland) and the firms of
auditors (Ernst
& Young and Nkonkwe Sizwe) who were retained by
Wooltru to advise on its unbundling, and participated in the weekly
meetings
with Newton representing Wooltru when the affairs of
Consolidated were considered in detail, did not suggest that
Consolidated
should be liquidated. Newton was entitled to rely on
this multi-disciplinary array of talent for advice that Consolidated
should
be liquidated, if that was the view held by any of them.
(b) Deloittes, who audited the financial statements of
both Consolidated and Holdings at February 2001, expressed an
unqualified
audit opinion, which meant, as Wainer readily conceded,
that their view was that Consolidated was a going concern for the
foreseeable
future, ie for at least the next 12 months. In addition,
on 4 September 2001, Deloittes advised the management of
Consolidated,
after reviewing management reports, that both before
and after the restructuring in the CNA group, the assets of the
companies
in the group, fairly valued, exceeded the liabilities and
that the companies were therefore technically (ie factually) solvent.
Wainer disagreed with all of the conclusions reached by Deloittes.
But the point is not who is correct. The point is that Newton
was
entitled to rely on the views of a reputable firm of auditors in
performing his duties as a director of Consolidated.
(c) The corporate and retail banking divisions of Absa,
which each conducted in depth investigations into the affairs of the
companies
in the CNA group, did not suggest liquidation. I have
already dealt with the evidence of Norman and Meisenholl. Again, the
question
is not whether Wainer was correct in stating that 'many of
them [ie bankers] do not have high level skills' or justified in
saying
that 'It appears from the files [Absa retail bank] didn't have
the full story. From my experience with these banks, they certainly
wouldn't have the appropriate expertise at the advances level to
analyse it anyway, and they got critical pieces of information
which
were materially incorrect.' The point is that the ongoing actions of
both divisions of Absa, in continuing to provide and
extend overdraft
facilities after careful consideration and in attempting to find an
equity partner, of all of which Newton was
well aware, would have
made liquidation of Consolidated the remotest possibility present to
his mind.
(d) The management of Consolidated,
in their monthly reports after the sale of shares agreement in March
2001 to which Newton had
access at least after January 2002, and in
their monthly reports before the sale of shares agreement to which
Newton did have access,
far from mentioning liquidation as a
possibility, were consistently positive. Newton was entitled to
accept and rely upon the judgment,
information and advice of
management, unless there were proper reasons for querying such.
15
It was submitted in argument on
behalf of the liquidators that those in management were simply
seeking to protect their jobs. But
that cannot explain why management
proposed a management buyout on two occasions. The first was between
October and December 2000
when it was known that Wooltru was looking
for a buyer for Consolidated; and the second was as late as mid-June
2002. There can
be no stronger expression of confidence by management
in a business than a proposed management buyout. Wainer could not
explain
why it was that management did not see that liquidation was
inevitable in and after March 2001, and he did not address the
continuously
positive outlook by management which continued at least
until shortly before Consolidated was liquidated.
[69] Newton dealt succinctly with the funding
opportunities available to Consolidated, and the liquidators'
touchstone of clarity
and commitment, as follows:
'As at 1 March [2001] there was
no shareholder . . . interest bearing debt, and CNA had a huge raft
of possible sources of funding
available to it. It had creditor
funding, it had the ability to sell down stock, it had the ability to
raise bank debt. It had
the ability to sell off equity and inject
funds. There was absolutely no need to have clarity about which of
those sources it was
going to utilise and certainly it was not
necessary to have commitment from any of those sources at that time.
The company's assets
exceeded its liabilities and it could trade and
it could rely in the normal course of events to acquire funding from
one or other
of those sources. So I don't think this term "clarity
and commitment" is of any application to any business situation
other than where it is relying solely on a shareholder to provide the
funding.'
As a matter of law, I disagree with the last sentence:
clarity and commitment are required not only where a company relies
solely
on a shareholder to provide funding, but also where
shareholder funding is essential for the company to survive even
though other
funding is available.
[70] Newton quantified the sources of funding as at 1
March 2001 as follows:
(a) Stock: As at 28 February 2001 stock was in the books
at R318 million. Said Newton, one could assume that the CNA was
overstocked
by R180 million. As a matter of fact, the CNA ran down
stock by even more than R180 million ─ at cost. Had stock been
sold
at the normal margin of 40 per cent, it would have realised R300
million in cash.
(b) Creditors: Creditors had been paid down from R220
million at the end of January 2001 to R100 million at the end of
February.
There was accordingly R120 million available in the form of
creditor finance.
(c) Cash: There was cash in the bank of R10 million.
(d) Overdraft: Bank overdraft facilities of R70 million
were ultimately granted.
(e) MTN: The RA was capable of renegotiation for R85
million. That is what happened when the ARA was concluded.
(f) Investors: If 50 per cent of the shares in Central
were sold, the outstanding purchase price due to Wooltru could have
been
paid.
(g) Franchising: There were 160 stores in the
franchising division. 100 stores could have been franchised at a
price of R500 000
per store realising a minimum of R50 million.
(As will appear from para 71(b) below, the 100 day plan anticipated
that 150 stores
would be franchised.)
Newton was not cross-examined on the figures he put to
the various funding opportunities. He repeatedly tendered in
cross-examination
to provide those figures, which he had calculated
during an adjournment after he had been led in chief, but that
opportunity was
denied him. The figures were accordingly given in
re-examination and the objection by the liquidators' counsel to this
evidence
was correctly overruled.
[71] As at March 2002, the financing opportunities had
diminished and some had been utilized to their full extent. In
addition,
I agree with the liquidators' counsel that because of
Consolidated's obligations to MTN under the ARA and GKA's obligations
guaranteed
by Consolidated to pay the balance of the purchase price
to Wooltru, it is unlikely that any cash inflow from an equity
partner
(assuming that one could be found because of these very
obligations) would have gone to Consolidated ─ although the
debt
due to Wooltru by GKA would have been discharged. But there was
still the prospect of overdraft finance, and the plan to franchise
stores was being implemented.
(a) Overdraft: In June 2002 the overdraft was increased
from R40 million to R70 million until 1 September of that year. It
was submitted
on behalf of the liquidators that it was reckless for
the board to have applied for this facility. I cannot agree. Although
as
a matter of law an overdraft is repayable on demand, it was not
reckless for Newton to assume that once Absa retail bank, after
due
consideration, had granted an overdraft for a fixed term, it would
not, shortly after it had been increased (again after due
consideration), and before that term had expired, unexpectedly call
it up. The expected cash flow of the business presented to
Absa in
June 2002 by the management of the CNA showed that cash in the
bank/overdraft would fluctuate (overdraft figures in brackets)
from
about (R40 million) in March to bottom out at (R70 million) in August
2002, gradually recovering to between (R50 million)
and nil to
November, becoming positive in December and exceeding R100 million in
January and R150 million in February 2003. Traditionally,
the
Christmas and back to school period (December and January) was the
only period in the year that the CNA made a profit and that
was well
known to the board of the CNA and to Absa. At the board meeting on 28
March 2002, which Newton attended, Holden, the senior
member of
management present, said (and I quote the minutes):
'Tim Holden reported on the
financial results, and indicated that the business was tracking ahead
of the initial plan as presented
to ABSA with expenses being well
contained and the business achieving better margins. The loss for the
trading year is approximately
R52 million. Plans for next year have
already taken out R40 million of costs which implies that CNA should
break even. CNA requires
approximately R30 million cash injection to
enable the double-digit growth and smooth operation of the business
going forward.
The down side is the upward fluctuation of interest
rates.'
The increase in the overdraft granted by Absa was
precisely the cash injection which management sought.
(b) Franchising: The 100 day plan envisaged that 150
stores would be franchised. It read:
'The current owners [GKA] have
taken the decision to begin the process of franchising with the
objective of having the first fully
operational franchise stores up
and running by October 1, 2001. It is anticipated that a total of 150
stores will be franchised
during the 24 month period beginning in
October 2001 and ending in October 2003. This being said, the target
is to convert ten
stores per month starting in February 2002.'
There was a delay in implementing the franchising plan
but the report given to the CNA board at its meeting held on 28 March
2002,
far from giving cause for concern, was positive. The minute in
this regard reads:
'
Franchising
update: The first five franchise stores are up and running. The
system is now in, once all the minor problems are resolved
the
balance of the franchise stores can be sold in earnest. Anton
Hingeston has completed another presentation that has again sparked
interest. Banks are processing and finalising the loans, as no
payments have been received yet.'
As a matter of fact, the list of creditors of
Consolidated reflects that R1,82 million was paid as a deposit for
franchising rights
on 30 April 2002, and that two other deposits were
paid on 1 March. Counsel for the liquidators submitted that the
franchising
plan ended up as a debacle. But the argument again loses
sight of the fact that the conduct of Newton does not fall to be
evaluated
with the benefit of hindsight.
[72] No particular event occurring after March 2002,
apart from the application for the increased overdraft which I have
dealt with,
was relied upon in argument on behalf of the liquidators
as constituting reckless conduct. The unchallenged evidence of Newton
was that the CNA was paying trade creditors in June 2002. The
liquidation of Consolidated in July was precipitated by Absa
unexpectedly
reducing the overdraft facility, which it had granted
until September, apparently because it realised that Wooltru was not
interested
in again becoming a shareholder in the CNA.
[73] On Newton's evidence alone, which I see no reason
to reject, he was not guilty of reckless trading. On the contrary, he
was
well aware of the fiduciary responsibility he owed to
Consolidated and, as is quite apparent from the clash between himself
and
Gordon at the CNA board meeting of 28 March 2002, he was prepared
to exercise it. At that meeting Gordon suggested that over and
above
the overdraft facilities already obtained from Absa, a further R70
million overdraft should be obtained by Central. That
money was
intended by Gordon to be taken out of the CNA group and used to
reduce the purchase price GKA owed to Wooltru. The minutes
record
that a 'heated discussion' then ensued. Newton agreed with Holden who
expressed the view of management that the business
of the CNA could
not sustain the additional loan burden of R70 million. The minute
records:
'Responding to a question from
Brian Leroni [a director], John Newton said that whilst he could not
express the view of Wooltru,
his view as a Director of CNA was that
he recognises the upcoming "cash squeeze" and that should
debt be incurred in
CNA to repay Wooltru, the Directors should be
mindful of their fiduciary responsibilities should this put CNA in a
potential insolvent
position.'
Conclusion
[74] I am quite unable to find that the board of
Consolidated, or Newton in particular, in any way conducted the
business of Consolidated
in or after March 2001 with an attitude of
reckless disregard for the consequences. Nor in my judgment would a
reasonable man of
business in the position of Newton have foreseen,
when credit was incurred, that there was a strong chance that
creditors would
not be paid. Several witnesses, including Newton,
gave entirely acceptable evidence that they saw no reason to consider
liquidating
Consolidated. Save in regard to the possibility of an
outside investor, which Wainer considered improbable after the
conclusion
of the ARA, no-one gave evidence that the funding
opportunities available to Consolidated, to which Bird and Newton in
particular
testified, had no reasonable prospect of being realised
and no-one testified that these funding opportunities were inadequate
to
turn the CNA around. Wainer's evidence, constituting an
accountant's view based on the management accounts alone, was not
sufficient
to counter the evidence given by and on behalf of Newton;
and the liquidators' case in any event rested on a misinterpretation
of this court's decision in
Philotex
.
[75] The appeal is dismissed with costs, including the
costs of two counsel.
_______________
T D CLOETE
JUDGE OF APPEAL
APPEARANCES:
APPELLANTS: H Z Slomowitz SC (with him E A Limberis SC)
Instructed by Werksmans, Cape Town;
Lovius Block Attorneys, Bloemfontein.
RESPONDENTS: S F Burger SC (with him I P Green)
Instructed by Webber Wentzel Bowens, Cape Town;
Matsepes Attorneys, Bloemfontein.
1
Whilst
Wooltru owned Holdings and Consolidated, the executive board of
Consolidated met monthly and the supervisory board, on
which Newton
sat, met quarterly.
2
Philotex
(Pty) Ltd & others v Snyman & others
;
Braitex (Pty) Ltd & others v Snyman
& others
[1997] ZASCA 92
;
1998 (2) SA 138
(SCA) at
143G.
3
Philotex
at 147E.
4
Philotex
at 143G-H and 148E-H.
5
S
v Dhlamini
1988 (2) SA 302
(A) at
308D-E, applied in the corporate context in
Philotex
at 143F-G and
Ebrahim
& another v Airport Cold Storage (Pty) Ltd
[2008] ZASCA 113
;
2008
(6) SA 585
(SCA) para 14.
6
Fisheries
Development Corporation of SA Ltd v Jorgensen & another;
Fisheries Development Corporations of SA Ltd v A W J Investments
(Pty) Ltd & others
1980 (4) SA 156
(W) at 170B-C, approved in
Philotex
at 144B-D.
7
Philotex
at 147C.
8
1993
(1) SA 493
(A) at 504E-F.
9
Blackman
et al
Commentary on the Companies Act
,
vol 3 14-130, relying on Australian authority.
10
Above,
n 2.
11
At
175F-H.
12
Issued
in July 1999 by the South African Institute of Chartered
Accountants.
13
The
question was left open in
Philotex
at 185F.
14
This
view accords with what Newton told the supervisory board meeting of
Consolidated held some two months previously, on 15 April
2000 ─
see para 9 above.
15
The
Fisheries Development Corporation
case, above, n 4, at 166C,
approved in
Philotex
, above, n 2, at 144I.