The Western Cape High Court[1] has recently passed judgment in a decision which reiterates the bounds of the duties of directors of holding companies to subsidiary companies.  Even though the case involved a damages claim against the liquidators of the holding company (in liquidation), the principle applies equally to directors.

The 34 Plaintiffs in the action were shareholders in a company, Kimberley Consolidated Mining (Pty) Ltd (“KCM”). In their particulars of claim, they alleged that on 12 November 2010, KCM was provisionally wound up, and that such winding up order was made final on 9 December 2010. They further alleged that prior to its liquidation, the sole business of KCM was its shareholding in two subsidiaries, being Bo-Karoo Diamond Mining (Pty) Ltd (“Bo-Karoo”) and Channal Mining (Pty) Ltd. According to them, the solvency, financial viability and share value of KCM was accordingly determined solely by the business activities of the two subsidiaries.Three individuals were joined as defendants, as were their respective employers. The basis for the claim was alleged negligence in administering the affairs of KCM (in liquidation) and in so doing causing the shareholder dividend to be significantly reduced.

The first set of allegations supporting the allegation of negligence involved the following alleged conduct:

  • a valuable 27 carat diamond (“the Diamond”) was discovered on a mining site worked by Bo-Karoo;
  • in what appeared to be a fraudulent transaction, it was thereafter sold by one Pikwane, or a company controlled by him, Pico Diamonds (“Pico”), who endeavoured to appropriate the proceeds of the sale either to himself or an entity controlled by him;
  • this ultimately led to an application to court, by interested shareholders, to preserve the proceeds of the sale and two orders directing that the amount of R30 million be retained in trust until 7 February 2011 “to enable the liquidators and/or any other interested party to institute proceedings, within such period, for the recovery of the proceeds of the sale of the Diamond and for further interim relief pertaining to the protection and preservation of such proceeds”;
  • as the Liquidators of KCM, the defendants had a duty to inter alia take reasonable steps to investigate the relevant facts and timeously institute action to protect the rights of Bo-Karoo and/or KCM and/or its creditors and/or its members in regard to the aforesaid amount of R30 million; which they failed to do; and
  • but for this failure, an additional R30 million would have been paid as a dividend to KCM and been available for distribution to the members and creditors of KCM.

The second set of allegations turned around the following alleged set of circumstances:

  • a subcontract was concluded between Bo-Karoo and Pico which was void or voidable for various reasons;
  • as duly appointed Liquidators of KCM, the Liquidators were duty-bound to assume control of KCM’s two subsidiaries;
  • had they done so, they would have taken steps to set aside the subcontract agreement and recover the proceeds of diamonds mined by Pico, pursuant to the aforesaid void subcontract agreement; and
  • this would have resulted in amount of R56 483 (the nett profits which would have been earned on the diamonds mined and appropriated by Pico pursuant to the sub-contract agreement) being made available as a dividend to KCM, as the holding company of Bo-Karoo which would, in the course of liquidation, have been distributed to the members and creditors of KCM.

Finally, it was alleged that while acting as the duly appointed liquidators, the defendants sold Bo-Karoo’s equipment and mineral rights at a price of R14 000 000, allegedly R61 000 000 below market value. In consequence of the aforesaid actions by the Liquidators, the amount available for distribution to the members and creditors of KCM, as the holding company of Bo-Karoo, was reduced by R75 000 000 (this is what was pleaded).

The plaintiffs alleged that but for the negligence of the liquidators, as described above, the sum R118 566 012,64 would have accrued as a dividend to KCM and, after payment of claims due to creditors and of commissions, a balance of R101 957 995,78 would have been distributed to the members of KCM pro rata to the shareholding of such members.

The matter proceeded by way of exception and one of the key considerations for the court was whether or not there was a duty on the liquidators of KCM to take control of its wholly-owned subsidiary, Bo-Karoo.As a matter of law, the duty of a liquidator is to wind up the company in liquidation.  The question was whether this might also include an obligation to take control of subsidiary companies.

The case of Macadamia Finance CC and Another v De Wet & Another 1993 (2) SA 743 (A) featured prominently in argument. In that case, the defendant liquidators, appointed at the time as liquidators of the holding company only, were sued flowing from their failure to insure assets owned by its subsidiary company (the assets being plantations that were ultimately destroyed in a fire). The plaintiffs argued that given the close relationship between the holding and subsidiary companies (who shared a board of directors), the liquidators should have taken the steps to insure the assets. The lower court decided that even though there is a general duty on a liquidator to insure the assets of the company in liquidation, such duty does not extend to subsidiary companies controlled by its own board of directors. The decision was confirmed on appeal.

In the case before her, Cloete J concluded that one cannot contend that merely by virtue of the shareholding of one company in another, there was either power to control, or a right of control by the former of the latter. Relying on the authority of Macadamia Finance she held that the claims brought by the plaintiffs all pre-supposed a right of control that did not exist, or, if one was supposed to have existed, the basis upon which any such control was asserted was unclear, vague and embarrassing.

The exception was accordingly upheld.

Even though the issue arose in the context of the duties of liquidators, the same rationale would apply equally to directors of holding companies with no direct connection to a subsidiary company.