In a case where a company is harmed by the actions of a third party and the company’s share price consequently depreciates, a shareholder in the company is ordinarily not entitled to bring proceedings to recover his or her losses from the relevant third party. This is referred to as the principle of reflective loss, because the shareholder’s loss is said to be a mere reflection of the loss suffered by a company, rather than the personal loss of the shareholder.
There has, until two recent decisions, been some uncertainty as to whether, contrary to the principle of reflective loss, the Companies Act, 2008 (the “Act”) permits a shareholder to claim from a third party for loss sustained as a result of the diminution of a company’s share price.
In Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others and in De Bruyn v Steinhoff International Holdings N.V. and Others, the courts concluded that the Act does not permit a deviation from the principle of reflective loss.
The De Bruyn decision
Ms De Bruyn held shares in various Steinhoff companies. After a public announcement by Steinhoff of accounting irregularities, Steinhoff’s share price declined dramatically. As a result, Ms De Bruyn, on behalf of various groups of Steinhoff shareholders, instituted a class action against certain of the Steinhoff companies, its directors and Steinhoff’s auditors.
Ms De Bruyn alleged that the impugned directors had:
- acted in breach of their duties to prepare proper financial statements and this violated the Act;
- carried on the business of the companies recklessly, with gross negligence and in breach of the Act; and
- failed to fulfil their fiduciary duties as is required in terms of the Act.
Ms De Bruyn also alleged that such breaches had caused Steinhoff’s shareholders to suffer loss through the diminution in value of their shareholding and that the impugned directors should therefore be held liable by Steinhoff’s shareholders in terms of the Act.
In the application for certification of the class action, the High Court was required to determine whether a triable cause of action was raised. The court considered section 218(2) of the Companies Act, which provides that “[a]ny person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention” The court held that:
- section 218(2) indicates that contraventions of the Companies Act give rise to a right of action but it does not indicate what right of action is enjoyed in respect of a specific contravention of the Act or who enjoys the relevant right of action. These are all matters regulated by the substantive provisions of the Act, rather than section 218(2);
- section 77(2), which expressly imposes liability for a breach of the director’s duties, provides that such liability will be imposed in accordance with the common law. Since the principle of reflective loss forms part of the common law, section 77(2) does not permit a shareholder to bring a claim on the basis of a diminution in share price. Accordingly, it would create an “incurable contradiction” between section 218(2) and section 77(2), if such a claim were permissible under section 218(2);
- section 77(3)(b), which imposes liability for acquiescence by a director in reckless trading, provides that a director of a company is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of such acquiescence. The relevant loss or damages are therefore sustained by the company and, in accordance with the common law, the company is therefore required to pursue a claim for such a loss;
- similarly, 77(3)(d)(i), which imposes liability in respect of contraventions of the financial reporting duties, imposes such liability for damages sustained by the company, and therefore it is the company that is vested with a right of action in respect of such damages.
The court also considered section 20(6) of the Companies Act, which provides that “[e]ach shareholder of a company has a claim for damages against any person who intentionally, fraudulently or due to gross negligence causes the company to do anything inconsistent with (a) [the Companies Act]; or (b) a limitation, restriction or qualification contemplated in this section, unless that action has been ratified by the shareholders in terms of subsection (2).” In this regard, the court held that:
- section 20 is concerned with two remedial functions: to empower named classes of person to apply to court to restore the company to a state of affairs where it acts within its powers and lawfully in terms of the Companies Act and to secure the position of third parties who deal with a company that is acting ultra vires;
- it would be inconsistent with these restorative features of section 20 if section 20(6) were to be interpreted to provide the shareholders of a company with a right of action to claim damages suffered by them as a result of the ultra vires and unlawful actions of the company.
- instead, section 20(6) should be interpreted to be in line with the restorative objectives of section 20 and therefore enables shareholders to apply to a court to have those who have caused the company to act beyond authority or unlawfully to make good to the company by way of damages for the loss they have caused to the company. In addition, the contrary interpretation should be rejected because it is inconsistent with or third parties such as creditors, to recover losses sustained by the company.
The Hlumisa decision
Hlumisa Investment Holdings (RF) Ltd and Eyomhlaba Investment Holdings, two shareholders in African Bank Investments Limited (“ABIL”), alleged that the directors of ABIL and its auditors acted in contravention of the Companies Act, which resulted in ABIL’s share price depreciating. The two shareholders sought to claim damages from ABIL’s directors and auditors in terms of section 218(2) of the Companies Act.
The Supreme Court of Appeal upheld an exception to the two shareholders claim, holding that section 218(2) did not vest the two shareholders with a cause of action against the directors of ABIL because:
- the principle of reflective loss recognises the rule that a company enjoys separate legal personality and this rule has long formed part of the South African common law;
- statutes should not be construed so as to alter the common law, unless they do so expressly or by necessary implication;
- sections 77(2)(b) and 77(3)(b), which impose liability on directors for a breach of the duties imposed on directors by the Companies Act, provide that such liability is to be imposed in accordance with the principles of a common law, and is to be claimed by the company;
- sections 77(2) and 77(3)(b) therefore indicate that
- it is the company that is vested with a cause of action where a director breaches a duty owed in terms of the Companies Act and
- the Companies Act expressly preserved rather than altered the common law principles relating to directors liability;
- section 218(3) of the Companies Act provides that “the provisions of this section do not affect the right to a remedy that a person may otherwise have”; and
- If a shareholder was entitled to bring a claim against a director for conduct that caused a diminution of the company’s share price, this might prejudice the company’s ability to recover its losses from the impugned director. Accordingly, section 218(3) provides a further indication that the Companies Act preserves the principle of reflective loss.