Two recent South African court cases considered the rights of shareholders to hold directors accountable for breaching their fiduciary duties and duty of care and skill under common law and under the Companies Act, 2008 (Act). In both cases, the shareholders' claims related to a deterioration in the value of their shares. Both judgments dismissed the shareholders' claims for damages against the directors on the basis that they had no cause of action. The courts ruled that only the affected companies could hold their directors liable for losses that the companies suffered.
The High Court in Johannesburg considered an application brought by an investor in Steinhoff International Holdings (Pty) Ltd and Steinhoff International Holdings NV (Steinhoff companies) against a number of Steinhoff directors, among others. The applicant shareholder advanced a number of alternative claims against the directors of the Steinhoff companies, including a claim for damages for the directors’ breach of their fiduciary duties and duty of care and skill under common law (common law claims) and under sections 218(2) and 20(6) of the Act (statutory claims), for the losses she suffered.1
African Bank case
In a different case, the Supreme Court of Appeal (SCA) considered the appeal by the former empowerment partners of African Bank Investments Limited (Abil) and African Bank (a wholly owned subsidiary of Abil) against a decision of the High Court. The High Court had dismissed the shareholders' claims in terms of section 218(2) of the Act against the African Bank companies' directors, among others, for damages related to the deterioration of the value of their shares.2 In this case, the shareholders claimed that the directors had acted in bad faith, for ulterior purposes, and without the requisite degree of care, skill and diligence, and therefore that they were in breach of the provisions of the Act (statutory claim).
We set out below the key company law principles laid down by the courts on which a party is entitled to claim damages against the directors for wrongdoing.
Rule against reflective loss - if it is the company's loss, it is the company’s claim
In both cases, the courts discussed the well-established common law rule against reflective loss in relation to companies and their shareholders. The rule can be summarised as follows: where wrong is done to the company, only the company may sue for damage caused. The shareholders' claims in both cases were reflective loss claims. They were suing for the diminution in value of their shares which was simply a reflection of the loss suffered by the companies.
The SCA judges stated that since the shareholders' shares are merely the right to participate in the company on the terms of the memorandum of incorporation, and this right remains unaffected by a wrong done to the company, a personal claim by a shareholder against the wrongdoer for a loss related to the diminution in value of his or her shares is misconceived.
Common law fiduciary duties and the duty of care and skill
In the Steinhoff case, the applicant shareholder claimed that the Steinhoff directors owed shareholders fiduciary duties and a duty of care and skill at common law which they breached when they allegedly made negligent (and in some instances allegedly grossly negligent) misstatements concerning the Steinhoff companies.
The court dismissed the applicant's claim for breach of the directors' common law duties on the basis of the following well-established principles of South African company law:
- a company has a distinct legal personality from its members;
- directors owe their fiduciary duties and duty of care and skill to the company, not to the shareholders; and
- the company itself, and not its shareholders, has an action for wrongs done to the company and losses suffered by the company.
It is therefore the companies, and not the shareholders, which have the right to enforce the directors' common law fiduciary duties and duty of care and skill, seek redress and claim damages against the directors, in the event of breach.
While the breach by the directors of their fiduciary duties and duty of care and skill may also cause harm to shareholders, and potentially to other classes of persons such as creditors, employees, suppliers and customers, the harm does not mean that the duty is owed to all persons who suffer harm. On the contrary, the court held that there must be a special relationship between the directors and the plaintiffs to require that the duties owing to the company are also due to other persons, which was not proven in this case.
In the Steinhoff case, Judge Unterhalter also stated that shareholders must look to the company to mitigate their risk and to claim for any loss caused to the company. Beyond this, the diminution in the value of shares caused by the impact of the directors’ conduct upon the pricing of shares is simply one of many risks assumed by investors when they acquire risk assets in a market.
Statutory fiduciary duties and the duty of care and skill
In both cases, the applicant shareholders alleged (as an alternative claim to the common law claim in the Steinhoff case) that the directors contravened various sections of the Act (including ss 22 (reckless trading), 28, 29, 30 (financial information), and 76 (standards of directors conduct), among others) and these contraventions gave rise to liability to the shareholders for any damages they suffered in terms of sections 218(2) and in terms of section 20(6) of the Act (in the Steinhoff case only).
The courts found that the principle under the common law, and summarised above, that directors are liable to the company and not shareholders for breach of their fiduciary duties must also apply to their statutory fiduciary duties and duty of care and skill under the Act. The Act expressly incorporates by reference the common law principles relating to a breach of these duties under section 77(2)(a).
Statutory claim for contravention of any provision of the Act
In both cases, the applicant shareholders sought to hold the directors liable for their loss in terms of section 218(2) of the Act. Section 218(2) provides that any person who contravenes any provision of the Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention.
The scope of section 218(2) of the Act has been debated since the law was enacted. The language of section 218(2) has led certain courts to interpret the provision literally and in a wide manner to mean that all persons who contravene the Act have general liability in favour of all who suffer loss as a result. However, in both cases, the courts found that section 218(2) should be interpreted narrowly.
The courts held that section 218(2) has no real substance as a standalone provision and does not in itself provide a cause of action. In order to trigger section 218(2), a person must show that a substantive provision of the Act has been breached. Whether a shareholder, among others, has a claim under section 218(2) depends on the exact wording of the provision that has been breached.
Most, if not all, of the provisions in the Act state that the directors owe their duties and obligations to the relevant company, not to individual shareholders. In addition, section 77 of the Act, which governs the liability of a director for breach of fiduciary duties or the duty of care and skill, deals explicitly with loss suffered by the company. In effect, a shareholder would very rarely have legal grounds for a claim under the Act.
As a result, in both cases, the courts found that the applicant shareholders' statutory claim predicated upon section 218(2) could not be sustained because the specific contraventions of the Act they relied upon did not grant shareholders a right of action against the directors. The companies would be the proper plaintiffs. The courts stated that any different conclusion would be a drastic departure from the core principles of company law.
Statutory claim under section 20(6)
In the Steinhoff case, the applicant also alleged that the directors of the Steinhoff companies, acting with gross negligence, caused the Steinhoff companies to conduct themselves in a manner inconsistent with the Act and therefore, in terms of section 20(6), the Steinhoff companies and their directors were liable to shareholders for any damages suffered by shareholders.
Section 20(6) confers a right of action on each shareholder of a company against any person who causes the company to do anything inconsistent with the Companies Act or
ultra vires the powers of the company. Unlike section 218(2), section 20(6) specifies:
- the various species of fault that the defendant must be proven to have committed for liability to accrue; and
- the class of defendants upon whom liability is cast, namely any person who, intentionally, fraudulently or due to gross negligence, causes the company to do anything inconsistent with the Act or
ultra vires the powers of the company.
The court held that section 20(6) imposes liability on persons who cause loss to the company (such as persons charged with managing the business of the company, especially the directors) and not on the company that acts as a result of what persons cause it to do. Accordingly, the applicant shareholder could make no claim against the Steinhoff companies under this provision of the Act.
In addition, the court determined that section 20(6) grants shareholders the right to claim damages for losses suffered by the company and not by the shareholders themselves. Therefore the applicant shareholder could not claim damages for losses it has suffered as a result of the contravention of the Act by the Steinhoff directors.
Shareholders' appropriate remedy - the statutory derivative action
While both judgments dismissed the shareholders' claims under the common law and section 218(2) of the Act, this does not mean that shareholders are without remedy when directors act wrongly. If a company fails to hold the directors liable for any breach of duty to the company that caused loss, the Act makes provision for shareholders to require the company to commence legal proceedings against the directors.
Section 165 provides a remedy that allows shareholders (among others) to enforce rights on behalf of a company in circumstances where the wrongdoers, who are in control of the company, will not enforce the rights of the company against themselves. Specific statutory requirements must be complied with to invoke the remedy in section 165.
In any event, neither sections 218(2), 20(6), nor section 165 afford shareholders a remedy for loss they personally suffered as shareholders. The loss compensated by these provisions is that of the company.
This alert focuses on the findings of the courts in relation to the shareholders' claims against the directors. However, it is important to note that, in both cases, the courts also dismissed the shareholders' claims against the auditors for a deterioration in the value of their shares, based on the same interpretation of the relevant provisions of the Act as were used to dismiss the shareholders' claims against the directors.
1 De Bruyn v Steinhoff International Holdings N.V. and Others (29290/2018)  ZAGPJHC 145 (26 June 2020)
2 Hlumisa Investment Holdings (RF) Ltd and Another v Kirkinis and Others (Case no 1423/2018)  ZASCA 83 (3 July 2020)