In today’s article, I will elucidate in plain language the concept of a Distribution in terms of Section 46 of the Companies Act (71 of 2008) (“the Act”)along with a few salient points that derive from it.

Firstly, a Distribution is simply a benefit to shareholders at the expense of the company. There are three categories of Distributions:

1. Money or property being transferred by the company to a shareholder or shareholders (excluding shares) – an example of this is cash dividends;
2. A company incurs a debt or obligation on behalf of a shareholder or shareholders – a well-known example of this is a suretyship; and
3. Waiving of a debt otherwise owed to the company by a shareholder or shareholders – this essentially means the Company abandons its right to claim a debt owed to it by a Shareholder.

As you may or may not know, there is no obligation on the Company to declare its Distributions to its Shareholders even though there is an expectation by shareholders to share in the profits of the company. However, this may differ according to the Memorandum of Incorporation and the Shareholders Agreement. It is important that you consider both documents to see what limits have been placed on Declarations of Distributions.

That being said, there is a legislative process to enabling a Distribution which must be followed. The process involves major shareholders participating in the decision-making around the Distribution in the first place. Naturally, therefore, the majority of shareholders will come to know of the Distribution through the compliance process. Let’s unpack that for a moment.

Section 46 of the Act sets out specific requirements which must be met in order for a Distribution to be made. If these requirements are not met, then the Distribution should not be made:

1. The Board of Directors has authorized the Distribution by way of a Resolution (unless the Distribution is to satisfy an existing obligation pursuant to a Court Order);

1. The proposed Distribution will not hamper the Company’s Liquidity (see below); and

1. The Board of Directors have acknowledged in the Resolution that the Company’s Liquidity will not be hampered.

Liquidity and Solvency

In the process of determining the outcome of point 2 above, the Board of Directors will need to apply the Liquidity and Solvency Test. This is a two-pronged test which entails the following:

1. From the Balance Sheet, looking at the fair value of assets, are they equal to or do they exceed the fair value of liabilities? This test is commonly referred to as the commercial solvency test.

1. When assessing its Budget for a 12-month period, will the Company still be able to honour its financial commitments if the Distribution is made? This test is commonly referred to as the factual solvency test.

This test has been adopted by the Courts with approval. In this exercise, the list of documents a Company must consider has not be circumscribed. However, protocol dictates that accounting records and financial statements are amongst the most popular. Notably, all obligations in terms of Distributions lie with the Board of Directors, and not the Shareholders.

If the Board of Directors completes the aforementioned test and adheres to the requirements, resolving that the Distribution is to be made, then the Company has 120 days to implement the Distribution. If it is not done within that period, the aforementioned liquidity and solvency tests must be redone and a new Resolution must be adopted.

Consequences of Non-Compliance

The movement towards piercing the veil of separate legal personality, and attributing liability to Directors, is a strong one; much has been envisaged in the Act insofar as unlawful Distributions are concerned. A Director can be held personally responsible for losses or damages suffered by a Company resulting from unlawful Distributions. It is not an all-encompassing liability curtain – here are the limitations placed on attributing liability:

1. Immediately after implementing the FULL Distribution, the Company does not satisfy the Liquidity and Solvency test; AND
2. It was unreasonable to Resolve that the Company would have satisfied the Liquidity and Solvency test after fully implementing the Distribution.

There are also limits to the amounts claimable against the Directors which can be seen from Section 77 of the Act. Essentially, the amount claimable as damages cannot exceed the difference between the amount by which the Distribution exceeded the amount that it was reasonably able to satisfy in terms of the liquidity and solvency test. Illustrating by way of example, if the Company was factually and reasonably able to Distribute R150,000 but instead Distributed R400,000, the loss in this context is the difference between what was actually Distributed and what the Company was able to Distribute without compromising its liquidity. The Company, in essence, would have exceeded its capacity by R250,000 and this is the amount by which the Company suffered a loss resulting from the Distribution; therefore, this is the amount that is potentially claimable from the Director(s).

If a Director has reason to suspect that a Claim will be brought against him or her for unlawful Distributions, he or she is able to apply to Court for relief. The Court may excuse him or her from liability if it is shown that the Director acted honestly and reasonably (without any willful misconduct or willful breach of trust).