THE STATUTORY DERIVATIVE ACTION, A NUANCED APPROACH – SECTION 165

The statutory derivative action, a nuanced approach – Section 165

Section 165 of the Companies Act 71 of 2008, as amended, (“the Companies Act”) allows a person to commence or continue legal proceedings in a company’s name for the purpose of protecting the legal interests of a company where the management of a company fail to do so.

It is common for people to find themselves in a position where they – in some way, shape or form – have aligned their interests with that of a company only to be disappointed by the people responsible for ensuring that the legal interests of a company are protected. Alternatively, to find themselves in a position where they fall prey to the controlling interest(s) of a company. Such a person, or people, may wish to ensure that the legal interests of a company are protected, and in so doing, may wish to find remedy in the provisions of section 165 of the Companies Act.

Use of the remedy contained in section 165, requires an astute understanding of the circumstances which may give rise to its use (which includes the jurisprudential principles circumvented by the statutory derivative action) and how the statutory derivative action, in its current form, is to be initiated.

Therefore, we will summarily explore the nuances of the section 165 derivative action in its current form and its use in comparable jurisdictions.

Section 165 provides that a person may, by service of a demand upon a company to commence or continue legal proceedings or take related steps, to protect the legal interests of the company, if the person is – a registered shareholder or a person entitled to be registered as a shareholder of the company or a related company, a director or prescribed officer of the company or a related company, a registered trade union representing employees of the company or another employee representative, or a person who has been granted standing by the court, may pursue a derivative action on behalf of the company, but only with the leave of the court in the exercise of its discretion (s165 (2) (a) – (d)). It is noteworthy to mentioned that service of the demand on the company (or its board) is a prerequisite for any party wishing to commence or continue derivative proceedings.

Upon interrogation of the abovementioned provision(s) it is of utmost importance that cognizance be taken of the well-established jurisprudential principles which section 165 circumvents. The first being the internal management principle. This principle, as more fully contemplated in section 66 (1) of the Companies Act, provides (in summary) that the management of the business and the affairs of a company rests with its board. The board has the authority to exercise all powers and perform all the functions of a company. This includes the decision of whether or not the company wishes to litigate.

The second principle circumvented is the democratic majority rule principle. This principle is applicable to those persons with vested interest(s) in the company, or a related company i.e., shareholders, directors, committee members etc. In summary, this principle provides that people who become part of a company, howsoever arising, do so of their own volition and accept the consequences that flow therefrom. A natural consequence in this regard being that such person shall accept the decisions of the majority as binding upon them. South African Courts will not readily interfere with the internal management and majority rule principle where persons have taken a decision, by majority, within the ambit of the law.

The third principle circumvented by the statutory derivative action is the proper plaintiff principle. A company is a separate juristic person, and as a result, is to be regarded as the only person who can commence or continue legal proceedings where its legal interests are affected. This principle was adequately captured by Beck in Foss v Harbottle wherein he says – “if the corporation is a legal person separate from its members, it follows that for a wrong to be done to it the corporation itself is the proper plaintiff.”

Although the law bestows (juristic) personhood upon a company, a company is limited in that it can only protect its legal interests through the (natural) people authorized to do so. However, at times it is these very same people who are responsible for the harm caused to the company and at such times others may wish to protect the legal interests of the company. The foregoing lays the basis for foundation and development of the derivative action at “Common-Law”. Although founded in the United Kingdom, the statutory derivative action would later be established and developed outside of the UK, with the UK only incorporating a statutory derivative action provision in the Companies Act, 2006 (Part 11, Chapters 1 & 2 – Derivative claims and proceedings by members).

Ghana was the first “Common-Law” country to provide for statutory derivative action in their company laws, with comparable common-law jurisdictions like South Africa, Australia, Canada, New-Zealand and Singapore following.

First incorporated in South Africa under section 266 of the Companies Act 61 of 1973, the statutory derivative action only found application where the company itself had suffered damages or loss of faith that was committed by a director or officer of that company or by a past director or officer while such person was still in office.

The current section 165 derivative action, however, is distinctly different from its predecessor. The s165 derivative action abolishes the Common-Law derivative action (s165(1)) – where its predecessor, s266, could be read with the Common-Law. This includes partially abolishing the rule in Foss v Harbottle, with the proper plaintiff principle logically remaining as a general principle in our law.

Further, it increases the scope of persons having locus standi by giving standing to trade unions, individual directors, shareholders (in the minority and otherwise), persons to be registered as shareholders and third parties whose rights may be affected by the company’s failure to institute or continue legal proceedings i.e. creditors. Finally, it increases the scope of claims which may be instituted in the name of the company by providing that an applicant may make use of the derivative action in all instances where the legal interest of the company require protection, while its predecessor, in addition to limiting the locus standi of persons, limited the nature of claims to those which have caused the company damage or loss.

The procedure contemplated for the use of the statutory derivative action requires a party to first deliver a letter of demand to the company or its board. Thereafter, the company (or its board) may then, within fifteen (15) days of receipt of the demand, esquisse to the demand – in which instance the company shall then litigate or continue proceedings in its own name as the provisions of this section shall no longer find application due to the proper plaintiff having accordingly taken the reins of the legal proceedings.

In addition to the above the board may (within 15 days) elect to apply to court to set aside the demand only on the grounds that it is frivolous, vexation or without merit (s165(3)). The foregoing grounds are to be given their ordinary meaning and are not to be read and interpreted euisdem generis. Therefore, what is “frivolous” connotes an application characterized by a lack of seriousness; what is “vexatious” is an action which is clearly unsustainable in the circumstances and brought merely to cause frustration to the defending party; and what is “without merit” is a claim which, in the circumstances before the court, cannot succeed if leave were granted (Amdocs SA Joint Enterprise (Pty) Ltd v Kwezi Technologies (Pty) Ltd 2014 (5) SA 532 (GJ); S v Cooper 1977 (3) SA 475 (T); Bisset v Boland Bank 1991 (4) SA 603 (D); Argus Printing & Publishing Co Ltd v Anastassindes 1954 (1) SA 72 (W); Marib Holdings (Pty) Ltd v Parring NO. 2020 JDR 1576 (WCC)).

Should the company not acquiesce or apply to court to set aside the demand, it may then appoint an independent person or committee to investigate the demand. Whereafter, the company shall, within sixty (60) days of receipt of the demand, inform of whether or not it intends to commence or continue the legal proceedings or take related steps.

On the question of seeking leave, should the court find that the applicant is acting in good faith, that the proposed (or continuing proceedings) involve a trial of a serious question of material consequence to the company, and that it is in the best interest of the company for the applicant be granted leave to commence or continue proceedings (s165 (5) (b) (i-iii)) it may then, within its discretion, grant such leave to the applicant and the matter will then proceed to be heard in the name of the company.

In its current form, the statutory derivative action has been underutilized in South Africa and, as a result, understanding its use in comparable jurisdictions with similar statutory derivative action provisions, proves to be of great assistance in the interpretation and application of this provision.

The statutory derivative action requires a two-pronged approach, the first being an application to court to grant leave to the applicant and the second being the actual commencement or continuation of the legal proceedings in question.

When considering the first leg of the two-pronged approach, which concerns itself with the application for leave to the courts and the courts discretion to grant leave, an understanding of cases in comparable jurisdictions proves quite invaluable i.e. those of Canada (Ontario Business Corporations Act R.S.O 1990, c. B.16, s 246 (2)(a); s239(1) Canada Business Corporations Act R.S.C. 1985, c.C-44), the United Kingdom (s261(1) Companies Act 2006), Australia (Part 2 F1A, s237 of the Corporations Act 50 of 2001), New Zealand (s165 (1) of the Companies Act 1993) and Singapore (s216A, Singapore Companies Act). All of these jurisdictions require the leave of the court prior to a party being permitted to continue with a derivative action.

Unlike the abovementioned jurisdictions, South Africa’s section 165 derivative action shares a similarity with the US company law in allowing the board of a company the election to appoint an independent and impartial person to investigate the demand. The distinction being that the US law provides for the appointment of an independent and impartial amalgamation of directors while our South African law provides for the appointment of an independent and impartial person or committee to investigate the demand. The US law offers great guidance on issues that are to be taken cognizance of in determining what is meant by an “independent and impartial” person(s) and what level of reporting is to be expected from such a person or committee.

The plethora of case law in comparable jurisdictions on statutory derivative actions is of great assistance when considering the issues pertaining to our section 165 derivative action. Especially when one considers the provisions of section 5 (2) of the Companies Act which enables our courts to take cognizance of foreign law in interpreting and/or applying the Companies Act – where appropriate.

In conclusion, although the s165 derivative action remains underutilized in South Africa it remains a powerful tool in the law of companies and should be used with meticulous understanding and comprehension of, inter alia, its common-law foundation, how its statutory incorporation has been interpreted in comparable jurisdictions and the circumstances which may best suit its use.

Author – Irvin Lesego Moffat (Director – Corporate & Commercial)

Any Interest ?

ANY INTEREST?

The National Credit Act 34 of 2005 (“the Act”) enacted to regulate consumer credit, encompasses, defines, and regulates a wide range of credit agreements. An agreement constitutes a credit agreement in terms of the Act, if two elements are present, firstly, payment for consideration of goods or services should be deferred, secondly, a charge, fee or interest should be levied on the amount deferred.[1]

Section 8(1) of the Act further provides that a credit agreement may subsist as several different forms, including; credit facilities, credit transactions, credit guarantees and any combination of the aforementioned.[2] Section 8(4) of the Act further holds that a credit transaction may subsist as one of eight different forms including; pawn transactions, discount transactions, incidental credit agreements, mortgage agreements, secured loans, leases and any other credit agreement.[3] In this article, the focus shall be on incidental credit agreements.

What is an Incidental Credit Agreement?

In terms of section 1 of the Act, an incidental credit agreement “means an agreement, irrespective of its form, in terms of which an account was tendered for goods or services that have been provided to the consumer, or goods or services that are to be provided to a consumer over a period of time and either or both of the following conditions –

(a) a fee, charge or interest became payable when payment of an amount charged in terms of that account was not made on or before a determined period or (b) two prices were quoted for settlement of the account, the lower price being applicable if the account is paid on or before a determined date, and the higher price being applicable due to the account not having been paid by that date.”

In light of the above, it is apparent that an incidental credit agreement is a form of a credit agreement and are thus defined as credit agreements in terms of which a person or entity provides goods or services to a consumer for consideration, to be paid on a future determined date.[4] A lower amount becomes payable in the event of early settlement of an account by the client, or; a fee charge or interest is levied in the event of late settlement of the account. The fee, charge or interest being applicable also in those instances where part payment is received, and the remainder of the account remains outstanding on the due date for payment of the entire account.[5] We shall elaborate further hereunder.

When does an Incidental Credit Agreement come about?

In most instances when an incidental credit agreement is entered into it is not the outright intention of either the supplier or the consumer to enter into such an agreement. It is a consequence, or a natural result, albeit a creation of legislation, of the defaulting of timeous payment by the consumer to the supplier, therefore, the occurrence is uncertain or incidental.[6]

Section 5(2) of the Act states the following,

“The parties to an incidental credit agreement are deemed to have made that agreement on the date that is 20 business days after; (a) the supplier of the goods or services that are the subject of that account, first charges a late payment fee of interest in respect of that account; or (b) a pre-determined higher price for full settlement of the account first becomes applicable”.[7]

The above provisos contemplates that an incidental credit agreement shall be deemed to have been concluded twenty (20) business days after a credit provider charges a fee for late payment, or interest for the first time.[8]

For example, where a credit provider renders an account to a client/customer, which account is payable on 15 May 2021, failing which the credit provider shall be entitled to charge a fee or interest in the outstanding amount. Should the account remain outstanding on the aforementioned date and the credit provider charge a late payment fee or interest on 28 May 2021, the parties shall be deemed to have concluded the incidental credit agreement as at 25 June 2021, being twenty (20) business days after the date upon which the late payment fee or interest was first charged. Common examples found in practice wherein incidental credit agreements come about as contemplated hereunder include inter alia, cell phone contracts, utility bills, doctor’s and lawyer’s fees.

Some writers hold the view that although the definition of an incidental credit agreement holds that the account tendered should be in consideration of goods or services, the moment in time which these goods or services are made available to the consumer is irrelevant. These goods or services may therefore be provided to the consumer immediately, over a period, or on a future determined date.[9]

From the above, there is thus an impression created that an incidental credit provider may provide the consumer with a deferred account for goods and services which are yet to be provided.[10] The aforementioned view very seldom holds true in practice as delivery of goods, or the rendering of a service, and the obligation to pay, are inextricably intertwined.

In light of the above information, it is no wonder that the usage of section 5(2) in practice, has given rise to a plethora of perplexity as to when exactly an incidental agreement comes into existence. Two possibilities can be connoted. The possible first explanation of when an incidental credit agreement comes into effect, suggests that the agreement comes into effect 20 (twenty) business days after the date upon which the credit provider levies a late payment fee or amount of interest to the consumer, for the first time.[11] That being; the day after which the amount deferred becomes due and payable, and will conclude on the twentieth (20th) business day. The aforementioned suggests that the fact that consensus between the parties was reached in terms of the supply of the goods or services, the consideration thereof, the deferment of payment and the tendering of interest, is rendered irrelevant to the formation of an incidental credit agreement.[12] The second possible explanation suggests that an incidental credit agreement comes into effect upon the expiry of the 20 business days after the date upon which a credit provider levies a late payment fee or an amount of interest for the first time.[13]

If regard is given to the fact that goods or services were provided by a supplier to a consumer for an amount that has been deferred and interest has been levied, the aforementioned constitutes a credit agreement which complies with all the requirements prescribed by the Act.[14] It may therefore be argued that prior to the expiry of the twenty (20) business days, subsequent to the default on behalf of the consumer to satisfy the account and the levying of interest by the supplier on the outstanding amount, that a “other agreement” in terms of section 8(4)(f) of the Act is created.[15]

It is impractical to suggest that an agreement should shapeshift pending the lapse of the 20 business days.[16] Section 5(1) of the Act denotes that although the provisions encompassed in the Act are applicable to credit agreements in toto, a section 8(4)(f) “other agreement” being included in this ambit, only certain provisions of the Act are applicable to incidental credit agreements.[17] Therefore if the credit agreement is to take another form prior to the lapse of the twenty days, after which it would become an incidental credit agreement, legislative provisions would lose applicability.

In a judgment handed down by supra, Wallis J in JMV Textiles (Pty) Ltd v Da Chalalin Spareinvest 14 CC & Others,[18] where the Plaintiff argued the existance of a credit facility and the Defendant argued the existence of an incidental credit agreement, it was held that both party’s arguments were plausible, however, both arguments could not be correct, as the credit agreement cannot exist in two different forms.

Wallis J further refers to the definition of a credit facility encompassed in section 8(3) of the Act as being;

“a technical description for the purposes of a technical statute and common descriptions are not of a great assistance in construing the language of such provision.”

In light of the above, as well as the remarks made by Ngcobo J in Bato Star Fishing (Pty) Ltd v Minister of Environmental Affairs and Tourism 2004 7 BCLR 687 (CC),[19] where it was stated that regard must be had to the context in which the sentence was structured, even in instances where the construction is clear an unambiguous, when a statute to be interpreted is capable of interpretation, and such interpretation should further advance an identifiable value enshrined in the Bill of Rights,[20] it is my interpretation that the statute should be understood to reflect the fact that should the legislature have intended a shapeshifting of credit agreements before the lapse of the 20 business days, that provision for this would have been made.

Perhaps it is the intention of the legislature that the legislation be interpreted to suggest that an incidental credit agreement arises upon the default of the obligation placed on the consumer to pay the amount deferred, the levying of a charge, fee or amount of interest on this amount and the expiry of the twenty (20) days, and that prior to default of payment, that the agreement concluded is a mere purchase and sale agreement, perhaps not. In my opinion, this question remains unanswered.

The Interest?

The interest which may be levied by a credit provider in respect of incidental credit agreement is prescribed by the Minister in in terms of section 103 of the Act, by Regulations.[21] The current Regulations on rate of interest, as prescribed by the Minister is 3,5% monthly.

Does an Incidental Credit Provider have to be a Registered Credit Provider?

Section 40(1) of the Act describes the persons obliged to register as credit providers as those who have entered into at least one hundred credit agreements, other than incidental credit agreements, or those who have entered into credit agreements, other than incidental credit agreements, wherein which the principal debt owed to them is greater than the threshold encompassed in section 42(1) of the Act.[22] As is evident from the aforementioned, persons who conclude incidental credit agreements are exempt from being required to register as a credit provider, and thus, the Act has limited applicability to incidental credit providers. An incidental credit provider could however voluntarily apply to the National Regulator to be registered as a credit provider in terms of section 40(5) of the Act.[23]

Credit Facilities and Incidental Credit Agreements

A common incertitude in South African law regulating credit agreements is the distinction between credit facilities and incidental credit agreements. A credit facility is defined as a credit agreement wherein which a credit provider supplies goods or services to a consumer or pays an amount to, on behalf of or at the direction of a consumer. [24] The obligation placed on the consumer to furnish the provider with payment or re-payment of the aforementioned amounts is deferred, alternatively the consumer could be billed periodically, and a charge fee, or amount of interest, becomes payable on the amount so deferred.[25] A credit facility constitutes a credit agreement to which the Act applies wholly.[26] As a result, credit providers who enter into 100 (one hundred) or more credit facilities or to whom a principal debt exceeding the threshold prescribed by section 42(1) of the Act is owed, are obligated, in terms of section 40(1) of the Act, to register with the National Credit Regulator as credit providers.[27]

Aside from the above, the most evident distinction between these credit agreements stems from the levying of the fee, charge or interest on the deferred amount payable. As stated above, in terms of an incidental credit agreement, this fee, charge or amount of interest becomes due only when the consumer default on payment, however, in terms of a credit facility, as a term of the facility, the consumer is permitted to defer the full amount due, and make lesser payments in terms thereof, subject to the levying of interest.[28] Examples of credit facilities include credit cards, store cards and bank overdrafts.[29] Credit facilities offer loans only on a short-term basis. Usually their accounts have to be balanced within a month.

The nature of these credit agreements differ in that, there is no intention to enter into an incidental credit agreement, but it is rather a result of default, whereas a credit provider in terms of a credit facility, willingly extends credit to the consumer, who may take advantage of the credit offered subject to the payment of a charge, fee or an amount of interest.[30] There is therefore an intention on the part of the credit provider to profit from a credit facility, whereas incidental credit providers do not intend the same, their focus is on profiting from the sale of their goods or services, and utilizing the funds receipted from the charge, fee or interest levied, to compensate the loss incurred as a result of default of payment of the purchase price by the consumer.[31]

Discount Transactions and Incidental Credit Agreements

A supplier of goods or services may also provide a consumer with two accounts. Like the above, the first amount will be in consideration for the value of the goods or services provided to the consumer and will become payable on a later determined date. The second amount will also be in consideration for the value of the goods or services provided, but a fee, charge or interest will be included in the calculation of this amount. Should the consumer furnish the supplier with the funds required to satisfy the sale value of the goods or services on or before the date determined, the lower amount will become applicable. However, should the sale value of the goods or services not be satisfied on the date determined, the higher amount will become applicable.

Within the context of the South African law which regulates credit agreements, the above definition very closely resembles the definition of a discount transaction. Discount transactions are defined as credit agreements where a supplier provides goods or services to consumer over a period of time and provides the consumer with a quote for a lower price, for the instance where the account is satisfied on or before a determined date and a higher price if the account is satisfied after that determined date, or the account is paid periodically.[32] The distinction between these credit agreements is found in their nature.[33] In the case of a discount transaction, the two quotes are presented to the to the consumer from the outset, and the consumer may elect to satisfy the lower quote on or before the determined date, or the higher quote after the determined date or if the amount is to be paid periodically.[34] In the case of incidental credit agreements, as stated above, it is a credit agreement that gains existence incidentally, as a result of the charging of interest, the occurrence of which is not certain.[35] A second distinguishing factor is that in terms of an incidental credit agreement, the interest will only be levied 20 business days after higher quoted amount becomes payable.[36]

Recovery of Debt in respect of Incidental Credit Agreements

Although the Act is limited in its application in respect of incidental credit agreements, section 129 and 130 of the Act shall be applicable where an incidental credit provider wishes to recover the debt created by the agreement in the circumstances, inclusive of the interest levied, through legal proceedings.

To preemptory provision to instituting legal proceedings in this regard is a notice in terms of section 129 (read with section 130) to the debtor prior to instituting legal proceedings, wherein which the provider may propose that the consumer refer the dispute to a debt counsellor, alternative dispute resolution agent, consumer Court or Ombud having jurisdiction to either find a plausible resolution to the dispute, or to form a payment plan allowing the debt to be paid periodically.[37] This is an integral part of debt recovery before an order shall be issued by the Courts, as it forms the basis of an averment to be made for the purposes of considering a cause of action complete in the circumstances. In other words, should this recovery process not be followed the Courts shall not be placed in a position to issue the order sought.

Author : Junaid Mally (Candidate Legal Practitioner)
Reviewer : Irvin Lesego Moffat (Director Corp & Comm)

[1] Erasmus, J, The National Credit Act: discount transaction vs incidental credit agreement, South Africa Accounting & Auditing, 2013, page 1
[2] Section 8(1) of the National Credit Act, 45 of 2005
[3] Section 8(4) of the National Credit Act, 45 of 2005
[4] Aucamp, RL, The incidental Credit Agreement: A Theoretical and Practical (1) (August 1, 2013). Journal of contemporary Roman- Dutch Law, vol. 76, page 377
[5] Nagel et al, Commercial Law 5th Edition, 2015, page 297
[6] (See note 4 above) page 377
[7] Section 5(2) of the National Credit Act, 45 of 2005
[8] Reneke, S, Aspects of Incidental Credit in terms of the National Credit Act 34 of 2005, 2011 (74) THRHR page 465
[9] (See note 8 above) page 465
[10] (See note 8 above) page 464
[11] (See note 8 above) page 465
[12] (See note 8 above) page 465
[13] (See note 8 above) page 465
[14] (See note 8 above) page 465
[15] (See note 8 above) page 465
[16] (See note 8 above) page 465
[17] Section 5(1) of the National Credit Act, 45 of 2005
[18] (See note 16 above) paragraph 13
[19] Bato Star Fishing (Pty) v Minister of Environmental Affairs and Tourism 2004 7 BCLR 687 (CC)
[20] (See note 34 above) paragraphs 72,88 and 90
[21] Section 103(6) of the National Credit Act, 45 of 2005
[22] Section 40(1) of the National Credit Act, 45 of 2005
[23] Section 40(5) of the National Credit Act, 45 of 2005 Also see Collotype Labels RSA (Pty) Ltd v Prinspark CC & Others 2016 (HC) SA, paragraph 20
[24] (See note 5 above) page 297
[25] (See note 5 above) page 297
[26] JMV Textiles (Pty) Ltd v De Chalain Spareinvest 14 CC & Others 2010 (6) SA 173 (KZD), paragraph 13
[27] Section 40(1) of the Nation Credit Act, 45 of 2005
[28] (See note 16 above) paragraph 16
[29] Schraten, J, The Transformation of the South African Credit Market, 2014 (85) ISSN, page 3
[30] (See note 16 above) paragraph 16
[31] (See note 16 above) paragraph 17
[32] (See note 1 above) page 1
[33] (See note 1 above) page 1
[34] (See note 1 above) page 2
[35] (See note 8 above) page 472
[36] (See note 1 above) page 2
[37] Sections 129 and 139 of the National Credit Act, 45 of 2005