Trading under insolvent circumstances

The new Companies Act of 2008 entails fewer criminal offences, but there is a greater risk of personal liability arising from action which contravene the Memorandum of Incorporation (MOI) of a company or contravene the provisions of the Act.

The Act further states that a company must not carry on its business recklessly, with gross negligence, with intent to defraud or trade under insolvent circumstances. (Sect 22) If a company trades in such circumstances, the Commission may require the company to cease carrying on business.

It is unclear in the Act exactly what will be defined as “trading under insolvent circumstances” but it is accepted to mean that a company does not meet the “solvency and liquidity test” criteria. There are many trading companies which are liquid, meaning they can pay their debts as they become due, but not necessarily solvent as defined in the solvency and liquidity test.

In terms of Sect 4 of the Companies Act, 2008, there is a solvency and liquidity test. Solvency relates to the assets of the company, fairly valued, being equal or exceeding the liabilities of the company. Liquidity relates to the company being able to pay its debt as they become due in the ordinary course of business for a period of 12 months.

The solvency and liquidity test applies to the following:

• financial assistance for the subscription of securities (sect 44)
• loans or other financial assistance to directors (sect 45)
• distributions to shareholders authorized by the board (sect 46)
• capitalization of shares (sect 47)
• company or subsidiary acquiring company’s shares (buy backs or buy ins) (sect 48)
• amalgamations or mergers (sect 113)

Directors (which include board members) are held personally liable to the company for various acts and omissions as set out in sect 76-77. Section 218 (2) specifies that any person who contravenes any provision of the Companies Act is liable to any other person for any loss or damage suffered as a result of the contravention. A director may be held liable to a company for any loss suffered by the company while trading under insolvent circumstances (sect 77 (3)) and may also be held liable to any third party who have had dealings with the company and suffered loss as a result of the director’s actions.