Merely belonging to a close corporation is not sufficient to hold a member personally liable for the corporation’s debts where its juristic personality is abused, the Supreme Court of Appeal (SCA) has confirmed.
The SCA’s decision – handed down on Friday – arose from a High Court order granting the provisional liquidation of a close corporation, Eastco Travel. The urgent application for the winding up of the travel agency was brought by Wynberg Boys’ High School (the first respondent in the appeal) in Cape Town.
The members of Eastco Travel (second respondent) were the appellant, Herman Mercer Crous, and his daughter, Lorraine Fourie (third respondent). Crous held 49% membership, and Fourie the remaining 51%.
Wynberg Boys’ High said it was the victim of a fraudulent scheme allegedly conducted by Fourie through Eastco. The school engaged the travel agency’s services to book flights for learners to the United States.
The judgment noted that although the school claimed Crous was complicit, it did not provide a factual basis for this assertion, relying solely on his membership of the close corporation and his supposed duties arising therefrom. The school explicitly linked only Fourie and Eastco to the scheme.
Crous submitted his involvement with Eastco was limited. In 2008, he provided financial assistance to Fourie to establish the business but ceased involvement once it began trading. He was never part of its management, nor did he receive any financial benefits. In January 2014, he submitted a resignation letter to Fourie, who agreed to remove his name from the corporation’s records. However, he discovered in June 2023 that a financier required his signature when Fourie told him she had applied for a loan to assist Eastco.
Crous did not deny the allegations against Fourie and Eastco, but he denied abusing the close corporation’s juristic personality Crous said he had not been aware of any wrongdoing, and if he had, he would have intervened to prevent the misappropriation of funds.
The SCA’s judgment pointed out there is no provision in the Close Corporations Act in terms of which a member can “resign” from a close corporation. A member can disassociate him- or herself from a close corporation by disposing of his or her membership. Therefore, Crous’s letter purporting to resign from Eastco was legally ineffective, and he was, at all material times, a member of the close corporation.
High Court’s decision
The High Court in Pretoria found it was immaterial that Crous had not contributed to the abuse. As long as he remained a member, he had a fiduciary duty to ensure that the close corporation was run in a manner that was not detrimental to members of the public.
The Court declared the close corporation not to be a juristic person for its liability towards the school. It found that Crous and Fourie had abused Eastco’s juristic personality. Accordingly, the Court ordered Crous and Fourie, jointly and severally, to pay the school R638 880, and the costs of the application.
In his appeal to the SCA, Crous submitted that his mere membership of Eastco was not sufficient to impute liability to him for the alleged fraudulent scheme conducted through the corporation.
Exceptions to the default position
The SCA considered the relevant provisions of the Close Corporations Act. It observed that the default position is set out in section 2(3) under Part I of the Act, which provides that the members of a corporation shall not merely by reason of their membership be liable for the liabilities or obligations of the corporation.
The exceptions to the default position are set out in sections 63, 64, and 65 under Part VIII. The judgment emphasised that the exceptions to section 2(3) carved out by the provisions in sections 63, 64, and 65 require active participation in the impugned conduct to justify personal liability.
Under section 63(a), liability is limited to members who authorised or knowingly permitted the omission of the “CC” abbreviation from the corporation’s name. Similarly, section 64 imposes liability only on those who knowingly participate in reckless, grossly negligent, or fraudulent business practices.
Section 65: gross abuse
The judgment focused on section 65, which was central to the case, because the school sought to impute liability to Crous under this provision.
The SCA said section 65 provides for personal liability of members where there is “gross abuse” of the juristic personality of the corporation as a separate entity. Under those circumstances, the court may declare that the corporation is to be deemed not to be a juristic person in respect of such rights, obligations or liabilities of the corporation, or “of such member or members thereof, or of such other person or persons, as are specified in the declaration, and the court may give such further order or orders as it may deem fit in order to give effect to such declaration”.
The judgment noted that for liability to be imposed under section 65, a member or person’s conduct “must amount to gross abuse of the juristic personality of a close corporation or contributed thereto. It is not enough that they were members of the close corporation. Thus, the participation in the actual impugned conduct is required.”
The High Court had accepted Crous’s uncontroverted evidence that he was not a party to the gross abuse of Eastco’s juristic personality. Despite this, it held that his mere membership of the close corporation was sufficient to impose liability under section 65. The SCA explicitly rejected this reasoning.
Fiduciary duty limited to the CC
The SCA also rejected the High Court’s conclusion that the mere membership of a close corporation imposes a fiduciary duty on a member to ensure that its affairs are managed in a manner not detrimental to members of the public.
The SCA pointed out that the fiduciary position of members is regulated in sections 42 to 52 of the Act. Section 42 provides that each member of a corporation shall stand in a fiduciary relationship to the corporation. The Court held this clearly limits the fiduciary duty of members to the close corporation, and a member does not owe any fiduciary duty to external parties.
The High Court’s imposition of liability on Crous based on a supposed fiduciary duty to the public was therefore incorrect, because it misconstrued the legal framework governing members’ responsibilities under the Act.
Accordingly, the SCA upheld Crous’s appeal and ordered Wynberg Boys’ High to pay the costs of the appeal.
It also set aside the impugned part of the High Court’s order and replaced it with one in terms of which the application against Crous was dismissed with costs. Instead, Fourie alone was liable to pay the R638 880 to the school.
