The High Court in Hlumisa Investment Holdings (RF) Limited and Another v Kirkins and Others (Hlumisa judgment), was recently tasked with considering whether shareholders are empowered to hold directors liable, in terms of section 218(2) of the Companies Act, 71 of 2008 (Companies Act), for conduct which results in a decrease to the share price. Although the Hlumisa judgment also concerned the conduct of auditors and holding the auditors liable for such conduct, this article does not seek to elaborate on those points.
The plaintiffs, in this instance, were shareholders of African Bank Investment Limited (ABIL), a subsidiary of African Bank Limited (African Bank), which carried on the business of a bank. The plaintiffs instituted action against the directors of ABIL, on the basis that, among others:
(i) certain financial statements and a prospectus contained false and/or misleading financial information; and
(ii) the directors failed to vote against the provisions of loans by African Bank in circumstances where the directors knew that the recipient would be unable to repay the loans, which was in contravention of section 45 of the Companies Act.
The plaintiffs accordingly alleged that the directors conducted the business of ABIL and African Bank recklessly, in contravention of section 22(1) of the Companies Act, thus amounting to a breach of section 76(3). The plaintiffs alleged that the breach of these provisions resulted in significant losses on the part of African Bank and ABIL, which in turn caused the share price of ABIL to drop substantially. The plaintiffs contended that in terms of section 218(2) of the Companies Act, the directors were liable to compensate the plaintiffs for the loss they suffered as a result of a diminution in value of their ABIL shares.
The directors of ABIL took exception to the plaintiffs' claim on the basis that, among others, the claim against the directors lacked averments necessary to sustain a cause of action.
Section 218(2) of the Companies Act provides:
"Any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention".
In interpreting section 218(2) of the Companies Act, the court held that although the section is widely worded, this section requires a particular person to have suffered damage as a result of a particular contravention, in order to be able to invoke a claim for the damage as a result of the contravention. The court's sentiments in the Hlumisa judgment were that losses to a share price are merely a reflective loss, which loss is actually suffered by the company, who would be the proper plaintiff in the circumstances to bring such a claim against the directors who breached the provisions of the Companies Act.
The court noted that, based on the common law principles of statutory interpretation, a specific remedy should be followed in preference of the general remedy. Accordingly, the specific remedy provided for in section 77 of the Companies Act, catering for contraventions of section 76(3), should be followed in preference of the general remedy of section 218(2) of the Companies Act.
The court held, however, that even if the plaintiffs could advance a claim for a breach of section 76(3) of the Companies Act under section 218(2), they would be required to show that section 218(2) has altered the common law to allow a reflective loss. The court went on to note that there is nothing contained in section 218(2) to indicate that the legislature intended to alter the common law and to allow reflective loss claims to be brought under this section.
The court cited the decision of Itzikowitz v ABSA, which held that one of the principles underpinning the reflective loss doctrine is that in law a company has a separate legal personality distinct from its shareholders. This decision stated that a loss to the company, which causes a fall in the share price, is not a loss to the shareholders and that the shareholders cannot be said to have suffered a loss as a result of a breach of the duties owed to the company, simply as a result of the share price falling.
In light of the points which the court in the Hlumisa judgment noted, as elaborated above, the court accordingly upheld the exceptions of the directors and dismissed the plaintiffs claim against the directors for the loss suffered as a result of the decrease in the share price.
In light of the Hlumisa judgment, shareholders should be mindful of their lack of capacity to bring a claim for "reflective losses" due to directors breaching the Companies Act, resulting in a decrease in the share price of the company. Furthermore, shareholders should be mindful that our courts have held that decreases in the share price of a company are not regarded as losses being incurred by the shareholders, but are rather losses incurred by the company and are merely reflected in the share price. The Hlumisa judgment has accordingly set down an important precedent in terms of the applicability of section 218(2) of the Companies Act to such claims for reflective losses and has sought to reaffirm the trite principles of statutory interpretation in South African law.
By John Bell, Partner, Rui Lopes, Associate and Michael Collett, Candidate Attorney, Dispute Resolution, Johannesburg