The Supreme Court of Appeal (SCA) in CDH Invest NV v Petrobank South Africa (Pty) Ltd and Another, was recently tasked with considering the validity of a written resolution passed by the majority of a company’s directors, in terms of section 74 of the Companies Act of 2008 (Companies Act), where the underlying intention of passing that resolution was misrepresented to the other directors.
In this instance, CDH Invest NV (CDH) and Amabubesi Investments (Pty) Ltd (Amabubesi) established a partnership vehicle called Petrotank South Africa (Pty) Ltd (Petrotank), which manufactured steel and petroleum storage tanks. CDH and Amabubesi therefore held all the shares in Petrotank, amounting to 100,000 shares, in a 60/40 split respectively. Accordingly, CDH was the majority shareholder and was entitled to appoint three directors to the board of Petrotank, whereas Amabubesi, as the minority shareholder, was entitled to appoint two directors to the board.
Due to an inadvertent error on the part of the individual responsible for the incorporation of Petrotank, the Memorandum of Incorporation (MOI) of Petrotank recorded that it had an authorised share capital of 1,000 and not 100,000. Both CDH and Amabubesi were, at all material times, unaware of this error.
After some time, one of the directors of Petrotank noted the error and addressed an email to the directors notifying them of the fact that Petrotank may be in contravention of the Companies Act, as there were more shares in issue than have been authorised and that such needed to be rectified. Attached to this email was a round robin resolution, in terms of section 74 of the Companies Act. The round robin resolution provided that the company was to increase the number of authorised shares to 1,000,000 ordinary no par value shares, in terms of section 36(2)(b) and (3) of the Companies Act, and that the MOI be amended to reflect same in terms of section 16(1)(b) of the Companies Act.
One of the directors appointed by Amabubesi objected to signing the written resolution as they wanted an investigation as to why the MOI was incorrectly reflecting the amount of authorised shares. Additionally, the director proposed an amendment to the resolution in order to reflect that the authorised shares would be increased to 100,000 and not 1,000,000.
Despite this director’s objection, the three directors appointed by CDH signed and passed the round robin resolution, thereby ignoring the director’s request. Accordingly, the amendment to Petrotank’s MOI was filed with the Companies and Intellectual Property Commission on 21 July 2014.
Amabubesi was, at all material times, unaware of the passing and registration of the resolution and was of the incorrect belief that the matter had been resolved. Additionally, CDH offered no explanation as to why it failed to have any regard to the objections raised by the director appointed by Amabubesi.
After some time, CDH sought an order in terms of section 61(12) of the Companies Act, directing the board of directors of Petrotank to convene a shareholder’s meeting for purposes of considering a pro rata rights offer of 98,835 ordinary no par value shares, which was then challenged by Amabubesi upon becoming aware of what had unfolded.
The High Court found that the resolution was invalid. This was because the three directors that had signed the resolution had breached the fiduciary duty owed to the company. In terms of this duty, it was required that the power to increase the authorised shares be done in good faith and in the best interests of the company, which is a subjective test, and for a proper purpose, which is an objective test.
The High Court held that these directors failed on both the subjective and objective tests. In terms of the first leg, the motivation provided for the resolution was a devious misrepresentation as it failed to offer any justification for increasing the authorised shares to 1,000,000 as opposed to 100,000. Secondly, this resolution was not proposed and passed for a proper purpose. The High Court’s declaration of invalidity had the consequence of there being no additional authorised shares that could be utilised to conduct a rights offer. Unsatisfied with the decision, CDH appealed to the SCA.
On appeal, the SCA agreed with the line of reasoning of the High Court. The SCA held that section 36(2)(b) and (3) of the Companies Act was starkly different to section 75 and 221 of the 1973 Companies Act. In terms of the 1973 Companies Act, it was provided that a company was only entitled to increase its shares by means of a special resolution and that the directors required the company’s prior approval at a general meeting before allotting or issuing the shares. Comparatively, section 36(3) of the Companies Act provides that a company’s shares can be increased or decreased by the board of a company, save to the extent that the MOI provides otherwise.
The SCA noted that the conduct of the directors clearly amounted to a misrepresentation and an obscuring of the real/true purpose behind the resolution and that they failed to adhere to the good faith requirement of directors conduct in terms of section 76(3) of the Companies Act. Accordingly, the appeal was dismissed.
Although there is much argument to be made that this case should not have been permitted to go to the SCA (when considering the clear cut nature of the decision of the High Court), this decision has provided much needed clarity and certainty on the interpretation of section 74 of the Companies Act, which is now binding on all divisions of the High Court in South Africa.
Companies are therefore advised that (i) a round robin resolution must be clear in what its intended purpose is, (ii) directors must be aware of the two-pronged test when these resolutions are pass so as to ensure that they abide by their fiduciary duties; and (iii) the result of a failure to abide by directors’ fiduciary duties will lead to a declaration of invalidity of the resolution.
