Liability of directors of an incorporated law practice

July 1st, 2017
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By the Prosecutions Unit of the Attorneys Fidelity Fund

There are conflicting views among legal practitioners as to whether the directors of an incorporated legal practice are liable for the debts and other liabilities of the practice or not. This difference of opinion is more accentuated in the case where one of the directors misappropriates or steals money from the firm’s trust account. As far as criminal liability is concerned it is obvious that only the perpetrator of the crime and anyone who aids and abets him in the commission of the crime will be liable for criminal prosecution. The innocent director or partner cannot be held criminally liable. In the context of an attorney’s practice where one of the directors steals trust funds, it will be difficult, if not impossible, to establish vicarious criminal liability on the part of the innocent director who knows nothing about the theft. The position is different with regard to the civil liability of the directors in an incorporated legal practice. Attorneys often ask how they can be held liable to repay the trust funds stolen by one of their co-directors when they were not even aware that the latter was stealing the money. In a law firm with two or more directors and where each director operates and controls his ‘own’ trust bank account, the argument often advanced is that the director whose trust account incurs a deficit should alone be held liable to repay the missing funds. This argument sounds very persuasive, but is it tenable? Are the directors of an incorporated legal practice personally liable for the debts and other liabilities of the practice? If so, to what extent and under what circumstances are they liable? This article deals with the civil liability of the said directors and will provide answers to the questions raised above.

Legislation

Section 23(1)(a) of the Attorneys Act 53 of 1979, as amended, permits a private company to conduct an attorney’s practice. The said section provides that a company may conduct a practice if such a company is a ‘personal liability company’ contemplated in the Companies Act 71 of 2008 (the Companies Act). A personal liability company is defined in the Companies Act as a profit company that meets the criteria of a private company and whose Memorandum of Incorporation states that it is a personal liability company (s 8(2)(c)).

Section 19(3) of the Companies Act provides that: ‘If a company is a personal liability company the directors and past directors are jointly and severally liable, together with the company, for any debts and liabilities of the company as are or were contracted during their respective periods of office’. This section creates a statutory liability, which is intended to protect the company’s creditors. It is also important to note that a director’s liability is limited to the company’s contractual debts and liabilities incurred during the director’s term of office. It follows, therefore, that any debts or liabilities, which do not arise out of a contractual relationship with the company, will not be imputed to the directors and former directors of the company even if such debts and liabilities were incurred during the directors’ terms of office. This aspect will be discussed further below with reference to theft of trust funds.

Joint and several liability

Section 19(3) of the Companies Act further provides that the directors are jointly and severally liable, together with the company, for the debts and liabilities of the company. This means that the directors are jointly and individually liable to pay the contractual debts and liabilities of the company. Thus a creditor will be entitled to pursue any one of the directors to recover the full amount of the debt. A director who pays the debt or liability has a right of recourse against each of his fellow directors for their proportionate share of the debt. Where a creditor elects to recover the full amount of the debt from only one of the directors, such a director cannot complain about the creditor’s decision not to pursue his fellow directors for payment.

The company does not have a right of recourse against the directors if it pays the debt or any portion thereof. The liquidator of the company will also have no right to institute proceedings against the directors to recover the amounts of claims proved in the winding- up (see Maritz and Another v Maritz and Pieterse Inc (SCA) (unreported case no 175/2004, 30-5-2005) (Heher JA) .

Case law

In Laniyan v Negota SSH (Gauteng) Incorporated and Others [2013] 2 All SA 309 (GSJ) the court considered the provisions of s 53(b) of the Companies Act 61 of 1973 (the 1973 Act), a precursor to the current s 19(3) of the Companies Act, read with s 23(1)(a) of the Attorneys Act, as well as s 19(3) of the Companies Act. The prominent facts of this case are briefly as follows: The applicant purchased an immovable property in terms of a written sale agreement. The first respondent, an incorporated law practice, was appointed as the seller’s attorneys. The agreement further stipulated that the applicant should deposit the full purchase price into the first respondent’s trust bank account and that the money should be invested in an interest bearing account for the benefit of the applicant pending the transfer of the property into his name. The fourth respondent, one of the directors of the firm, misappropriated the entire purchase price. The applicant sought the final liquidation of the firm and an order that the four directors of the firm are personally liable to repay the stolen funds in terms of s 53(b) of the Companies Act read with s 23(1)(a) of the Attorneys Act.

The essential question was whether there was a contractual relationship between the applicant and the seller’s attorneys (the firm). In other words, was the firm acting as an agent for both the applicant and the seller in dealing with the property transaction? The court had to decide whether the applicant was the creditor of the firm and whether the relationship was contractual. The court found that the firm was the applicant’s agent based in his mandate to invest the money in an interest bearing account and then pay the money out on registration of transfer. The court further decided that the nature of the applicant’s claim against the firm was contractual and that applicant was the firm’s creditor. The firm, as transferring attorney, accepted payment from the applicant of the purchase price, which was to be deposited and invested in trust and paid out on behalf of the applicant. In so doing, the firm assumed a contractual obligation as the applicant’s agent. As such, a contractual claim arises against the respondents in terms of s 53(b) of the Companies Act.

The court also referred to Fundtrust (Pty) Ltd (In liquidation) v Van Deventer 1997 (1) SA 710 (A) in which Hefer JA held that the word ‘contracted’ referred only to contractual debts and liabilities of a company. The judge also held that this limited interpretation of the word ‘contracted’ should not lead to the anomalous result that directors would be liable for a contractual debt owed to the company but not for money stolen from such creditors.

In view of the aforegoing, the court in the Laniyan case dismissed the respondents’ argument that the applicant’s claim was not based in contract. The four directors were thus held personally liable and were ordered, jointly and severally, together with the company, to repay the stolen money. The respondents had initially argued – which argument was subsequently abandoned – that they were not aware of the theft of the money by one of the directors. In this regard, Weiner J remarked that the respondents’ ignorance provides no defence to their personal liability in terms of s 53(b) of the Companies Act.

Conclusion

It is clear from the aforegoing discussion that the directors and former directors of an incorporated law practice are liable, jointly and severally, together with the company, for the debts and liabilities of the company contracted during their terms of office. The discussion has also highlighted the fact that where one of the practitioners misappropriates trust funds, all the practitioners who were the directors of the law practice when the funds were misappropriated will be liable to repay the stolen funds. A director’s ignorance of what is happening in the firm’s trust account will not serve as a basis for him or her to escape liability in the event of theft of trust money by his co-directors.

There should be increased vigilance on the part of practitioners in order to prevent the risk of trust funds being misappropriated. It is not prudent for the firm to permit a situation where a particular director has unfettered and exclusive control of the firm’s trust account. The existence of several trust accounts in the firm does not only cause administrative and accounting problems for the firm, but also provides fertile ground for the misappropriation of trust money. It will amount to gross negligence on the part of a director who does nothing to monitor the activities of his or her co-director especially where trust money is concerned. This may also amount to a breach of the director’s statutory duties as codified in s 76(3) of the Companies Act.

Furthermore, it is imperative for practitioners to introduce measures designed to curb rampant theft of trust money. This will include keeping proper accounting records and adhering to the rules governing trust accounts.

The Prosecutions Unit of the Attorneys Fidelity Fund is situated in Centurion.

This article was first published in De Rebus in 2017 (July) DR 18.

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