When investigating professional indemnity (PI) claims, the team at the Legal Practitioners Indemnity Insurance Fund NPC (LPIIF) has encountered instances where legal practices have either:
(a) purported to continue operating as such after the demise of a sole director of an incorporated practice; or
(b) purported to be established/constituted as private companies which are neither a public company, rather than personal liability companies, in terms of the Companies Act 71 of 2008; or
(c) been constituted as partnerships of incorporated companies.
In this article, I:
This section of the article considers the legal consequences flowing from the death of a sole director of an incorporated legal practice. This question has an important bearing on the practice’s liabilities after the passing of the sole director and whether the entity is still authorised to conduct legal practice. Those liabilities, for example, might be the payment of a deductible to a claimant in the event of a successful professional indemnity claim against the practice.
Section 34 of the Legal Practice Act 28 of 2014 (the Act) sets out the statutory framework for the types of legal practice permitted in South Africa. These include incorporated legal practices. The incorporated legal practice is conducted through what the Act refers to as a commercial juristic entity (s 34(7)). This is a company established in accordance with the provisions of s 8(2)(c) of the Companies Act. Under the Companies Act, such an entity-practice is a private company whose memorandum of incorporation states that it is a personal liability company. Section 34(7)(a) of the Act prescribes that only attorneys can be the shareholders, partners, or members of such commercial juristic entity. Such an entity is also a profit company. The terms ‘personal liability company’ and ‘incorporated company’ are used interchangeably in this article.
A sole director of an incorporated legal practice would be the only shareholder or member. In terms of s 66 of the Companies Act, ‘the business and affairs of a [personal liability] company must be managed by or under the direction of its board’. The authority and powers to perform the functions of the company, therefore, vest in the board. Subsection 66(2) stipulates that the board of a personal liability company must comprise of at least one director. It is, therefore, legally permitted for an entity to have only one director. Such a director can also be the sole shareholder of the company.
The question then arises as to what happens to the company in the event of the death of such a sole shareholder and director. The immediate logical consequence and implication is that the company’s board ceases to exist. The next implication is that the company cannot perform its functions in the absence of its board. There would be no authority available to make decisions on behalf of the company. The resultant problems can manifest in several ways, such as the negative impact on the continued operations of the company, including the freezing of the company’s bank accounts, non-payment of creditors and employees’ salaries. The Western Cape High Court was called on to consider this issue in the matter of Ellis v Saga Wine Farms (Pty) Ltd and Others (WCC) (unreported case no 4469/2014, 4-4-2014) (Dlodlo J). Dlodlo J (as he then was) was faced with an application by Mr Daniel Ellis who was a financial manager of the applicant to be appointed as an interim receiver to take control of the business of Saga Wines pending appointment of the executor of the estate of Ms Roza Galimovna Sagazidinov, the sole director and shareholder of Saga Wines Proprietary Limited.
The court (at para 8 of the judgment) dismissed the application on the basis that the relief sought was incompetent because it sought to give Mr Ellis the power to conduct the affairs of the company –
‘(a) without regard for the provisions of the Companies Act, 2008 or the Articles and Memorandum of Association … ;
(b) in a manner not provided for or envisaged in either the Companies Act, 2008 or the Articles and Memorandum of Association … ;
(c) without the applicant being a director …; [and]
(d) without regard for the rights of the shareholder … , which is the deceased estate of the late [Ms] Roza and in whose deceased estate dominium in respect of the shares of the company vests’.
It is instructive that the court stated that the right of ownership and control (dominium) of the shares of a company belonged to the deceased estate. The implication of this is that the estate (represented by the executor/executrix) is the only authority that may determine the continued existence of the company in such circumstances. In the absence of the executor/executrix appointed in terms of the Administration of Estates Act 66 of 1965, to which the court made pertinent reference, it seems that the affairs and operations of the company are halted pending the appointment of the executor/executrix for the deceased estate.
The Chancery Division of the High Court of England and Wales was also called on to consider a similar question in the matter of Kings Court Trust Limited and Others v Lancashire Cleaning Services Limited [2017] EWHC 1094 (Ch). The company, Lancashire Cleaning Services Limited, ran the risk of not being able to pay its creditors, including Value Added Tax (VAT) due and the company’s employees after the death of its sole director and shareholder, Mr Pilling. It had also received an offer for the purchase of its business, which offer would be at risk if it could not be accepted. To his credit, the deceased, Mr Pilling, had executed a will in which he appointed three co-executors and trustees of his estate. He was the sole shareholder and director of Lancashire Cleaning Services Limited during his lifetime. The company did not have any surviving director or a company secretary either. An application was brought to appoint a director to take control of the company but the executors who could, with required authority, action such a step had not yet been properly appointed as such.
The court granted the application after it found the circumstances of the case to be exceptional. It seems that the existence of the will saved the day for the applicant in this matter. In para 16, the court stated the following:
‘In my judgment, in the exceptional circumstances of this case, it does seem to me that unnecessary delay is taking place in entering the names of the named executors on the company’s register of members. The company is presently completely directionless, with no officer capable of acting on its behalf. It is only the court that can rectify that situation by ordering rectification of the register. Normally the company should await the grant of probate; but, in this case, it may be too late for company if it does.’
It seems that if the deceased had not left an appropriately drafted will, the situation would have been different (see also Shandu Attorneys ‘Business continuity risk – death of a company’s sole shareholder and sole director’ (https://shanduattorneys.co.za, accessed 7-3-2022)). The result would probably have been like that which resulted in the South African judgment in the Saga Wine Farms Proprietary Limited matter.
It appears that a memorandum of incorporation can include a provision detailing how the shares of a company with a sole director can be devolved. Rosie Todd argues that succession planning can be managed by having a will in place in which the sole director directs who the shares of the company should pass on to upon their death (Rosie Todd ‘How to prepare for the death of a sole director and shareholder’ (www.stevens-bolton.com, accessed 7-3-2022)). However, it should always be kept in mind that, in terms of s 34(7) of the Act, the shares of an incorporated legal practice cannot be held by persons who are not practising legal practitioners. It is also important to note that s 33(2) of the Act provides that ‘no person other than a legal practitioner may hold himself or herself out as a legal practitioner or make any representation or use any type or description indicating or implying that he or she is a legal practitioner.’ Section 33(3) provides that ‘no person may, in expectation of any fee, commission, gain or reward, directly or indirectly, perform any act or render any service which in terms of any other law may only be done by an advocate, attorney, conveyancer or notary, unless that person is a practising advocate, attorney, conveyancer or notary, as the case may be’.
In answering the question whether an incorporated personal liability company ceases existing and/or operating on the death of its sole director, one should not lose sight of the fact that as a company, an entity, has its own legal personality separate from its shareholders or incorporators. Such separate legal personality enables the company to survive the death of its directors and/or shareholders. The challenge faced by that the entity on the death of its sole director is that it would not be able to comply with the requirement of s 66(2)(a) which requires it to have at least one director. Failure to have a will in place might have an effect that the operations of the company are suspended pending the legal process of passing its shares to the person or legal entity that can legally conduct the operations of the company.
A practice has been noted where the Legal Practice Council (the LPC) appoints a ‘caretaker’ of the practice on the death of the sole director of the practice. I do not know what the duties of such a caretaker are, or what they entail. It is also not known, at this point, which section of the Act gives the LPC such powers. It must be noted that the article does not, in anyway, intend to criticise the LPC for adopting such a practice, nor does it intend to take a stand for or against such practice.
Your succession planning must include a consideration of what will happen to your practice in the event of your passing.
Clause 6 of the Master Policy provides that the cover is provided to the legal practice itself. The Master Policy indemnifies only the following types of legal practices:
‘(a) a sole practitioner;
(b) a partnership of practitioners;
(c) an incorporated legal practice [that is, a commercial juristic entity] as referred to in section 34(7) of the Act; or
(d) an advocate referred to in section 34(2)(b) of the Act’.
For purposes of this policy, an advocate referred to in s 34(2)(b) of the Act, will be regarded as a sole practitioner, who can only practice for their own account. It should be noted that such advocate cannot practise in the form of a commercial juristic entity as s 34(7) of the Act restricts such entity’s shareholding or membership exclusively to attorneys. Section 34(6)(a) states that an advocate in private practice can only do so for their own account. It is also important to note that such an advocate has a limitation in that they cannot practice as a conveyancer or a notary. The respective definitions of a conveyancer and notary (s 1 of the Act) exclude an advocate.
Some legal practices have formed private ((Pty) Ltd) companies to handle, on behalf of the legal practice, areas of work such as deceased estates, liquidations, tax related work etcetera. While the principals of the legal practice would, simultaneously, be the directors of such (Pty) Ltd entities, the work would exclusively be carried out in the name of the (Pty) Ltd entities. The (Pty) Ltd may even have an identical or similar name to the legal practice itself with which it shares premises. If any professional errors or omissions were to be committed by such entities, the LPIIF’s professional indemnity policy would not cover such claims as the entity would not be covered as an insured in terms of clause 5 of the policy.
An argument may be raised that the Act does not define a commercial juristic entity the reference to which is made in s 34(7). Such lack of definition, an argument may proceed, therefore means that any form of company can be included in the term ‘commercial juristic entity’, including a company incorporated as a (Pty) Ltd. While it is true that the Act gives a definition, it should be noted that s 34(7)(c) requires that the founding documents of such an entity should stipulate that all members or shareholders, past and present, of the entity bear joint and several liability together with the entity concerned. In this regard, s 8(2)(c) of the Companies Act also stipulates that the memorandum of incorporation must state that it is a personal liability company. It should be noted that the directors and/or shareholders of a (Pty) Ltd company, on the other hand, do not ordinarily bear joint and several liability for the debts and/or liabilities of the entity. They are, therefore, excluded because they would not meet those stringent requirements. The officers of the company would, therefore, have to consider purchasing relevant professional indemnity and directors’ and officers’ liability cover on the open market, and independently of the LPIIF.
In one known case, the legal practice was conducted in the form of a (Pty) Ltd entity. It is irrelevant whether the practitioner concerned was unaware that a legal practice could not be conducted under such an entity. The professional indemnity policy is clear in this regard. The Master Policy will, unfortunately, not indemnify such a practice in the event of a professional indemnity claim against it.
In another known case, incorporated practices came together to form a partnership for purposes of conducting a legal practice. During the existence of this practice, constituted by the incorporated practices, a claim arose. The ‘legal practice’ applied to the LPIIF for the provision of indemnity for that claim. The LPIIF successfully rejected the claim on the basis that the legal practice so constituted was not an insured as defined in the policy and that the legal practice was not conducted in accordance with the Act.
Finally, it should be noted that clause 16(t) of the Master Policy provides that any claims ‘arising out of or resulting from legal services carried out in violation of the Act and the Rules’ will be excluded. Practising in the form of an entity that violates the provisions of the Act and the Rules will trigger the exclusion referred to in this clause.
Sithembinkosi Joseph Kunene BProc (UNIZULU) MBA (Wits Business School) is the Claims Executive at the LPIIF.
This article was first published in De Rebus in 2022 (April) DR 5.
