Legal opinion: Security and dispositions without value

by Ofentse Sefolo
Legal opinion: Security and dispositions without value

Comparing Covid-19 to fighting a war is not a stretch of the imagination. Much like after a time of war, the effects linger much longer than the war itself. As Betrand Russel said, “War does not determine who is right – only who is left.” And it is up to those who are left, to rebuild, rehabilitate and adapt.

This pandemic has seen many businesses close, with countless jobs lost and livelihoods threatened as the fight to save lives has meant sacrifices on the global economic front. As with war, positive outcomes will emerge. Covid-19 has demanded urgent efforts with high stakes and has united people across the globe, showing the demand to effect social change and the advancement of technologies in a very short space of time.

Many industries are moving out of their Covid slump and into a more functional economy almost unscathed. However, the struggle to deal with the Covid hangover has affected both business and the economy, with many businesses needing to consider drastic measures. It is important to consider the implications of these actions as these, like war, can have long lasting effects.

It is with this in mind that we need to consider inter-group provision of security and dispositions without value. Creditors being offered financial assistance by inter-group companies should be cautious, as the aid could be regarded as dispositions and could possibly be set aside. Gearing up to weather the effects of this storm, we need to be mindful of our actions by ensuring that we are within the parameters of the law and that we follow good practice.

According to the firm of attorneys, Cliffe Dekker Hofmeyr (CDH), guarantees, indemnities and suretyship agreements all fall within the ambit of a disposition and are subject to section 26 of the Insolvency Act, 1936. A disposition without value is any transfer or disposal of a right to property, excluding those mandated by a court order, for no value or for a consideration less than the risk incurred by the insolvent in the relevant transaction. The Court has the discretion to set aside a disposition without value if it can be proved that immediately after the disposition, the insolvent’s liabilities exceeded its assets.

A liquidator may apply to the High Court to have a disposition made for no value set aside if the disposition in question was made by the company (i) more than two years before its liquidation and it can be proved that the company’s liabilities exceeded its assets at the time of the disposition, or (ii) within two years of the liquidation of the company and the person who benefited from the disposition cannot prove that the company’s assets exceeded its liabilities immediately after the disposition. Whether a disposition is made for no value turns or whether the insolvent company obtained a benefit from making final determination.

In the case of Langeberg Koöperasie Bpk v Inverdoorn Farming 1965 (2) SA 597 AD (Langeberg), it was stated that the test for whether a disposition is made for value is whether it can be fairly said that the person providing a guarantee, indemnity or suretyship received an adequate return for making the disposition under the circumstances. In Umbongintwini Land and Investment Co (Pty) Ltd (In Liquidation) v Barclays National Bank Ltd and Another 1987 (4) SA 894 (AD), the test for whether a disposition was made for value is whether there was a genuine commercial transaction with the expectation of some advantage at the time the transaction was entered into, which is equal to or more than the risk incurred by the party providing the security.

An issue arises where a company provides security through a guarantee, indemnity or suretyship for the obligations of another company in the same group of companies. If there is no direct or indirect benefit for the company providing the security and their liabilities exceed their assets immediately after the disposition, the security agreement may be set aside and the entity in whose favour the security was given, will no longer have a claim against the company in liquidation. A consideration accepted by our courts is the financial stability of the group of companies. However, there is no rule of general application in our law that providing security for another company in the same group of companies is a disposition made for value.

In the Langeberg case, a subsidiary bound itself as surety and co-debtor for the debts of its parent company and registered a mortgage bond in favour of its parent’s creditor. The liabilities of the company were greater than its assets immediately after it registered the mortgage bond. The company argued that the value it received was avoiding its own liquidation because the liquidation of its parent company would ultimately result in the liquidation of all its subsidiaries. The court found that by providing security to its parent company, the company had placed itself in a position where it was unlikely to be able to pay its debts. Therefore, the risk incurred by the company was greater than the advantage received. The court held that the disposition was not made for value and the suretyship and mortgage bond were set aside.

During these tumultuous and challenging times we find ourselves in, a company may want to offer security to another group company to assist the particular company with weathering the COVID-19 storm and for the particular company to avoid becoming financially distressed or eventually being liquidated. Creditors must carefully consider these acts of kindness, as they may constitute a disposition that may be set aside. A creditor may accept security from a company thinking that its rights are fully secured, only for the creditor to find itself in a position where the security agreement is set aside and the creditor in whose favour the security was given no longer has a claim against the company in liquidation. We recommend that should a creditor be considering taking certain security for its claim against a particular company, that the creditor first consults with an attorney to ensure that the correct steps are taken, that the creditor’s rights are fully protected and that the creditor is not exposed to a situation where the security agreement is set aside, leaving the creditor in a worse off position.

With thanks and acknowledgement to Ludwig Smith and Kylene Weyers of Cliffe Dekker Hofmeyr Legal for the information contained in this article.

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