Articles

managing internal relations in a close corporation

by Nicci - Posted 09 January 2010

Starting a new business is an incredibly exciting step.  One seldom stops to consider what would happen if your relationship with your business partner deteriorates to such an extent that the continued existence of the business itself is threatened.   

I have had a number of enquiries over the past year from members of Close Corporations who, in the absence of an Association Agreement (which would have regulated a “worst case scenario” situation), find themselves in a deadlocked situation with a fellow member.

The Close Corporations Act provides for two remedies available to a member of a CC where the continuation of the business relationship becomes impossible due to the breakdown of internal relations between the members of the Corporation:

1. Section 36 makes provision for a Court to order that any member of the CC be ordered to cease his membership in the CC.    The Order can be granted on any of the following grounds:

(a)    If a member is permanently incapable, because of unsound mind or any other reason, of performing his part in the carrying on of the business of the corporation;

(b)   that the member has been guilty of such conduct as taking into account the nature of the corporation’s business, which is likely to have a prejudicial effect on the carrying on of the business;

(c)    that the member so conducts himself in matters relating to the corporation’s business that it is not reasonably practicable for the other member or members to carry on the business of the corporation with him; or

(d)   that circumstances have arisen which render it just and equitable that such member should cease to be a member of the corporation.

A member must bring the application in the High Court and bears the onus of proving that he is entitled to the relief sought.   He must place before the Court the necessary evidence not only to enable the Court to decide whether it should grant an Order, but also to make any further Order,  eg  with regards to what financial adjustments should be made.     

The Court must be satisfied that the conduct to which the member is “guilty” must be at least objectively culpable given all the circumstances and it must have a prejudicial effect on the carrying on of the business, otherwise the Court cannot intervene.   The Court determines this objectively,  i.e. can a reasonable man in the position of the other member be expected to continue to carry on the business?     

Disputes can even go as far as having nothing to do the actual running of the business, eg. one member commits adultery with the other member’s wife or the members are spouses who divorce.

2. Section 49 makes provision for a Court to make any Order it deems fit, restricting the prejudicial conduct committed to other members of the Corporation.  The grounds for such an application are:

(a)    If any act or omission of the corporation or of one or more other members is unfairly prejudicial, unjust or inequitable to him,  or

(b)   that the affairs of the corporation are being conducted in a manner unfairly prejudicial, unjust or inequitable to him. 

If the Court finds that the conduct is unfairly prejudicial, unjust or inequitable, and considers it just and equitable, the Court may with a view to settling the dispute make such order as it thinks fit, whether for regulating the future conduct of the affairs of the corporation or for the purchase of the interest of any member of the corporation by other members thereof or by the corporation. 

The application is brought by a member and he bears the onus of proving that he is entitled to the relief sought.   The conduct complained of must affect the member directly and in his capacity as such and not be a personal issue between the members outside of the corporation.  

A member must bring the application in the High Court and the Court has wider powers in this section than S36, since it can make any Order regulating the future conduct of the affairs of the Corporation, including the winding up of the Corporation. 

Prejudicial conduct is necessary in both sections, but S36 is concerned with prejudicial conduct which is contrary to the carrying on of the business of the Corporation, whereas S49 is prejudicial conduct committed against the other members of the Corporation.

 I would therefore strongly recommend that, when registering your Founding documents for the CC, an Association Agreement be prepared, which regulates the internal relations between members, so as to avoid costly disentanglement down the line.