The Companies Act vs The Companies and Other Business Entities Act: A comparative analysis vis a vis The protection of corporate creditors in Zimbabwe

 

Introduction

 

One of the most troublesome of questions in company law is how company law should try to balance the legitimate main concern of shareholders, that they will be able to realise a return on their investment, with the chief concern of the creditors, that the board of directors, elected by the shareholders, will, especially if the directors see the company in trouble, drain it of funds and other assets, through dividends, share repurchases or otherwise, leaving insufficient assets to pay the creditors debts. The previous regime, as provided for in the old Companies Act, (Capital Maintenance Regime) was initially developed by the courts and the general principle established by the cases may be stated as requiring that a company with a share capital is bound to obtain a proper consideration for the shares which it issues and refrain from handing back any or all of the fund so acquired to its members except by a lawful distribution of profits or a lawful reduction of capital. The purpose of the legal rule is primarily to protect the creditors of a company limited by shares, whose existence is of course quite independent of any individual members of it, so that the creditors can be sure that there is something they can look to for the payment of their debts. The Capital Maintenance rule has however failed to provide adequate protection to creditors, thus prompting its potential replacement by the solvency-liquidity test, whose effect on Zimbabwean creditor protection is the subject of this paper.

 

The Solvency and Liquidity Test: Definition

The solvency and liquidity test as provided for by section 102 of the  Companies and Other Business Entities Act, entails that before a company can distribute, surplus capital in the form of dividends or otherwise, it must satisfy two essential requirements; (i) its income must at the present time exceed its expenditure and; (ii) from the state of the company, it must be foreseeable that the company will be able to service their debts as they become due in the ordinary course of business, within a twelve month period from the date of the consideration of the test.

 

Effects of the implementation of the Solvency and Liquidity Test vis a vis the weaknesses of the capital maintenance regime on corporate creditor protection in Zimbabwe

1.  Protection of creditors from the illusory effect of the previous capital maintenance regime

According to the doctrine of capital maintenance, share capital is a pool of resources ensuring the payment of creditor debts by the company in question. This has over the years resulted in share capital, having an illusory effect on creditors, as the amount of share capital is based on historical and not actual, present values, thus giving creditors the false impression that the company’s original share capital is still available for the satisfaction of company debts. The capital maintenance regime tries to remedy this by restricting the use or reduction of share capital, with the goal of “maintaining” the share capital. This has proved to be an insufficient guard, as share capital is depleted through the ordinary course of business, thus creating a material difference between available company funds and the purported available share capital.

 

However, this predicament has been remedied by the adoption of the liquidity and solvency test, as creditors  no longer look to share capital as security for their debts but instead will find security from the fact that the new solvency and liquidity regime, restricts conduct leading to insolvency, thus protecting the creditors from bad debts, as insolvency is the only instance whereby corporate creditors may not be paid back their debts. This goes to show how the new regime will increase both creditor confidence and security in Zimbabwe, as risk of default will drastically reduced.

 

2.  Creditors will be better protected by a regime that insures that a company maintains its ability to pay debts, than a regime that assumes that creditors are covered by a previous and possibly unavailable sum, paid to the company at its initiation

The capital maintenance doctrine implies that share capital as paid into the company by its members, is enough to cover all of its future debts. Even if all the share capital as initially paid is still available, this view is still flawed and has proved to be detrimental to corporate creditors, as any chosen amount (minimum capital in the case of public companies) would be arbitrary and economically doubtful, because it is difficult to determine ex-ante the amount of capital necessary to cover a firm’s future liabilities, thus proving how share capital can never be a fund capable of catering for a company’s debts whatever their amount.

 

The utilisation of the solvency and liquidity test, gets rid of this problem, as its core mandate is to ensure that a company maintains or improves its current financial standing, by barring the company from initiating actions that would render the company bankrupt, for example by barring a company that is on the brink of bankruptcy from issuing dividends to its shareholders, thus improving creditor protection in Zimbabwe, by ensuring that creditor security is maintained by making sure that a company does not lose its capability to pay debts via insolvency.

 

3.  The Solvency and Liquidity test will increase corporate creditor security by ensuring that company directors refrain from arbitrary actions.

 

 

According to the solvency and liquidity regime, company directors will be held personally liable for loss incurred as a result of loss caused by a failure to adhere to the requirements of the solvency and liquidity test (Section 138 (6)of the Companies and Other Business Entities Act). This will have the effect of compelling company directors to make hard thought and risk-minimal decisions, thus offering creditors protection like never before, as the directors will refrain from taking actions that are detrimental to the creditors, in a bid to favor the company shareholders, for example directors will refrain from issuing dividends with the full knowledge of the fact that the issuance of these dividends will effectively deplete company debt payment funds. This goes to show how the implementation of the new bill will go a long way in increasing creditor protection in Zimbabwe.

 

Conclusion

The implementation of the solvency and liquidity test will, as highlighted above, go a long way in improving and solidifying corporate creditor protection by filling most of the holes that where in the previous capital maintenance regime, and introducing new heights of security for creditors in Zimbabwe.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bibliography:

T. Mongalo (2010) Modern Company law for a competitive south african economy JUTA, Claremont

J.birds; A.J Boyle ETAL (2009) “Boyle and Birds’ Company Law(7th edition)” :Jordan Publishing Limited; Bristol

 

G.Morse (2005) “Charlesworths’s Company Law (7^th edition)”: Sweet and Maxwell Limited; London

Enriques/Macey, Cornell Law Review , 2001

Miola, European Company and Financial Law Review, 2005

Interdisciplinary Group on Capital Maintenance, European Business Law Review, 2004

Mülbert/Birke, European Business Organization Law Review, 2002

Schön, European Business Organization Law Review, 2004

companies and other business entities bill

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