Removal of Directors in South Africa: Understanding the Different Routes Under the Companies Act

The seven routes by which a director may be removed or cease to hold office under the Companies Act 71 of 2008.

Introduction

The removal of a director is often treated as though it were a single legal process. Under the Companies Act 71 of 2008, however, there are several different mechanisms by which a director may be removed from office, or otherwise cease to hold office.

The distinction is important. A director may be removed by shareholders, by fellow board members in specified circumstances, through the Companies Tribunal, through a mechanism contained in the company’s Memorandum of Incorporation (MOI), or pursuant to a court order. A director may also cease to hold office automatically following resignation, disqualification, death or another statutory vacancy event.

Each route has its own requirements. Perhaps the most important practical distinction is between removal by shareholders and removal by the board. Shareholders enjoy a comparatively broad power to remove a director, whereas the board may remove a fellow director only on specific statutory grounds and after complying with substantially more demanding procedural requirements.

Failure to identify the correct procedure can result in the purported removal being challenged and set aside. This article considers the principal mechanisms available under the Companies Act, together with some of the developing case law.

1. Removal by shareholders: section 71(1)

Section 71(1) gives shareholders a powerful statutory right. Despite anything to the contrary in a company’s MOI, rules or any agreement between the company and a director or between shareholders and a director, a director may be removed by an ordinary resolution adopted at a shareholders’ meeting by persons entitled to exercise voting rights in the election of that director.

This means that contractual arrangements cannot ordinarily be used to deprive shareholders of the statutory power contained in section 71. Importantly, section 71(1) does not prescribe misconduct, incapacity, negligence or any other substantive ground which shareholders must establish before voting a director out of office. That distinguishes shareholder removal fundamentally from removal by the board.

Procedural protection for the director

Although shareholders enjoy a broad power of removal, section 71(2) provides procedural safeguards. Before the shareholders may consider the resolution, the director concerned must:

• receive notice of the meeting and the proposed resolution comparable to the notice to which a shareholder would be entitled; and
• be afforded a reasonable opportunity to make a presentation, personally or through a representative, before the resolution is put to a vote.

The right to be heard is therefore important, even though the shareholders are not necessarily required to establish misconduct.

Must shareholders provide reasons?

This issue has attracted considerable judicial attention. In Pretorius v Timcke, the Western Cape High Court took the view that meaningful procedural fairness required the affected director to know the reasons for the proposed removal.

That approach subsequently came under scrutiny. In Miller v Natmed Defence (Pty) Ltd, the Gauteng High Court distinguished shareholder removal from board removal and concluded that section 71(1) does not require shareholders to establish or provide substantive grounds for removing a director.

The distinction was reinforced in Weir v Wiehahn Formwork Solutions (Pty) Ltd, where the court again recognised that shareholder removal under section 71(1) is fundamentally different from the grounds-based process applicable where directors seek to remove a fellow board member.

The practical result is significant: shareholders may generally remove a director without proving misconduct, provided the procedural protections contained in section 71(2) are properly observed.

2. Removal by the board: section 71(3)

A completely different regime applies where a board seeks to remove one of its own directors. Section 71(3) applies where a company has more than two directors.

The board cannot simply vote a director out because relations have deteriorated or because the majority no longer wants that person on the board. An allegation must first be made that the director:

• has become ineligible or disqualified in terms of section 69, subject to the statutory exclusions;
• has become incapacitated to such an extent that the director is unable to perform the functions of a director and is unlikely to regain that capacity within a reasonable time; or
• has neglected or been derelict in the performance of the functions of a director.

These are substantive statutory grounds. The board must therefore determine whether one or more of those grounds actually exists.

Reasons are essential

Section 71(4) gives the affected director substantial procedural protection. Before the board may consider the matter, the director must receive:

• notice of the meeting;
• a copy of the proposed resolution; and
• a statement setting out the reasons for the proposed resolution with sufficient specificity to enable the director to prepare a response.

The director must also be given a reasonable opportunity to make representations, personally or through a representative, before the board votes. This is markedly different from a shareholder removal.

A vague allegation that a director has “failed in his duties” or “lost the confidence of the board” is unlikely, without more, to satisfy the statutory standard. The allegations should identify the conduct complained of and explain why it is said to constitute one of the grounds set out in section 71(3).

3. The courts require proper grounds and proper procedure

The courts have repeatedly stressed that board removal is not an informal mechanism for resolving boardroom disagreements. In Mthimunye-Bakoro v PetroSA, the court emphasised the importance of compliance with the statutory process where a board seeks to remove a fellow director.

More recently, Jones and Others v Delport and Others demonstrated the extent to which the substantive basis of a board’s decision may be scrutinised. A section 71 review is not necessarily confined to checking whether the correct notice was sent. The court may examine whether the alleged statutory ground for removal actually existed.

In Pityana v Absa Group Ltd, the litigation also highlighted the importance of the underlying record and reasons where a board decision is challenged on review.

The message for companies is straightforward: section 71(3) should not be used as a convenient method of removing a difficult or unpopular director. The board must be able to establish a recognised statutory ground and demonstrate procedural fairness.

4. Review of a board removal: section 71(5)

Where the board determines that grounds for removal exist, the affected director has a statutory right of review. Section 71(5) permits the director — and, in appropriate circumstances, the person who appointed that director under an MOI mechanism contemplated in section 66(4) — to apply to court to review the board’s determination.

The application must generally be brought within 20 business days after the board’s decision. That period should not be treated casually. The decision in Peter v Mimosa Court Shareblock RF (Pty) Ltd illustrates the importance of acting promptly where a section 71 determination is to be challenged.

Advisers should therefore immediately identify the date on which the board made its determination and calculate the review period.

5. What happens where the board refuses to remove the director?

Section 71 does not operate only for the benefit of the director facing removal. Where the board determines that the alleged grounds do not exist, dissenting directors or persons holding voting rights may, in the circumstances contemplated by section 71(6), approach a court for review.

The court may confirm the board’s decision or, if satisfied that a statutory ground has been established, order the director’s removal. The legislation therefore provides review mechanisms on both sides of the dispute.

6. Companies with fewer than three directors

The board-removal procedure creates an obvious difficulty in a company with only two directors. One director cannot realistically constitute an independent board process to determine the removal of the other.

Section 71(8) deals with this problem. Where a company has fewer than three directors, the ordinary board-removal mechanism in section 71(3) does not apply. Instead, a director or shareholder may apply to the Companies Tribunal for the determination that would otherwise have been made by the board. The procedural protections contained in sections 71(4) to 71(6) are then applied with the necessary contextual changes.

This provision is particularly important in owner-managed companies, where two-person boards are common. A shareholder in a two-director company should therefore not simply attempt to convene a board meeting and use section 71(3) against the other director.

7. The MOI may contain an additional appointment and removal mechanism

Section 66(4)(a)(i) allows a company’s MOI to provide that one or more directors may be appointed and removed directly by a person named in, or determined in accordance with, the MOI. This mechanism can be especially important in:

• joint ventures;
• family-owned companies;
• investment structures;
• companies where a particular shareholder is contractually entitled to nominate a director; and
• structures involving different classes of shareholders.

The wording of the MOI must therefore always be examined before advising on director removal.

Interaction between the Act, MOI and shareholders’ agreements

The courts have increasingly had to consider the relationship between section 71 and contractual or constitutional mechanisms governing board composition. In Mawerco (Pty) Ltd v Sithole and Others, the Supreme Court of Appeal considered shareholder and corporate mechanisms affecting the continuation of directors in office and, importantly, the legal consequences of corporate acts until they are properly challenged and set aside.

In Ramela v Ndzunzu, the court considered whether section 71 and section 162 should be regarded as the only routes through which a director may leave office. The judgment recognised the potential operation of properly drafted MOI mechanisms, provided those mechanisms are consistent with the Companies Act.

The lesson is that section 71 cannot be considered in isolation. The first documents that should ordinarily be examined in a director dispute are:

• the Companies Act;
• the company’s MOI; and
• any shareholders’ agreement affecting board appointments.

8. Not every departure is technically a “removal”

Section 70 deals with vacancies on the board and identifies a number of circumstances in which a person ceases to be a director. A vacancy may arise where a director:

• resigns;
• dies;
• ceases to hold an office which entitled the person to serve as an ex officio director;
• becomes incapacitated in circumstances recognised by the Act;
• is declared delinquent or placed under a probation order inconsistent with continuing in office;
• becomes ineligible or disqualified;
• is removed by shareholders;
• is removed by the board; or
• is removed pursuant to an appropriate court process.

It is therefore important to distinguish between a removal decision and a statutory event which causes office to terminate. A resignation, for example, does not require a section 71 process.

9. What happens to the office while a board removal is being reviewed?

A further important distinction arises where a director has been removed by the board under section 71(3). Section 70(2) prevents the vacancy from necessarily taking effect immediately. The legislation accommodates the review rights created by section 71.

Depending on the circumstances, the director may effectively be suspended while the statutory review period runs or while review proceedings are determined. This has practical implications for:

• quorum;
• voting;
• access to board information;
• banking mandates;
• CIPC records;
• signing authority; and
• the appointment of a replacement director.

Companies should therefore resist the temptation to treat the board seat as immediately and finally vacant without considering sections 70 and 71 together.

10. Ineligibility and disqualification under section 69

Section 69 deals with persons who are ineligible or disqualified from acting as directors. A person who is ineligible or disqualified may not be appointed or elected as a director, and a company may not knowingly permit that person to continue to act where the Act prohibits it. Examples of ineligibility include certain circumstances involving:

• juristic persons;
• unemancipated minors; and
• persons who fail to satisfy qualifications prescribed by the company’s MOI.

Disqualification provisions extend considerably further and should be examined carefully where questions of criminal conduct, delinquency, insolvency or other statutory restrictions arise. Sections 69, 70 and 71 must therefore often be read together.

11. Delinquency proceedings under section 162

Removal under section 71 is not the only court-based remedy available where serious director misconduct is alleged. Section 71(10) expressly preserves the right to apply to court under section 162 for an order declaring a director delinquent or placing the director under probation.

A delinquency application is substantially more serious than an ordinary shareholder decision to remove a director. Its consequences can extend beyond the company in which the misconduct occurred because it concerns the individual’s fitness to hold directorships.

South African courts have developed a substantial body of jurisprudence around section 162. In Kukama v Lobelo, serious financial misconduct resulted in delinquency consequences. In Gihwala v Grancy Property, the Supreme Court of Appeal emphasised the protective nature and seriousness of delinquency orders. The most prominent modern example is Organisation Undoing Tax Abuse v Myeni, where the court made an extraordinary delinquency order following serious findings concerning the exercise of directors’ duties.

At the same time, section 162 should not be used merely as an aggressive tactical weapon in an ordinary commercial dispute. In Lewis Group Ltd v Woollam, the court emphasised the importance of satisfying the statutory requirements applicable to delinquency proceedings.

12. Director removal during business rescue

A further specialised mechanism arises during business rescue. The business rescue provisions allow the practitioner, in prescribed circumstances, to approach a court for the removal of a director whose conduct is inconsistent with the requirements of the rescue process, including where the director fails to comply with statutory duties or impedes the rescue. This remedy operates in addition to other remedies that may be available under the Act.

The commercial context is important. During business rescue, the continued presence of a director who actively obstructs the practitioner may affect the prospects of rescuing the company, which explains the availability of this additional court remedy.

13. CIPC filing does not itself determine whether the removal was lawful

An important practical distinction must also be made between the legal removal of a director and the subsequent administrative updating of company records. Once a director has validly resigned, been removed or otherwise ceased to hold office, the company’s records and prescribed CIPC filings should be updated.

However, the filing process should not be confused with the legal act that caused the directorship to terminate. Where there is a genuine dispute about whether the underlying resolution or removal process was valid, merely changing the CIPC record does not necessarily resolve the substantive legal dispute. The company must be able to demonstrate the legal basis upon which the director ceased to hold office.

For company secretarial practitioners, maintaining the complete supporting record is therefore crucial. That record may include:

• meeting notices;
• proposed resolutions;
• proof of delivery;
• written reasons where required;
• representations made by the affected director;
• attendance records;
• minutes;
• voting records;
• the final resolution;
• relevant MOI provisions; and
• subsequent regulatory filings.

14. Do not confuse shareholder removal with board removal

This is probably the single most important practical lesson arising from section 71.

Shareholders

Under section 71(1), shareholders exercise a broad statutory power. They do not generally have to prove negligence, misconduct, incapacity or dereliction. The director must, however, receive proper notice and a reasonable opportunity to address the shareholders before the vote.

The board

Under section 71(3), the board exercises a fundamentally different power. It must establish one of the statutory grounds. The director must be told sufficiently clearly what is alleged and why removal is proposed, and must then be given a meaningful opportunity to respond. These two procedures should never be treated as interchangeable.

15. The MOI remains critical

A recurring mistake in company secretarial practice is to look only at section 71. Whenever a dispute arises concerning the removal of a director, the MOI should immediately be obtained and reviewed. Questions to consider include:

• Who appointed the director?
• Was the director elected by shareholders?
• Was the director appointed directly by a named person under section 66(4)?
• Is the director an ex officio director?
• Does the MOI prescribe a term of office?
• Does the MOI contain qualification requirements?
• Does a particular shareholder have nomination or removal rights?
• Are there different classes of directors?
• Is there a shareholders’ agreement dealing with board composition?
• Does that agreement conflict with the Act or MOI?

The answers may fundamentally alter the procedure that should be followed.

16. Practical comparison

17. A practical checklist before removing a director

Before taking any step to remove a director, practitioners should establish:

1. How was the director appointed?
2. What does the MOI say?
3. Who is proposing the removal — shareholders, the board, an appointing shareholder or another person?
4. Is the company attempting to use section 71(1) or section 71(3)?
5. If it is a board removal, which precise statutory ground is relied upon?
6. Has adequate notice been given?
7. Where reasons are legally required, are they sufficiently detailed?
8. Has the director been afforded a genuine opportunity to make representations?
9. Does the company have fewer than three directors, requiring the Companies Tribunal route?
10. Is there a possible court review and, if so, when does the 20-business-day period expire?

Only once the legal process has been completed should the consequential company secretarial records and CIPC filings be dealt with.

Conclusion

Director removal under the Companies Act is considerably more nuanced than merely passing a resolution and notifying CIPC. The correct procedure depends on who is removing the director, how the director was appointed and why the director is being removed.

Shareholders have a relatively broad statutory power to remove a director, subject principally to procedural fairness. A board, by contrast, may remove a fellow director only on the specific grounds prescribed by section 71(3) and after giving sufficiently detailed reasons and a proper opportunity to respond.

Companies with fewer than three directors face a different process involving the Companies Tribunal, while MOI provisions may create additional appointment and removal mechanisms. Serious misconduct may also justify the more far-reaching remedy of delinquency under section 162.

The developing case law shows that courts are increasingly prepared to distinguish carefully between these different routes and to scrutinise whether the correct statutory process has been followed.

For accountants, directors and company secretarial practitioners, the practical rule should therefore be simple: do not start with the resolution. Start with the Companies Act, the MOI and the manner in which the director came into office. Once those questions have been answered, the correct removal procedure can usually be identified — and a costly challenge to an invalid removal can potentially be avoided.