Insolvency in South African law refers to a status of diminished legal capacity (capitis diminutio) imposed by the courts on persons who are unable to pay their debts, or (which amounts to the same thing) whose liabilities exceed their assets. The insolvent's diminished legal capacity entails deprivation of certain of his important legal capacities and rights, in the interests of protecting other persons, primarily the general body of existing creditors, but also prospective creditors. Insolvency is also of benefit to the insolvent, in that it grants him relief in certain respects.Wille's 387.
In broad and everyday terms, a person is insolvent when he is unable to pay his debts. In legal terms, however, the test for insolvency is whether or not the debtor's liabilities, fairly estimated, exceed his assets, fairly valued. Inability to pay debts is, at most, merely evidence, and in itself, of insolvency.
A person who has insufficient assets to discharge his liabilities, although he satisfies the test for insolvency, is not treated as insolvent for legal purposes unless his estate has been sequestrated by an order of court. A sequestration order is a formal declaration that a debtor is insolvent. The order is granted either at the instance of the debtor himself (voluntary surrender) or at the instance of one or more of the debtor's creditors (compulsory sequestration).
The term “sequestration” should be used only with reference to a person's estate. It is the debtor's estate that is sequestrated, not the debtor himself. On the other by, both the debtor's estate and the debtor himself may properly be described as insolvent.
When the word “insolvent” is used to describe a debtor, it carries two possible meanings—either
that the debtor's estate has been sequestrated; or that his liabilities exceed his assets.
The notion of “becoming insolvent,” therefore, has a wider meaning than “being sequestrated.”
Purpose of a sequestration order The main purpose of a sequestration order is to score the orderly and equitable distribution of a debtor's assets where they are insufficient to meet the claims of all his creditors.
Executing against the property of a debtor who is in insolvent circumstances inevitably results in one or a few creditors being paid, and the rest receiving little or nothing at all. The legal machinery which comes into operation on sequestration is designed to ensure that whatever assets the debtor has are liquidated and distributed among all his creditors in accordance with a predetermined (and fair) order of preference.
The law proceeds from the premise that, once an order of sequestration is granted, a concursus creditorum (a “coming together of the creditors”) is established, and that the interests of creditors as a group enjoy preference over the interests of individual creditors.
The debtor is divested of his estate, and may not burden it with any further debts. A creditor's right to recover his claim in full by judicial proceedings is replaced by his right, on proving a claim against the insolvent estate, to share with all other proved creditors in the proceeds of the estate assets.
Apart from what is permitted in the Act, nothing may be done which would have the effect of diminishing the estate assets or prejudicing the rights of creditors.
“The object of the Act,” held the court in Walker v Syfret NO, “is to ensure a due distribution of assets among creditors in the order of their preference [...]. The sequestration order crystallises the insolvent’s position; the hand of the law is laid upon the estate, and at once the rights of the general body of creditors have to be taken into consideration. No transaction can thereafter be entered into with regard to estate matters by a single creditor to the prejudice of the general body. The claim of each creditor must be dealt with as it existed at the issue of the order.”
Core concepts The Act provides that the “estate” of a “debtor” may be sequestrated.
Estate An estate is usually described as a collection of assets and liabilities, but a debtor who has only liabilities may be regarded as having an estate for sequestration purposes.Miller v Janks.
Debtor A “debtor,” for the purposes of the Act, is “a person or a partnership, or the estate of a person or partnership, which is a debtor in the usual sense of the word, except a body corporate or a company or other association of persons which may be placed in liquidation under the law relating to companies.”
An entity or association of persons is regarded as “a debtor in the usual sense of the word” if it is able to possess an estate and incur debts.Magnum Financial Holdings (Pty) Ltd (in liquidation) v Summerly. The entities that may be placed in liquidation under the Companies Act are
a company; an “external” company; and “any other body corporate.”
“Body corporate” in this context refers to a juristic person or universitas.
The term “debtor” therefore embraces the following:
a natural person; a partnership (even one whose members are all juristic persons); a deceased person and a person incapable of managing his own affairs; an external company that does not fall within the definition of “external company” in the Companies Act (like a foreign company that has not established a place of business in the country); and an entity or association of persons that is not a juristic person, such as a trust.
Jurisdiction of the court Only a Provincial Division, or a Local Division of the High Court, may adjudicate on an insolvency matter. (In certain instances, though, a Magistrate's Court has jurisdiction, such as in prosecutions for criminal offences under the Act.)
In terms of section 149, a court has jurisdiction “over a debtor and in regard to the estate of a debtor”
if, on the date when the application for voluntary surrender or compulsory sequestration of the debtor's estate is lodged with the registrar of the court, the debtor is domiciled, or owns the property, or is entitled to property, situated within the jurisdiction of the court; or if, at any time within the twelve months immediately preceding the lodging of the application, the debtor ordinarily resided or carried on business within the jurisdiction of the court.
Constitutional overview The Constitution provides a basis for the reform of all South African law. It is supreme law and contains a Bill of Rights, against which the validity of all laws may be tested.
Insolvency laws pose a potential threat to a number of fundamental rights, like the right to equality, freedom and security of the person, privacy, access to information, property and administrative action.
The Constitutional Court has been called upon to consider the constitutional validity of several insolvency provisions, like
section 21 of the Insolvency Act, 1936 (upheld in Harksen v Lane); and section 66(3) of the Insolvency Act, 1936 (held in De Lange v Smuts NO to be invalid to the extent that it empowered a presiding officer at an interrogation who is not a judge or magistrate to issue a warrant of committal to prison).
The issue of constitutional invalidity involves a two-fold enquiry:
Does the provision conflict with a fundamental right? If it does, is the limitation reasonable and justifiable in an open and democratic society based on human dignity, equality and freedom?
To decide the latter issue, account must be taken of all the relevant factors, including
the nature of the right; the importance of the purpose of the limitation; the nature and extent of the limitation; the relation between the limitation and its purpose; and less restrictive means to achieve the purpose.
Only if the provision is neither reasonable nor justifiable, taking all pertinent factors into consideration, may the conclusion be drawn that it is unconstitutional.
Condonation of irregularities or non-compliance with formalities Sometimes a party making an application, or taking a step in terms of the Act, will omit prescribed details, or fail to act within the time stipulated, or commit some other procedural breach. When this happens, it is important to establish whether what has been done is invalid by reason of the defect or irregularity.
The starting point is section 157(1), which provides that “nothing done under the Act will be invalid by reason of a formal defect or irregularity, unless a substantial injustice has been thereby done, which in the opinion of the court cannot be remedied by any order of the court.” The effect of this is the following:
If a formal defect has not caused a substantial injustice, the procedural step in question is valid. It is said that the court may condone the defect in these circumstances, but this seems incorrect, since section 157 does not confer on the court the power to condone defects.Ex parte Slabbert. If a formal defect has caused a substantial injustice, but the prejudice to creditors can, in the opinion of the court, be remedied by an appropriate order, then the defect is not fatal—provided, of course, that the party concerned complies with the corrective order. If a formal defect has resulted in a substantial injustice, and the prejudice to creditors cannot be cured by any order of the court, then the procedural step is invalid.
Procedure There are two ways in which a debtor's estate may be sequestrated:
A creditor or creditors (or their agent) may apply to court for the sequestration of the debtor's estate (s 9(1)). This is called compulsory sequestration. The debtor himself (or his agent) may apply to court for acceptance of the surrender of his estate (s 3(1)). This is known as voluntary surrender.
The procedure and requirements for each method differ in material respects (although the consequences of the sequestration order are same in both instances).
Voluntary surrender An application by the debtor for the sequestration of his estate for the benefit of creditors is termed a "voluntary surrender" of the estate. A court may accept the surrender if the debtor proves, among other things, that his liabilities exceed his assets. The debtor's aim in surrendering the estate is, as a rule, to escape a financial position which has become intolerable. It has been pointed out, though, that "the machinery of voluntary surrender was primarily designed for the benefit of creditors, and not for the relief of harassed debtors."Ex Parte: Pillay 1955 (2) SA 309 (N) 311. The court, therefore, has to be satisfied that the surrender will be to the advantage of creditors.
Who may apply? The following persons may apply to surrender the estates mentioned:
In the case of the estate of a natural person, the debtor himself or his agent may apply. If an agent applies, he must be expressly authorised to do so. In the case of the estate of a deceased debtor, the executor may apply. In the case of the estate of a debtor who is incapable of managing his own affairs, the party entrusted with administering the estate may apply. In the case of a partnership estate, all the members of the partnership who reside in the Republic, or their agent, may apply. In the case of the joint estate of spouses married in community of property, both spouses may apply.
Requirements The court may accept the surrender of a debtor's estate only if it is satisfied
that the debtor's estate is, in fact, insolvent; that the debtor owns realisable property of sufficient value to defray all costs of the sequestration, which will, in terms of the Act, be payable out of the free residue of his estate; and that sequestration will be to the advantage of creditors.
In addition, the court must be satisfied that certain preliminary formalities have been observed.
Debtor’s estate insolvent A debtor is insolvent if the amount of his total liabilities exceeds the value of all his assets.