2008-01-11
Should I register my business as a close corporation?

First, let us consider the legal status of these forms of business. A sole proprietor is a person who trades under his own name, who is responsible for the assets and liabilities of his business, and who can sue and be sued in his own name.  The sole proprietor, like a partnership, enjoys no protection under the Close Corporation Act and has no legal status as a juristic person.

A partnership is formed when between two and 20 people sign a valid partnership agreement with a common goal of obtaining a mutual benefit, and where each person must contribute something to the partnership.  This form of business does not enjoy legal personality as it does not exist independently of its partners.  Its rights, responsibilities and assets are those of, and belong to the partners. As such, the partners have “joint and several” liability.

The close corporation, in contrast, is a juristic person which does enjoy a legal personality of its own. This type of business was created by the Close Corporation Act 69 of 1984.  It is particularly suited to the needs of a small business venture and although is uses some principles of both company and partnership law, it provides a simpler and cheaper form of enterprise for the single business person or a number of participants (not more than ten). There are no strict rules regulating the close corporation’s finances as long as its members honour their fiduciary responsibilities and maintain its solvency and liquidity. Running a business as a close corporation has advantages and disadvantages. Advantages
In a close corporation, there is no need for a board of directors as this function is the responsibility of the members of the close corporation. There is no need for an annual general meeting although there are provisions for members meetings to be held wherein decisions may be taken informally after consultation with members. Any decisions may be put in writing and recorded. A close corporation may acquire the interests of a member and/or assist a member financially in acquiring such interests. A close corporation enjoys perpetual succession and its members have a limited liability in respect of its debts.

Disadvantages
Each member is an agent of the close corporation and can act on its behalf. This could be a risk to the members, as any insolvency flowing from the actions of an errant member could impact on the personal liability of the other members.
Because it is so simple to establish and run a close corporation, this might present an opportunity for fraud or unauthorised dealings that could lead to its failure.
Section 42(2) of the Act says each member stands in a “fiduciary relationship” to the close corporation - he/she must act honestly and in good faith towards the close corporation, and must avoid any material conflict of interest that might exist between the member and the business. Common law rules that apply to companies in this respect also apply to close corporations.

Section 43 places a burden on each member of the close corporation to act with due care and skill towards it. A member can be held liable for any losses incurred by his/her failure to act with the skill and care that may reasonably be expected of a person with similar knowledge and skills.
Section 63 makes a member who contravenes provisions of the Act liable, together with the close corporation, for specific debts incurred by the corporation. In this case the errant member simply becomes jointly liable with the close corporation for the payment of the debt. This means that a creditor may sue either the member or the close corporation, or both simultaneously. In any situation where the business of the corporation is carried on recklessly or fraudulently, section 64 says anyone who knowingly helped to run the business that way is personally liable for those debts. To carry on business in such a manner is also a criminal offence, apart from any other criminal liability that arises from such conduct.

Any person considering running his business as a close corporation should ensure that the Close Corporation Act 69 of 1984 is followed, and that internal checks and balances are put in place and strictly controlled, so that the internal workings of the close corporation run smoothly.

Contact Andrew Overall, ECA(SA), Tel 031 312-6313, andrew@ecasa.co.za