11 Aug 2021

Substantial risk to property owners and bondholders if sales of certain investment properties are not advertised

by David Warmback, Partner, Durban, Suhail Ebrahim, Associate, Durban,
Practice Area(s): Corporate & Commercial |

Failure by an owner of an investment letting business conducted from immovable property to advertise a sale in compliance with the law, can in certain circumstances, have severe consequences for both the owner and its bondholder.

Section 34 of the Insolvency Act 24 of 1936 (the Act) obliges a trader who transfers a business or the goodwill of such business or any goods or property forming part thereof (except in the ordinary course of that business or for securing the payment of a debt), to advertise the proposed transfer in a manner prescribed in the section.  If the trader fails to advertise properly, the transfer is void as against creditors of the seller trader for a 6-month period after transfer and furthermore renders such transfer void against the trustee of his estate if his estate is sequestrated within the 6-month period.

A “trader” is defined in section 2 of the Act as “any person who carries on any trade, business, industry or undertaking in which property is sold, or is bought, exchanged or manufactured for the purpose of sale of exchange, or in which building operations of whatever nature are performed, … or who acts as a broker or agent of any person in the sale or purchase of any property or in the letting or hiring of immovable property”.

The purpose of section 34(1) is to protect creditors by preventing traders who are in financial difficulty from disposing of their business assets to third parties who are not liable for the debts of the business, without proper advertisement to all creditors of the business. Importantly the provisions of s 34(1) can be invoked only if the company is a ‘trader’ as defined in s 2 of the Act, and the important question is whether an owner of a property letting business is a trader, as defined.

On 17 June 2021, the Supreme Court of Appeal (SCA) in the case of K2013046547/07 (South Africa) (Pty) Ltd and Others (K Company) v Hyde Construction CC (Hyde Construction) and Another [2021] ZASCA 82 handed down a judgement where the main issue of the appeal was whether Blue Cloud Investments (Blue Cloud), the third appellant, and owner of a property, was a trader for the purposes of Section 34(3) of the Act. 

Hyde Construction was contracted by Blue Cloud which owned a shopping centre, to conduct renovations to the centre. Disputes arose between them over the renovations and the matter was referred to arbitration. Hyde Construction was substantially successful in arbitration proceedings, but this did not resolve all the issues between the parties.

In 2010, Hyde Construction instituted action against Blue Cloud for payment of what it claimed was due and owing to it.

On 11 April 2014, Blue Cloud sold the rental enterprise conducted from the shopping centre to the first appellant (K Company) for a purchase price of R36 million. R30 million of the purchase price was funded by a loan from Investec Bank Limited (Investec) and the balance, by other investors. As security for the loan, a mortgage bond was registered over the shopping centre in favour of Investec.

Hyde Construction sought an order setting aside the sale between Blue Cloud and K Company in terms of section 34(3) of the Act as well as setting aside and declaring void the subsequent transfer of the property to K Company and registration of a bond in favour of Investec. 

The Western Cape High Court in a judgement handed down in April 2020 held that since Blue Cloud was a trader as defined in section 2 of the Act, the transfer of immovable property and the mortgage bond hypothecating the property were hit by the provisions of section 34(3) which rendered such transfer and mortgage bond to be void. 

The SCA dealt with the appeal against the 2020 High Court judgment.

The court held that “it is clear that section 34(1), if applicable, results in a transfer which is void against all creditors for 6 months after transfer, and void against a trustee (or liquidator) in insolvency. By contrast, section 34(3), if applicable, results in a transfer which is void against a particular creditor or creditors for the purpose of the enforcement of their claim against the debtor. Put differently, this means that, to the extent that the transfer affects the ability of the creditor to enforce its claim, the transfer is void”. 

In this appeal, it was common cause that Hyde Construction had instituted proceedings to enforce its claim prior to transfer of the property to K Company of which K Company was aware. The only outstanding requirement of Section 34(3) was whether Blue Cloud was a trader as defined in Section 2 of the Act. The Court, in quoting other authoritative case authority, held that the question of whether a company is a trader is answered by having regard to the nature of the undertaking and determining whether such undertaking is part of the core business of the company or incidental thereto. The definition of a trader must be linked to the primary business activities of the enterprise concerned and not be extended to activities incidental thereto.

The SCA held that each case must be judged on its own facts. In this case, the central issue for determination was whether, at the time of transfer, the core business of Blue Cloud was the sale and purchase of property, or whether this was incidental to the business of holding property for investment purposes and earning rental income. Hyde Construction contended that the category of a trader in Section 2 of the Act, applicable to Blue Cloud, was that it carried on business in which property was sold or was bought for the purpose of sale. In doing so, it referred to a document termed “Board Paper”, which was issued by Blue Cloud in 2003, which document motivated, amongst other things, the sale of Blue Cloud of its entire property portfolio. Hyde Construction relied heavily on this document to contend that Blue Cloud did not have rental as its core business but rather the buying and selling of property, and that as a result, it was a trader. It was contended that this is supported by the many sales of properties made by Blue Cloud over the years. 

Blue Cloud contended that the objective of its acquisitions of property was the establishment of rental enterprises. All the properties it bought were tenanted, and when they were disposed of, they were sold as rental enterprises. In addition, the South African Revenue Services recognised rentals as income and the annual financial statements of Blue Cloud reflected, and were prepared on the basis, that the principal activity of the company was the acquisition and rental of immovable property. 
On a careful analysis of the facts, the SCA considered the properties which Blue Cloud owned over the years and the transactions relating thereto and held that on the date of transfer in August 2014, the shopping centre had been the only property held by Blue Cloud for a period of some five and a half years. No properties had been acquired after July 2005. The last sale of a unit in the sectional scheme in which the shopping centre was situated, was in August 2007 and the last sale of immovable property, in March 2009.  The court concluded that the most probable inference is that in August 2014, Blue Cloud was not a trader as defined in s 2 of the Act and the sale and related transfer were incidental to the core business of a rental enterprise, which had run into financial difficulty. 

The court therefore ruled that the transfer of the property was accordingly not hit by the provisions of s 34(3) of the Act, which applies only to traders. As the transfer was not affected, neither could a subsequent hypothecation be hit by it and there could be no basis for section 34(3) of the Act to apply to the mortgage bond if Blue Cloud was not a trader. Consequently, neither the transfer nor the registration of the mortgage bond was void for the purpose of Hyde Construction enforcing its claim against Blue Cloud. The appeal therefore succeeded with costs. 

This judgment highlights the risks associated with not advertising a sale of a property on which a rental business is conducted, in circumstances where the owner may be a trader for purposes of the Act. The case also highlights that courts should not readily declare property transfers to be void without carefully analyzing the facts of each matter together with the associated timelines when deciding whether an owner of a property rental business is a trader or not in terms of Section 34 of the Act.