Financing agreements routinely contain undertakings and consent requirements that restrict the circumstances in which a borrower may take certain actions without the approval of its lenders. Through certain consent rights, undertakings and enforcement mechanisms, lenders may move beyond being passive providers of capital and exercise substantial influence over corporate decision-making in borrower companies. These provisions may afford lenders a degree of negative control, typically through veto rights exercised over extraordinary corporate actions such as material asset disposals, additional debt incurrence, mergers or acquisitions while the board retains general authority over the management of the company’s business. Despite this influence, South African law continues to place ultimate responsibility for the management of a company’s business and affairs with its board of directors. Extensive lender consents can therefore create a potential accountability gap; on the one hand, lenders may possess significant power to prevent transactions by way of exercising their veto powers, shape strategy and influence corporate conduct, while on the other hand, they owe no fiduciary duties to the borrower company and are not ordinarily accountable under the Companies Act 71 of 2008 ("Companies Act") for decisions taken in the exercise of those rights. This dynamic may be particularly evident where a borrower has limited bargaining power when negotiating its financing arrangements. Companies seeking funding are often focused on securing capital and may have little practical ability to resist extensive consent regimes proposed by lenders. While commercially justifiable, the effect of such provisions may materially narrow the board's room to manoeuvre should circumstances change.
Consent regimes are typically justified as credit protections in that lenders are entitled, and often expected, to protect their credit position and to guard against conduct that materially alters the risk profile of a borrower after funding has been advanced. Without such protections, lenders would be exposed to risks they neither priced for nor agreed to assume. Their practical effect can, however, extend far beyond preserving a lender's financial position. This raises an interesting governance question: how far can lender influence extend before it begins to encroach upon the authority that company law reserves for the board?
The starting point is section 66 of the Companies Act which provides that the business and affairs of a company must be managed by or under the direction of its board. Subject to the Companies Act and the company's memorandum of incorporation, the board is empowered to exercise all of the powers and perform any of the functions of the company.
Lender consent rights, however, do not ordinarily derive from either the Companies Act or the memorandum of incorporation, instead, they arise from funding agreements. Practical examples include financing agreements that require lender consent before a borrower may incur additional indebtedness, dispose of material assets, amend constitutional documents, declare distributions or enter into transactions above agreed thresholds, amongst other things. Although such provisions do not transfer decision-making authority to lenders, they can place lenders in a position where they effectively, and often unintentionally, become gatekeepers when it comes to the implementation of significant corporate actions.
It is important to be precise about what these provisions do. As mentioned above, they are, in substance, negative covenants which may give lenders a right to veto specified extraordinary actions and not a right to initiate corporate action or to direct how the ordinary business of the company is conducted, which remains a matter for the board under section 66. The decision to enter into the financing agreement, and to accept its covenants as the price of funding, is itself an exercise of the board's authority, which the board must take in the best interests of the company. Not every decision that is subject to lender consent is a board decision either; an amendment to the memorandum of incorporation, or a disposal of all or the greater part of the company's assets or undertaking, requires a special resolution of shareholders (in terms of sections 16 and 115 of the Companies Act).
The existence of these restrictions does not alter the duties owed by directors. Section 76 of the Companies Act continues to require directors to exercise their powers and perform their functions in good faith, for a proper purpose, in the best interests of the company and with the degree of care, skill and diligence that may reasonably be expected of a director. These duties are owed to the company and persist irrespective of the contractual obligations assumed under any pre-existing financing arrangements. The tension arises when what the board believes is best for the company differs from what the lender considers acceptable from a credit perspective.
Consider a scenario in which the board, having carefully considered a proposed transaction, determines that proceeding with it would be in the company’s best interests and may help avert potential insolvency, while also seeking to ensure compliance with its obligations under section 22 of the Companies Act in relation to reckless trading. If the lender decides to withhold its consent to the transaction, the board may have little practical choice but to abandon it to avoid triggering an event of default under the relevant financing agreements. Although the lender has neither formally exercised the board’s powers nor made the decision on its behalf, its veto may, in practical terms, determine whether the transaction proceeds. This raises a potential tension between the lender’s contractual consent rights and the board’s statutory responsibilities, particularly where withholding consent may impede action that the board considers necessary to protect the company. The precise legal consequences would depend on the circumstances and the applicable statutory and contractual framework.
A board that abandons a transaction because consent has been refused is not, without more, in breach of its duties. The consequences of a default, which may include acceleration, cross-default and enforcement of security, are legitimate considerations in the board's assessment of what is in the company's best interests. Section 76(4) of the Companies Act also provides a measure of protection - a director who has taken reasonably diligent steps to become informed, has no material personal financial interest in the matter (or has complied with section 75) and had a rational basis for believing, and did believe, that the decision was in the best interests of the company, is regarded as having satisfied the duties to act in the company's best interests and with the required care, skill and diligence.
As such, the result is a potential disconnect between influence and accountability; one party may possess significant influence over the outcome of a decision, while another bears legal responsibility for the consequences of managing the company's affairs. Although a lender’s exercise of contractual consent rights will not ordinarily give rise to liability merely because it constrains the board’s decision-making, circumstances may arise in which the manner in which those rights are exercised warrants closer scrutiny. Depending on the terms of the financing agreement and the lender’s conduct, potential avenues of accountability may include contractual liability for breach of an express obligation such as a requirement that consent should not be unreasonably withheld or delayed or an obligation that imposes a duty to consider and act in good faith at all times. Further, delictual liability may be imposed on the lender where the requirements of wrongfulness and fault are fully satisfied. Liability may also be imposed, without limitation, under applicable statutory provisions such as section 424(1) of the Companies Act where any person knowingly participates in the carrying on of a business in a reckless manner, with intent to defraud a company’s creditors or creditors of any other person or for any fraudulent purpose.
None of this suggests that lender protections are inappropriate. The question is not whether lenders should be permitted to protect their commercial interests. Rather, it is whether there comes a point at which contractual protections begin to blur the distinction between influence and authority.
There is no easy answer. The issue sits at the intersection of freedom of contract, acting in good faith in the context of contractual agreement and corporate governance. What is clear, however, is that financing arrangements do not displace the statutory responsibilities of directors. A board may agree to restrictions on how a company conducts its affairs, but it cannot contract out of the obligations imposed on it by law. For borrowers, the challenge is therefore not merely to secure funding but rather, it is to ensure that, in doing so, they do not inadvertently constrain the very decision-makers whom the Companies Act charges with managing the company.
Much of the tension between the interests of lenders and the company can, however, be managed at the negotiating stage. Borrowers should, where possible, seek consent rights that are expressly "not to be unreasonably withheld or delayed" (with deemed consent if the lender does not respond within a reasonable stated period), coupled with deemed-consent mechanisms where the lender fails to respond within a specified period, appropriate thresholds and permitted-transaction carve-outs for ordinary-course business activities and majority rather than unanimous lender approval in syndicated facilities. Whether a lender's discretion is "sole" or "reasonable" matters. Where the agreement is silent, our courts will generally require a contractual discretion to be exercised reasonably and in good faith, but an express "sole" or "absolute" discretion leaves considerably less room for challenge. Boards, in turn, should ensure that decisions taken in the shadow of a lender veto are properly deliberated and minuted against their statutory duties, including the consideration given to the consequences of default and the potential implications for the company’s financial position.
In the next instalment of this series, we consider how the courts have approached this question and the lessons that can be drawn therefrom.
