Absa Bank Limited v Kernsig 17 (Pty) Ltd

Kernsig owned a farm (Karoovlakte) which it leased to a partnership (Karoovlakte Boerdery) formed by its two sole directors and shareholders, the Greyling brothers. Absa granted the partnership overdraft and loan facilities, secured by six covering mortgage bonds over the farm registered in Absa's favour, totalling R1.11 million. The Greylings entered into a sale agreement to sell their shareholding in Kernsig to the Barnards. The transaction was structured so that the Barnards would take over the partnership's financial obligations to Absa. On 8 December 2005, Absa approved a loan of R1.1 million to Kernsig (applied for by Barnard on behalf of Kernsig with the Greylings' knowledge), secured by the existing mortgage bonds. The proceeds were used to pay off the partnership's debts. The Barnards later repudiated the sale agreement in February 2008 and vacated the farm. After selling the farm to another buyer in May 2008, Kernsig demanded cancellation of the mortgage bonds, claiming the partnership's debts had been extinguished. Absa refused, asserting the bonds secured Kernsig's loan of R1.25 million. Kernsig approached the court seeking cancellation of the bonds.

• Whether the loan agreement of 8 December 2005 contravened section 38(1) of the Companies Act 61 of 1973
• Whether sufficient facts were pleaded and before the court to determine the section 38 issue
• Whether a court can take the point of illegality mero motu in the absence of proper pleadings and sufficient facts
• Whether the mortgage bonds should be cancelled

The appeal succeeded with costs, including costs consequent upon employment of two counsel. The order of the full bench was set aside and replaced with an order dismissing the appeal with costs, including costs of two counsel.

A section 38 inquiry under the Companies Act 61 of 1973 is fact-based and requires all necessary and relevant facts to be properly pleaded and before the court for determination. While courts have a duty to take the point of illegality mero motu, they can and will only do so if the illegality appears ex facie the transaction or from the evidence before it, and only if satisfied that all necessary and relevant facts are before it. In motion proceedings, where affidavits constitute both evidence and pleadings, a party cannot succeed on a section 38 challenge raised obliquely or for the first time on appeal without having properly pleaded it and placed all necessary facts before the court.

The court referred to the purpose of section 38, citing Lewis v Oneanate (Pty) Ltd and Gardner & Another v Margo, noting that the main purpose is to protect creditors and minority shareholders by preventing a company's resources being used to purchase its own shares, as this may deplete the fund to which creditors can look for payment. The court also noted the tendency to give section 38 a narrow interpretation despite its wide terms, observing the distinction between "ultimate goal" and "direct object" of a transaction established in Gradwell (Pty) Ltd v Rostra Printers Ltd - only the direct object is relevant for section 38 purposes. The court cited Schreiner JA's principle that the question depends not on how the company obtained money, but on what it was to do with the money when available. The court observed that the full bench itself acknowledged that relevant documents and facts were not before it, yet still proceeded to find a section 38 contravention, which was inconsistent with the fact-based nature of such inquiries.

This case establishes important procedural principles regarding section 38 of the Companies Act 61 of 1973 challenges in motion proceedings. It emphasizes that: 1. Section 38 contraventions must be properly pleaded and cannot be raised for the first time on appeal without adequate factual foundation. 2. Courts require all necessary facts before them to determine section 38 contraventions, as the inquiry is inherently fact-based. 3. While courts have a duty to take illegality points mero motu, this duty only arises when illegality appears ex facie the transaction or when all relevant facts are properly before the court. 4. In motion proceedings, the principle that affidavits constitute both evidence and pleadings requires parties to properly plead their case, including allegations of illegality under section 38. The judgment reinforces procedural fairness requirements and prevents parties from ambushing opponents with new legal arguments not properly raised in the pleadings, particularly on complex fact-dependent issues like section 38 contraventions.