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6. EFFECT OF SEQUESTRATION ON UNCOMPLETED CONTRACTS

AND LEGAL PROCEEDINGS NOT YET FINALISED

6.1 Uncompleted contracts

If an insolvent has entered into a contract(s) with a third party before he went insolvent
and has not performed in terms of that contract or has not performed in full; and thereafter
went insolvent, what happens to that contract? This section considers the legal issues
surrounding this issue.

In the absence of a statutory provision stating otherwise, a contract is generally not

terminated automatically by the sequestration of one of the contractants (see Bryant &
Flanagan (Pty) Ltd v Muller). The insolvent estate vests in the trustee and he must decide
whether to perform in terms of the contract or not (see Bryant & Flanagan (Pty) Ltd v
Muller). This means that the trustee has the choice to render specific performance (as
stipulated in the contract whatever that may be) or not. He will make this decision
depending on whether it will benefit the general body of creditors. [Performing in terms of the
contract = specific performance]

 If the trustee decides TO PERFORM in terms of the contract he steps into the
shoes of the insolvent and is bound to fulfil all the insolvent’s obligations as if he
were the insolvent (see Bryant & Flanagan (Pty) Ltd v Muller - trustee cannot accept the
contract on the one hand, but act in a manner that disregards the rights of the third party on the
other. If the trustee accepts the contract he is obliged to honour it.).

If the trustee accepts the contract, not only must he honour it by rendering
performance himself, but he is entitled to demand from the other contractant any
performance which that party is obliged under the contract to make. Further, any
defects in the rights that the insolvent held are taken over by the trustee and are
now rights with defects in the hands of the trustee and any defences that the other
contractant had against the insolvent can similarly be used against the trustee.
Thus, the trustee takes the rights under the contract as they are, he is afforded no
better rights by virtue of his position as trustee. (see Bryant & Flanagan (Pty) Ltd v
Muller).

The cost of making this performance is considered to be an administration cost to

be paid out of the insolvent estate. If it eventually turns out that the insolvent
estate cannot carry this cost then the creditors (who have proved their claims
against the insolvent estate) must contribute to the cost. The trustee must
therefore think very carefully before deciding whether to perform in terms of an
uncompleted contract or not as it may have a negative impact on the creditors.

 If the trustee decides NOT to perform in terms of the contract, he then repudiates
(rejects) the contract. This repudiation does not amount to a cancellation of the
contract. Repudiation is merely the trustee’s refusal to perform according to the
specific terms of the uncompleted contract due to reasons that he believes will be
in the best interest of the general body of creditors.

The other contractant, therefore, cannot force the trustee to perform in terms of the
contract (because the trustee has the right to make this decision). The other
contractant has 2 choices: He can either:
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1) Accept the repudiation – ie accept that the trustee does not want to fulfil
the obligations under the contract and consider the contract as terminated.
Restitutio in integrum must occur where the contractant and trustee each
give back to each other any performances made (if there were any). The
contractant can in addition sue the insolvent estate for any damages he may
have suffered in the process on the basis of breach of contract. He will only
be ranked a concurrent creditor (not of high priority) and receive very little if
anything. In fact, he may probably incur more legal costs instituting the law
suit against the insolvent estate to sue for the damages than the amount of
damages he will receive. [due to the fact that his claim for damages will be at the
bottom of the list of creditors with claims against the estate as concurrent creditors get paid
last].

2) Reject the repudiation – ie reject / disregard the fact that the trustee does
not wish to fulfil the obligations under the contract. If this is the contractant’s
reaction then he must make all performance that the contract so stipulates
from him, since according to him the contract is still alive and operative.
Since no specific performance will be forthcoming from the trustee and
since the contractant cannot force the trustee to perform in terms of the
contract (actual specific performance – eg complete construction of house),
his only other contractual remedy is a substituted specific performance in
the form of monetary performance where the trustee is liable to pay the
monetary value of the specific performance (eg monetary value of
completing construction). The contractant will, however, also be ranked as
a concurrent creditor of the insolvent estate and may receive little or nothing
from his substituted specific performance claim against the insolvent estate.

Discussed above are the general principles under the common law pertaining to general
uncompleted contracts. Sometimes special rules (which are slightly different) apply in
specific contracts which are regulated by the Insolvency Act, other statutes or other
principles of common law:

6.1.1 Immovable property

If the BUYER of immovable property is placed under sequestration before the transfer
of the property occurs, the position is governed by s35 of the Insolvency Act. The
content of s35 is exactly the same as explained above (ie trustee has the right to
perform in terms of the contract or reject it) with the only difference being that,
according to s35, if the trustee has not made his decision known timeously the other
contractant (in this case the seller of the immovable property) can call upon the trustee
in writing to make a decision. The trustee then has 6 weeks from the receipt of the
notice to make his decision known. If he fails to do so by the expiry of this time, the
seller may apply to the court for cancellation of the contract; for an order directing the
trustee to restore possession of the property to the seller (if the trustee was in
possession) and to make any order which the court thinks fit.
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If the SELLER of the immovable property is the person whose estate is being
sequestrated the situation is different. The Insolvency Act does not regulate such a
situation and common law must thus be applied.

According to the common law when the seller has entered into a contract for the sale
of immovable property, but is sequestrated before the transfer of the property, the
property vests in the trustee who may decide to perform in terms of the contract and
transfer the property OR he can repudiate the contract.

If the trustee performs in terms of the contract, the sale and transfer of the property
occurs as it ordinarily would (this is good for the buyer).

If the trustee decides to repudiate the contract and the buyer accepts the repudiation
he will only have a concurrent claim against the insolvent estate for any money that he
has already paid in terms of the contract as well as a concurrent claim against the
insolvent estate for damages he may suffer due to the trustee’s breaching of the
contract if he accepts repudiation.
If the buyer does not accept repudiation then he only has a concurrent claim for a
substituted specific performance sounding in money.

As has been discussed above, whether the buyer accepts or rejects the trustee’s
repudiation, he is still not in a strong position as a concurrent claim is not a high
ranking priority claim and the buyer may get little or sometimes nothing out of the
insolvent estate (in which case he will have to bear his own loss).

This consequence can be particularly harsh to the buyer if he was buying the property
by way of instalments – he may have already paid the bulk of the purchase price by
the time the seller’s estate is put under sequestration. The legislature has fortunately
come to the rescue of the purchaser in this instance in chapter 2 of the Alienation of
Land Act 68 of 1981.

According to s1 of the Alienation of Land Act, the protection is only afforded to buyers of
land in terms of a contract of sale payable by instalments where the price is payable in
two or more instalments over a period exceeding one year.

According to s22 of the Alienation of Land Act, the buyer may compel the trustee of the
insolvent estate to pass transfer of the land to him (should he want to continue with the
contract), provided he arranges to pay all transfer costs (of the property), together with the
costs of whichever is the larger of:

(a) all amounts owing under the contract (whatever they may be); or

(b) the sum of the following costs: the administration costs in respect of the land [as set out
in s89(1) of the Insolvency Act]; PLUS any endowment, betterment or enhancement levy,
development contribution or similar imposition, payable in relation to the land PLUS the
amount required to discharge any mortgage bond on the land, including interest to date of
transfer.

The buyer must make arrangements to pay the relevant amounts to the satisfaction of the
trustee, and within such period (which must not be less than 30 days) as the trustee may
allow.

According to s20(5) of the Alienation of Land Act, if the buyer decides not to compel the
trustee to transfer the property [perhaps the transaction does not prove to be advantageous to him
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once he has calculated the total transfer cost and addition costs (a or b above)] then the trustee may
realize the property as he ordinarily would. Section 20(5), however gives the buyer a
preferent claim in respect of the proceeds of the sale for repayment of the instalments
paid to the seller.

Section 28(1) of the Alienation of Land Act also allows the buyer to have a preferent claim
to recover the interest on the instalments made; AND
Reasonable compensation for either:

(a) necessary expenditure the buyer has incurred in preserving or improving the land; or

(b) any improvement which enhances the market value of the land and which was
effected with the consent of the seller.

6.1.2 Instalment sale transactions

In instalment sale agreements (also known as hire purchase or h/p agreements) the
buyer possesses and uses the property immediately and pays for it in instalments.
Ownership, however, vests in the seller and is only transferred to the buyer upon
payment of the final instalment. What happens if one of the parties is placed under
sequestration?

If the BUYER is placed under sequestration then s84 of the Insolvency Act applies.
But s1 of the Credit Agreements Act 75 of 1980 which defines an instalment sale
transaction must first be met before one can classify a particular transaction an
instalment sale transaction and apply s84.

Thus s1 of the Credit Agreements Act states that an instalment sale

transaction means a transaction in terms of which

a. goods are sold by the seller to the purchaser against payment

by the purchaser to the seller of a stated or determinable sum
of money at a stated or determinable future date or in whole
or in part in instalments over a period in the future; and

b. the purchaser does not become owner of those goods merely by

virtue of the delivery to or the use, possession or enjoyment
by him thereof…. [ownership is therefor reserved, usually until final
payment is made].

It is common sense that ownership of the property still vests in the seller (since the
final instalment would not have been paid by the buyer) BUT s84 brings about the
strange effect of divesting the seller of his ownership in the property and vesting it in
the trustee and in its place creating a hypothec over the property in favour of the
seller. The hypothec serves to secure the seller’s claim for the balance of the
outstanding amount still owing under the instalment sale transaction. However, in our
law one cannot have a hypothec over one’s own property and that is why the
ownership of property must pass to the trustee. (see Ukubona 2000 Electrical CC v City
Power Johannesburg (Pty) Ltd)
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The hypothec entitles the seller to demand that the trustee take possession of the
property from the buyer (the insolvent) or any third person who may be in possession
of it (see Venter NO v Avfin (Pty) Ltd) and deliver it to the seller so that he may hold it as
security for the outstanding balance. Should the insolvent estate be unable to pay the
amount owing he has the right to realise the property in lieu thereof.

If the property was sold in excess of what is owing under the instalment sale
transaction, the excess must be paid to the insolvent estate.

 In essence s84 takes from the seller his right of ownership in goods (ownership
passes to the trustee) and replaces it with a diminished right – that of a hypothec over
the goods that he once owned.

If the SELLER is placed under sequestration the common law applies as the
Insolvency Act is silent on this kind of scenario. The common law states that since
ownership of the property still vests in the insolvent (since the final instalment would
not have been paid) ownership will now vest in the trustee and he has the right to
either perform in terms of the contract or not.

If he elects to perform in terms of the contract and thus continue with the instalment
sale agreement, he must fulfil all the insolvent’s obligations under the contract,
namely, seeing to it that the instalments are paid promptly and to take necessary
steps if the purchaser defaults and to permit ownership to pass to the purchaser upon
the final instalment payment. In the majority of cases the trustee will probably elect to
keep the contract in force (provided that the purchaser pays his instalments regularly
and complies with his other obligations in terms of the agreement). A trustee would
rarely compel a sound and non-defaulting purchaser to surrender the article only to
sell it, (now a second-hand article), probably at a loss, to some possibly less reliable
purchaser; and at the same time possibility involving the estate in a claim for damages
for breaching the contract with the original (first) purchaser.

If the trustee decides not to perform in terms of the contract, he may reclaim the
property in the buyer’s possession and realise it for distribution amongst the creditors.
The buyer may not sue the trustee for specific performance (as has already been
discussed above), but the buyer will have a concurrent claim for damages for breach
of contract / substituted specific performance against the insolvent estate [depending on
whether the seller accepts of rejects the trustees repudiation] but as we know that is cold
comfort as a concurrent claim is not a high ranking priority claim.

6.1.3 Lease agreements

The general principle applying to leases regardless of whether the estate of the lessee
or the lessor is under sequestration is to be found in s37(5). This section provides
that any stipulation in a lease making provision for the lease to be terminated or varied
on the sequestration of either of the parties is null and void. The reason for this is that
it takes the decision out of the hands of the trustee. It seems as if the word ‘lease’ is
not restricted to immovable property only, but also includes movable property (see
Montelindo Compania Naveira SA v Bank of Lisbon). Consider now the effect of
sequestration on the lessee and lessor respectively:
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When the estate of the LESSEE is placed under sequestration s37 of the Insolvency
comes into operation. The trustee may decide to continue with the lease or terminate
it. The trustee can terminate the lease in one of two ways: Either in terms of s37(1)
by giving notice in writing to the lessor; or in terms of s37(2) if after three months of his
appointment he does not notify the lessor of his intentions he is deemed to have
terminated the lease (see Montelindo Compania Naveira SA v Bank of Lisbon). If the
trustee decides to terminate the lease s37(1) entitles the lessor to a concurrent claim
for damages by virtue of the cancellation of the lease.

If the trustee desires to continue with the lease he must notify the lessor of this
intention. Notification need not be in writing, but must be given formally with the
purpose of being understood as such. The effect of this is that the trustee must abide
by the terms of the lease, the most obvious being that he must pay the rent under the
lease.

The Insolvency Act does not govern the situation where the estate of LESSOR is
placed under sequestration [except for s37(5) see above]. The common law thus
applies. Of course the trustee must sell the property being leased so that the
proceeds can be distributed amongst the creditors, but what about the lessee leasing
the property? According to the common law principle ‘huur gaat voor koop’ (lease
goes before sale – ie the lease takes priority to the sale) the property must be sold
subject to the lease and the purchaser of the property is bound to all the terms and
conditions of that lease, for example, if the lease entitles the lessee the option to
renew the lease, the purchaser is obliged to allow the lessee to exercise the option to
renew the lease. The lessee is hereby protected if the lessor is placed under
sequestration.

BUT: The common law ‘huur gaat voor koop’ principle may fall away and the lessee
may lose his protection if the property is subject to a mortgage bond which was
passed prior to the lease. If the property is subject to such a mortgage bond the
mortgagor enjoys a priority over the lessee. The trustee must initially put the
property up for sale subject to the lease and if the highest offer of purchase is not
sufficient to cover the amount of the mortgage bond, then the trustee must put the
property up for sale free of the lease [keep in mind that prospective buyers may be put off by the
fact that there is a lease over the property and the property may therefore not fetch a high enough price
sufficient to cover the mortgage bond]. The lease agreement would then be terminated
prematurely. The lessee would, however, have a concurrent claim against the
insolvent estate for any damages which he might have suffered as a result of the
breach of the contract of lease.

6.1.4 Employment contracts

If the estate of the EMPLOYER is placed under sequestration s38 of the Insolvency
Act applies. In terms of s38(1) the effect is that the employment contracts of the
employees are suspended as from the date of the granting of the sequestration
order. In terms of s38(2) during this period of suspension the employees are not
obliged to render services, but neither are they entitled to their wages, salaries, or
employment benefits. The employees may, however, in terms of s38(3) receive
unemployment benefits in terms of the Unemployment Insurance Act from the date
of the suspension, and in terms of s38(10) have a concurrent claim for damages
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from the insolvent estate for any loss that they may have suffered as a result of the
suspension.
In s38(4)-(7) the Act gives the trustee of the employer’s estate the power to terminate
the employees’ contracts of service provided he has engaged in consultation (with
relevant parties like registered trade union reps, workplace forums or the employees
themselves if none of these representatives exist) as required by the Act with a view to
reaching consensus on appropriate measures to save or rescue the whole or part of the
employer’s businesses. Note that some of this is regulated by the Labour Relations Act
66 of 1995.
The point of doing is to prevent the situation where employees suddenly find themselves
jobless. Without prejudicing the creditors it must be investigated whether there is a
possibility of saving some jobs, for example, by transferring the business or part of the
business as a ‘going concern’ where the employees can stay on and work for the new
employer.
In terms of s38(9)(a) if the trustee and the parties that he must consult with cannot
agree on a measure that results in continued employment, the employees’ contracts
(which have been suspended) terminate automatically 45 days after the date of the
trustee’s appointment (unless the trustee makes arrangement to terminate the contracts
earlier). In terms of s38(10) the employees, whose contracts of employment have been
terminated by the trustee, have a concurrent claim against the insolvent estate for
damages should they have suffered any loss due to the trustee’s breaching of the
contracts of employment by virtue of its termination.

If the estate of the EMPLOYEE is under sequestration the position is quite different as it
clear from s23(3) of the Act that an insolvent employee is entitled to work or render
professional services with the exception of carrying on business as a trader who is a
general dealer of a manufacturer (See topic 4).
Sequestration, however, does have the effect of terminating certain the positions of
certain employee, although these are employees holding office. In terms of s47(3)(a) of
the Constitution, a member of the National Assembly must vacate his seat if his estate is
sequestrated, and according to s106(1)(c) of the Constitution, so must a member of a
provincial legislature.
In terms of s218(1)(d)(i) a director of a company; and in terms of s58(a) of the
Insolvency Act a trustee are obliged to vacate their respective offices on the
sequestration of their estates, and according to s10(e) of the Land and Agricultural
Development Bank Act the same would seem to apply to a member of the board of the
Land and Agricultural Development Bank of South Africa.
It would appear that, other than in these cases, and unless the parties have agreed
otherwise, the relationship of employer and employee does not terminate on the
employee’s insolvency, provided the insolvency does not affect the employee’s fitness
to act.

6.2 Legal Proceedings not yet finalised

 Criminal proceedings: unaffected.

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 Civil proceedings: except for those proceedings which the insolvent may pursue in
his own name (eg divorce) in terms of s20(1)(b) all other civil proceedings by or
against the insolvent are stayed (postponed) until a trustee is appointed.

In terms of s75 if any party wants to continue suing the insolvent he must give
notice of his intention to the trustee 3 weeks after the first meeting of creditors.
Within another 3 weeks after the notice the party should go ahead with the
proceedings with reasonable speed. If notice is not forthcoming the proceedings
automatically lapse, unless the court sees a reasonable cause for the failure to
give notice. Also the trustee must be substituted for the insolvent so that the
proper person is before the court at the hearing.

*Note: Some parts of these notes are an adaptation of:

R Sharrock ‘Insolvency’ in LAWSA 2ed vol 11 (2008) Durban, LexisNexis Butterworths.