Conversations and agreements – when are they binding?

Conversations and agreements – when are they binding?

Introduction

A major cause of disputes occurs over the content of agreements. Sometimes these disputes are a result of poorly drafted contracts; content and deliverables not being adequately described; or as a result of variations to the original contract. Another source of dispute is verbal contracts and conversations where the parties dispute the content of what was agreed upon.

Both verbal and written contracts are, in general, legally binding. However, sometimes writing is unavoidable and is a formality for the contract to be valid, for example: the sale of immovable property, antenuptial contracts, wills and executory donations. Along with the preceding list, all documents that have to be submitted to and registered with the Deeds Office must also be set out in writing.

Written contracts have various advantages, among others, they:

  • ensure that both parties are fully aware of the contents of their agreement;
  • create transparency between the parties;
  • create and maintain trust between parties;
  • can stipulate formalities that must be met for validity; and
  • serve to avoid unnecessary disputes.

Electronic communication

The Electronic Communications and Transactions Act 25 of 2002 (“ECTA“) recognises electronic messages (or “data messages“) as the functional equivalent of writing, meaning that data messages have the same legal validity as content written on paper. This results in any formality requiring writing to be met when the information is in the form of a data message. ECTA, however, imposes a requirement of accessibility to accompany data messages by requiring data messages to be easily accessible to the parties thereto.

The validity of electronic messages was confirmed by the Supreme Court of Appeal (“SCA“) in November 2014 in the case of Spring Forest Trading v Wilberry (Pty) Ltd. The court held that variations to an agreement between the parties made via email were binding – the arguments put forth were that the variation to the agreement was required to be made in writing and signed by both parties in order for it to be valid and that this requirement had not been met because the variations were only discussed and agreed to via email. The court stated that the email signatures at the bottom of the emails amount to signatures and that the email messages constituted writing in terms of ECTA.

Conclusion

Written contracts are always recommended. The rationale being that oral agreements offer no objective or clear record of the details of the agreement and the specific terms are often difficult to establish when a dispute arises. Well drafted agreements should include useful information and guidance to the parties to ensure a fair and smooth resolution of disputes or disagreements. The guidance information should address when parties may cancel the agreement, what constitutes breach and how the breach should be remedied.

Written agreements should also set out that any changes to the agreement are not valid if they are not in writing (and signed by both parties) – which prevents disputes over any amended terms of the agreement. This also prevents quarrels of a “he said, she said” nature as everything has been recorded. As set out above, this can be done via email or other electronic messages, including Whatsapp, for example, however, the name of the sender must be signed at the end of the message for it to be valid.

It is important to understand that following the abovementioned judgment, parties to a contract should specifically refer to an “advanced electronic signature” – which is a special signature provided for in ECTA – being required to amend the agreement if the intention is for the usual email type correspondence not to effect an amendment to the agreement.

Remember, you could be bound to a contract where you have willingly signed it even if you have not yet read it.

Important take-aways

  • electronic communication is legally binding and is the equivalent of writing;
  • some agreements can only be altered if the variation is in writing and signed by both parties;
  • some agreements must be in writing and signed (and sometimes commissioned or notarised) in order to be valid and binding; and
  • oral agreements are binding (but not advised!).
The difficulties involved in setting up and managing Section 12J Venture Capital Companies

The difficulties involved in setting up and managing Section 12J Venture Capital Companies

“Section 12J Venture Capital Companies” (Section 12J VCC) seem to be a bit of a buzz phrase doing the rounds in the South African entrepreneurial world at the moment. We have had several requests from new and existing clients to set one up, mainly because of the attractiveness of these structures to investors.

A Section 12J VCC is a company formed in terms of section 12J of the Income Tax Act, 1962 (ITA) – it is essentially a pooling mechanism created by the South African Revenue Service (SARS) to encourage largely high net worth individuals to invest in start ups. The incentive to invest in a Section 12J VCC comes from the fact that investors get a full tax rebate on the funds invested into the Section 12J VCC. So, if a person in the highest tax bracket (presently 45%) invests R 1 million, they will get a tax rebate of R 450,000, meaning that the net investment is R 550,000.

The Section 12J VCC itself is relatively simple to set up, but the real complexity and difficulty comes with the management of it. The legislators have included several anti-avoidance provisions in section 12J of the ITA, which have made it particularly difficult, and in our experience prohibitive, for anyone to manage and run a Section 12J VCC. In fact, at the moment, there are only fifty six Section 12J VCCs approved by SARS and according to the information that we have gathered, and less than half of those are actually trading. It is interesting to note that the legislation allowing these funds was put in place in 2009 – that equates to, on average, seven of these companies formed (not necessarily even operating) every year since inception.

So why is it so difficult to get a Section 12J VCC off the ground? Below we have highlighted some of the major difficulties that some of our clients have had:

  1. No investor into the Section 12J VCC may be a “connected person” in respect of the Section 12J VCC, which essentially means that a natural person cannot own 20% or more of the shares in the Section 12J VCC (directly or indirectly) and a company can own up to 50%, in limited circumstances, of the Section 12J VCC (directly or indirectly), but no more.
  2. No more than 20% of the capital raised through the issue of shares may be invested into any one investee company.
  3. An investee company cannot be a “controlled group company”, meaning that a Section 12J VCC cannot own 70% or more of the equity shares in an investee company.
  4. To be recognised by SARS, the Section 12J VCC must be registered in accordance with section 7 of the Financial Advisory and Intermediary Services Act, 2002 (FAIS), meaning that the company must have a “key individual” in its employment and the Financial Services Board must issue it with a certificate.

There are many more nuances to a Section 12J VCC that we have not highlighted here as they are too lengthy to get into, but they also make for significant barriers to entry.

Regarding point one above – the issue of being a “connected person” – this provision was clearly put in place to avoid situations where a single investor uses this platform to invest in a company where he ordinarily would have done so in any event, but he simply sets up a Section 12J VCC to reap the tax benefit on an investment that he was always going to make.

What we have seen is that there are legitimate arm’s length transactions where investee companies are told that the investor will only invest in them if they are able to use the section 12J of the ITA structure and because of the anti-avoidance restrictions, investee companies are losing out on a potential investment as it is often not possible for this to be done.

Regarding points two and three above, Section 12J VCCs are often restricted in the manner that they can invest when they see a good potential investee company, as they cannot invest more than 20% of their raised capital into the investee company. This means that investee companies can, and do, miss out on obtaining more funding or any funding altogether.

It can also prevent arm’s length investors from investing into one investee company, as they cannot use the Section 12J VCC vehicle to invest into a qualifying investee company because they cannot own more than 70% of the investee company and they cannot use more than 20% of the funds raised in the Section 12J VCC to invest in the investee company. The investor also cannot hold 20% or more of the equity shares in the Section 12J VCC.

The final point is possibly the most difficult, FAIS approval is difficult to obtain as you must have a person who fits the criteria to be a “key individual” in terms of FAIS, which requires experience in the industry and further study. With the fast pace of the business environment, it is often too much of a hurdle to cross to find a party with the correct industry experience to write the exam and become qualified as a key individual.

If you have a legal team that thinks laterally about it, there are ways to manoeuvre within the compliance framework, but even then, there are limitations to the extent that it can be done.

Section 12J VCCs look very attractive from the outside, but when you scratch below the surface, there is a structure that is complex and difficult to manage and balance, which is probably the reason that they have not taken off in South Africa yet. That is not to say that forming a Section 12J VCC cannot be done, as we have assisted in setting up several of them, but it is worth considering it a little bit deeper to see whether this is going to be the best structure for you.

Software-as-a-Service (SaaS) – understanding some of the aspects of this technology model

Software-as-a-Service (SaaS) – understanding some of the aspects of this technology model

As commercial law attorneys, much of our work is helping tech start-ups negotiate and draft software agreements. There is no doubt that the emergence of Software-as-a-Service (SaaS) – often referred to as “cloud computing” – has been one of the most profound technological developments in the commercial software industry.  It is shaking up traditional software vendors and it is expected to continue disrupting traditional businesses. Think “Slack”, “Trello”, “Salesforce”, “Stripe” and “Dropbox” – these are all SaaS enterprise applications delivered over the internet.

This article will provide a basic overview of SaaS and some of the legal aspects tech start-up founders need to understand when negotiating and preparing their SaaS agreements.

What is “SaaS” and SaaS Agreements?

Software-as-Service is a software distribution model with which a business hosts software applications and makes them available to customers over the internet.  The agreement or contract that governs the access and use of the software service and describes the rights and obligations of the parties is referred to as a SaaS agreement. The SaaS agreement differs from your typical software license agreement because SaaS is not a license to use the software, but rather is a subscription to software services and allows remote software access.

Benefits of SaaS

Low set-up cost: SaaS removes the need for organizations to install and run expensive software applications on their computers and data servers. It eliminates the expenses associated with hardware acquisition and maintenance, as well as software licensing, installation and support costs.

Payment flexibility: rather than purchasing software to install, or additional hardware to support it, customers subscribe to a SaaS offering. Typically, customers pay for this service on a monthly subscription or utility basis i.e. the number of users who has access or the number of online transactions.

Highly scalable: cloud services like SaaS offer high scalability. Upgrades, additional storage or services can be accessed on demand without needing to install new software and hardware.

Automatic updates:  customers can rely on a SaaS provider to automatically perform updates and software improvements and modifications, which are generally free of charge.

Accessibility:  customers aren’t restricted to one location and can access the service from any internet-enabled device and location.

Software Licencing Model vs SaaS Model

Software license agreements are used when a proprietary software is being licensed by the licensor to a licensee.  The licensee purchases the software and receives a right to install, download and use the software. The licensor owns all the intellectual property rights in the software and related documentation.  A license is a limited grant of use those rights.

With SaaS agreements, the customer does not download or install copies of the software, but remotely accesses and uses the software by logging into the software provider’s system.  The software provider hosts the software either on its server or in the cloud and provides a service to the customer which consists of hosting its software, performing services to support the hosted software and granting access to the hosted software.

Important legal aspects to consider in your SaaS Agreement

SaaS agreements can touch upon nearly every area of the law, but broadly, a SaaS agreement should include clauses regarding: the services provided; the parties who will have access to the service; user obligations and prohibited use; payment terms; data collection and personal information; termination; service levels; maintenance and support services; disclaimers and liability; and intellectual property rights.

We discuss a few of these below:

Limitation of liability

The most important provision of any SaaS agreement is the liability clause as liability presents itself in many forms. What if the SaaS service is hacked or the subject of a cyber-attack and the customer’s sensitive confidential data (including banking details) is stolen? Are you going to indemnify and hold the customer harmless for all the damages suffered as a result of the data breach? Limitation of liability explains the extent of damages your customer can seek against you and how much they can sue you for. A well-drafted limitation of liability cannot be overstated!

Service levels

An important consideration is whether the SaaS service is going to be up and running and functioning for a guaranteed minimum amount of time. Service level agreement or commitments are very common in any SaaS agreement. Generally, the SaaS provider guarantees that the service will be up and running for 365 days a year 99% of the time, for example. Your company will need to consider what type of service guarantees and commitments it will be making in terms of its service “uptime” and “downtime”.

Maintenance and support

What types of maintenance and support services will your company be providing? Will you be guaranteeing bug fixes in a timely manner, providing customer support via email and telephone or periodic software upgrades and maintenance? These are issues that need to be considered and which will affect your agreements with your customers. To this end, the contact details, extent of support and troubleshooting methods offered by the provider should be recorded in your agreement.

Upselling and upgrading

You should consider including language in your agreement that allows for future orders or “up-sales” from the customer. By specifying that “up-sales” or upgraded orders from the customer will be governed by the agreement, you avoid having the customer sign or click through another agreement if they purchase additional services, upgrades or expand their usage.

Conclusion

A SaaS agreement is designed to be a comprehensive document and as such, companies should pay careful attention to the multiple aspects of the agreement that set out their liability, responsibilities and obligations. Failing to include or properly define a crucial clause can have serious legal implications on a business’ risk, reputation and commercial relationships.

If you require any assistance in preparing any SaaS, software development or any other software related agreements don’t hesitate to contact us.

 

Due diligence: an inevitable destination on any start-up’s yellow brick road to investment success

Due diligence: an inevitable destination on any start-up’s yellow brick road to investment success

In the age old classic, The Wizard of Oz, Dorothy is advised to follow the yellow brick road through the surreal and unfamiliar world of Oz until she reaches the Emerald City. Red boots and all, she, together with her travel companions, set out on this journey, facing some unnerving scenarios along the way. Sound familiar?

Although not written with start-ups in mind, this story can easily serve as a metaphor to illustrate the fascinating world start-up entrepreneurs must navigate on the “yellow brick road” to their next “Emerald City” destination – be it funding rounds, impossible deadlines, incubator pitches or that big exit – this journey has it all. One of the most important, however, not-so-often-discussed, destinations on this “yellow brick road” are due diligence investigations. This article explains why start-ups (or investors) should always keep this often-forgotten destination, and its potential impact on future investment success in mind.

What is a due diligence investigation (commonly referred to as a “DD”)?

Startuplawyer.com defines a due diligence as “an investigatory process performed by potential investors or acquirers to assess the viability of an investment or acquisition and the accuracy of the information provided by the target corporation (or start-up)”.

As such, although a due diligence is usually done by the investors, any start-up would be well-advised to consider the due diligence implications of all their actions leading up to that point. Simply put, this starts by ensuring that internal processes are in place to accurately and continuously record, save and timeously update documentation from the get go. More specifically, documentation and official company records, items relating to internal governance procedures, stakeholders’ communications and company information (i.e. organisation information, market size, team structure), key and material agreements, financial management and annual statements, asset valuation, regulatory approvals, product development and proof of intellectual property (IP) protection are all important for the start-up to keep on record. Furthermore, saving these documents in an orderly and easily accessible folder system eases the process of any due diligence investigation, which in turn, speeds up negotiations and valuations, potentially staving off weeks on an investment timeframe.

Why is it important?

Any sensible investor likes to determine beforehand exactly what it is that they are investing into and in doing so, considers various factors, including: compliance with the potential investor’s investment model, the financial position and investment viability of the start-up, material risks related to its business model, management structure, founders’ commitment, company valuation, legal standing and regulatory compliance. In short, investors are eager to get an all-inclusive and well-rounded snapshot of the start-up to encourage them to provide the necessary funding and to see if the two parties fit. Therefore, if a start-up can provide this information accurately and timeously, it may well contribute to investment negotiations being concluded far more easily than anticipated. Both parties are advised to note that due diligences generally take longer than anticipated, but by being adequately prepared and organised many a pitfall can be avoided.

Does a due diligence benefit the start-up at all?

Yes, regardless of whether the investment proceeds, the preceding due diligence is a good trial by fire for any start-up. Usually, by way of the investor providing a due diligence report, concerns or queries are highlighted in detail, providing an objective and holistic view of all the facets contributing to the start-up’s business. This can greatly assist the start-up in determining further strengths, weaknesses, opportunities or threats. Start-ups are, however, advised to not be duped into a due diligence too easily. Especially during early stage negotiations, a commitment from investors (usually in the form of a term sheet) is important to ensure mutual benefits are derived from the due diligence investigation.

Concluding remarks

Although a due diligence is a high level and intense review of the start-up’s business, it need not be a daunting experience. It is important to remember that both the investor and the start-up should benefit from this process – the start-up showing off its true colours, and the investor justifying its investment. As such, communicating honestly to avoid any confusion, disappointment or time wastage is well advised before any due diligence and subsequent negotiations commence. Considering the above, if a start-up is aware and is pro-actively engaging this inevitable destination from the get-go, the due diligence need only be a brief stopover on your “yellow brick road” to the next Emerald City destination.

Website terms – purpose, importance and consequences

Website terms – purpose, importance and consequences

Nowadays, websites almost always contain policies and terms that govern your use of the site. Sometimes these policies will appear as banners on the site (which you have to “agree” to in order to make them disappear), links in the page footer (like we have on our website) or as a statement along with a tick box saying that you have “read and agree with” the terms (usually when transacting online).

The questions on peoples’ minds are firstly, why do I need all these different sets of terms and, secondly, are these policies binding.

Why do we need all of these terms?

The website terms which we feel are important are browser terms, privacy policies and commercial/transactional terms. Each one of these deals with specific aspects of the website’s use, including, for example, the collection of personal information, social media integration, payment methods and your rights as a user of the website. Below we discuss each policy and its importance. These policies also protect your rights and interests in your website and can allow for you to have a claim in law against people who infringe your rights.

Browser terms

Although browser terms are not a legal requirement, they are useful to ensure that the “web surfer” understands and agrees to certain key points. Browser terms should be used to inform the surfer that:

  1. you, as the website owner, owe them no responsibilities;
  2. they get no rights to any services or IP merely by browsing;
  3. they are required to respect your website and the content thereof; and
  4. you comply with all necessary legal disclosure requirements.

Browser terms are “agreed” to through the surfer continuing to browse the website. These types of agreements are called “web-wrap” agreements. More on this below.

Privacy policies

Privacy policies are essential whenever the website collects or makes use of personal information. Personal information is often collected through cookies as well as when browsers become users of a website by creating an account or by integrating their social media accounts with the website.

The Protection of Personal Information Act 4 of 2013 (“POPI”) sets conditions for the lawful processing of personal information. Included in POPI’s ambit will be the mere storage of personal information when it is collected by cookies. POPI also requires that companies make certain information available to users when they collect their personal information. This can be achieved through a privacy policy. Privacy policies therefore also assist the website owner to comply with legal requirements

Privacy policies usually include the following important aspects:

  1. the use of cookies to collect certain information;
  2. the purposes for the processing of the personal information;
  3. the sharing of personal information by the website owner with certain select third parties;
  4. the storage of personal information, including the security measures taken and whether cross-border storage will occur; and
  5. the user’s rights in relation to his/her personal information and the recourse that he/she has.

Privacy policies are, like browser terms, usually agreed to by browsing, however, a recent trend has been to display the fact that cookies are used as a banner on a website requiring a “click-wrap” agreement to be entered into in order to remove the banner.

Commercial/transactional terms

As the name suggests, the commercial terms become applicable where the website enables users to transact with the website owner through the website. These terms serve as the terms of the contract which you conclude with the user when the user becomes a customer. The important aspects that this policy should govern includes:

  1. a general explanation of the service or product being offered by the website;
  2. the fees that are payable, which may be a once off purchase price or a subscription fee, as well as the fees relating to delivery costs, insurance and VAT;
  3. the terms applicable to returns;
  4. limitation of liability, which will be subject to the Consumer Protection Act 68 of 2008 (if it applies);
  5. the applicability of promotional codes and vouchers; and
  6. acceptable use policies, however, this is more applicable where the website offers a service and not a product.

The Electronic Communications and Transactions Act 25 of 2002 (“ECTA“) requires certain disclosures in terms of section 43 by the website owner when goods or services are offered for sale or hire through an electronic transaction. Some of the disclosures required include:

  1. company name, registration number and contact number;
  2. addresses, including physical, website and e-mail;
  3. a description of the main characteristics of the goods/services offered (which fulfils the requirement of informed consent;
  4. the full price of the goods, including transport costs, taxes and any other and all costs;
  5. the manners of payment accepted, such as EFT, cash on delivery or credit card, as well as alternative manners of payment such as loyalty points;
  6. the time within which delivery will take place;
  7. any terms of agreement, including guarantees, that will apply to the transaction and how those terms may be accessed, stored and reproduced electronically by consumers;
  8. all security procedures and privacy policy in respect of payment, payment information and personal information; and
  9. the rights of the consumer in terms of section 44 of ECTA.

ECTA also requires that the customer must have an opportunity to review the transaction, correct any mistakes and withdraw from the transaction without penalty before finally concluding the transaction. ECTA non-compliance gives the consumer the opportunity to cancel the order and demand a full refund.

Additional requirements are placed on suppliers transacting online regarding payment systems. The payment system used must be sufficiently secure in terms of current accepted technological standards. Failure to comply with these security standards can render the website owner liable for any damages suffered due to the payment system not being adequately secure.

Are these policies binding?

Essentially, yes, website terms will be binding based on the principles of contract law. Website users must be made aware of the terms that apply to their use of the website and you should always ensure that you include wording to the effect that by anyone continuing to use the website they agree to the terms.

To this effect, web-wrap and click-wrap agreements come into play.

Web-wrap agreements

Web-wrap agreements (also referred to as browse-wrap agreements) are used to acknowledge the terms of use of a website by continuing to use the website. The user indicates acceptance of the terms by using the website and does not expressly indicate acceptance of the terms. Such agreements are usually used in browser terms and privacy policies.

Click-wrap agreements

Click-wrap agreements require the user of a website to indicate their agreement with the terms through positive action – usually by clicking “I accept” before proceeding with their activity on the website. These agreements are usually used for more important agreements, such as when installing new software on your computer or when entering into online transactions.

Conclusion

Even though all of these policies may seem excessive, they are worth having. Yes, copying and pasting clauses from other policies will get the job done, but you may leave yourself vulnerable to certain consequences that you haven’t thought about. These consequences may be even worse when it comes to commercial terms. Contact us for a free quote and ensure that your online business is fully protected!

Potential oversights of entrepreneurs – protection of intellectual property

Potential oversights of entrepreneurs – protection of intellectual property

Running a business is a tough ask of anyone – between maintaining cash flows, keeping customers happy, managing your employees and looking for potential investors (or dealing with current investors), there is a lot that can fall through the cracks. One of the things that is very easy to forget about, especially with the more modern, technology-heavy businesses, is the protection of your intellectual property (IP).

In the technology sphere, copyright law governs the development of computer software, which is much of what the entrepreneur of today is dealing with. As an entrepreneur, you may come up with a great idea that is going to be the next “Google”. So you call your business partner up and spend countless hours in the office and cups of coffee developing this new idea, whilst running your business at the same time. You come to the end of this, completely overworked, and you have produced the holy grail of products that is going to revolutionise the industry, and you own it, right…? Well, when considering this a little further, that may not be the case.

If your business is a company, you may be in for a surprise – it is probably the company that owns the product that you have just developed and not you personally. If that previous comment made you break out into a cold sweat, not to worry. Below are some factors that you should consider when developing a new idea as a director of or shareholder in a company:

• Did you use the company’s property or time to develop the product? As an example, did you use a company laptop and normal working hours to develop your new product?

• Is the product that you developed substantially similar to other products developed by the company or did you use the company’s software code to make your new product? As an example, if your company develops an app that is involved in data collection in agriculture and you develop an app that collects data in retail, it is likely that because of the common data collection thread, the products are substantially similar. It may also be likely that you “borrowed” some of the code from the previous app to make your new app.

If your answer to both or one of the above is “yes”, then your company probably owns the product that you just developed. This also should not be too much of a problem though. If you and your business partner (if you have one) are the only shareholders in the company, then both of you can just agree to transfer the product out of the company. The only difficulty comes in where you have investors looking for an opportunity to get a return on their investment.

It is not uncommon for investors to factor in protection against the company disposing of any property (including IP) without their consent, as they will almost always want a good return on their investment. You could be stuck in a situation where you have to share the fruits of your labour with the other shareholders in your company, which is not ideal.

A good way of avoiding this is, as soon as you are in the process of obtaining your first round of funding from your first investor(s), introduce a “pay-to-play” option into your company’s shareholders’ agreement. This will essentially provide that any new intellectual property that you are thinking about developing will be offered first to the company and then to any investor, provided that if they want a share in it, they must put some capital into the project, which project can, and should, be placed into a new company.

There are many more layers to this issue, but the long and the short of it is that you should always be wary of losing all your hard work due to a simple legal slip up.

Introducing the SAFE document as a vehicle to raise capital in early-stage South African companies

Our regular involvement in funding transactions for startups in the South African tech space often requires us to implement US-style investment terms and instruments to ensure that we are as relevant as the market needs us to be. In recent months the SAFE document (being an acronym for ‘Simple Agreement for Future Equity’) was introduced in the US venture capital scene and made its way to South Africa fairly quickly, where it has now become a popular method for early stage financing.

The essential terms of this document are that the investor purchases the right to subscribe for preferred shares in the investee company upon the next round of equity funding in the investee company. The most common method of calculating the number of shares to be subscribed for by a SAFE-holder is by applying an agreed valuation cap to the investee company upon issuing the SAFE document to the investor. By way of example, if US$1 million is invested at a valuation cap of US$3 million and the valuation of the company grows to US$5 million by the time the next round of equity funding is done, the SAFE-holder’s US$1 million investment will buy more shares than that of an equity subscriber also investing US$1 million at a later stage.

An alternative to the valuation cap, is to apply a discount rate to the investee company’s valuation upon the next round of equity funding and issuing preferred shares to the SAFE-holder based on the reduced valuation. This discount rate is specified in the SAFE document issued to the investor and has a similar effect to the valuation cap, but is calculated differently. If a 20% discount rate is applied in the scenario above, that means that the investee company’s actual valuation on the next equity round (US$5 million) is reduced by 20% to calculate the preferred shares to be issued to the SAFE-holder. In this case that would mean that the SAFE-holder subscribes at a valuation of US$4 million.

The SAFE document can also include both a valuation cap and a discount rate, in which case the document will state that the method of calculation which results in the greater number of shares issued to the SAFE-holder will be applied. By way of example, based on the scenario above, if a valuation cap of US$3 million and a discount rate of 20% is provided for in the SAFE document, the valuation cap (and not the discount rate) would be applied, as that will result in more shares for the investor.

If the company’s valuation drops to below the valuation cap by the time the next equity round is implemented, the valuation cap is merely disregarded and the SAFE-holder subscribes for preferred shares at the same valuation as the other subscribers.

One of the reasons why SAFE documents were developed is to limit transaction fees by using a simple standardized document, cutting out significant costs, time and effort usually spent on closing equity funding rounds. This also enables the investee company to close transactions with investors (and get the funds needed in the business) one investor at a time, as each investor negotiates separate terms with the investee company. This can prevent the situation of one stubborn investor holding up a whole funding round.

Other positives are that the investee company can offer different valuation caps to different investors, depending on the timing of the investment or even the reputational or experiential value of the investor. Having flexibility in the valuation offered to different investors may be very useful when negotiating with investors who can contribute more to the business than just their monetary investment.

This may all sound very attractive to investors, especially if you consider that the flexible valuation may be a very effective way to reward the risk of very early stage investment with a higher return. However, the picture becomes slightly less exciting if you consider the SAFE-holder’s position in more detail.

Here are some of the obvious areas of concern from an investor’s perspective:

  • The SAFE-holder only subscribes for preferred shares in the investee company upon the occurrence of specified trigger events. These are usually an initial public offering (‘IPO’), the next round of equity funding, any other change of control or the dissolution of the investee company. In the interim period (unlike holders of convertible debt), the SAFE-holder is not a creditor, as the SAFE -document is not a debt instrument (there is no obligation on the investee company to repay the investor, no interest and no security). This means that the investor will have no recourse or further rights unless a trigger event occurs, which can be very problematic if, for instance, the investee company keeps on raising capital by issuing more SAFE documents to third party investors.
  • Unlike convertible loan notes, the SAFE document does not create an option in the hands of the SAFE-holder, as the subscription will happen automatically upon the occurrence of a trigger event. The only exception to this is where an IPO (the SAFE-holder has the option to subscribe for ordinary shares) or other liquidation event (the SAFE-holder has the option to have its investment returned) occurs. This means that a convertible loan note holder will be in a better position than a SAFE-holder, as the convertible loan note creates a debt with a defined payment obligation and an option for the holder to remain a creditor or subscribe for shares in the investee company.
  • Once the SAFE-holder subscribes for preferred shares in the investee company, its preferred shares will have a liquidation preference (like other preferred shareholders). However, if the SAFE-holder subscribed for shares at a lower valuation than that of the other preferred shareholders, the SAFE-holder’s liquidation preference is calculated on the lower valuation (i.e. on a lower ‘per share’ liquidation preference than that of other preferred shareholders).
  • When signing the SAFE document, the SAFE-holder does not know what the terms of its shareholding with the investee company will be. It knows that they will be materially similar to those of the other preferred shareholders, but that may not always be favourable for the SAFE-holder. If, for instance, other preferred shareholders are related to the founders of the investee company in some way, the rights attached to the preferred shares may be structured with slightly ‘lighter’ protective mechanisms (like vesting of founders’ shares, restraints, preferred distribution rights) compared to terms usually included in early stage funding transactions.

When we advise investors on SAFE documents, we aim to mitigate some of the risks highlighted above, by including certain restrictive measures not included in the standard SAFE document. These may include a restriction on the investee company to only source a limited amount of funding through the issuing of SAFE documents. This will ensure that the investee company does not delay the equity subscription with endless issuing of SAFE documents. In addition to this, we would also suggest to investors that there should be a time limit to the SAFE document, which triggers repayment (in real terms) or equity subscription (at the SAFE-holder’s option) if an equity funding round (or other trigger event) does not occur by a certain date.

Considering the above, it is clear that the SAFE document may hold certain advantages for both the investor and the investee company. However, it remains to be seen whether investors are willing to accept the risks associated with the SAFE document in its standardized form.

Moral Rights In The Context Of Copyright Law In South Africa

INTRODUCTION

In simple terms, a “copyright” is a form of intellectual property right that grants the creator of an original work (“the author“), the legal and exclusive right to the use and distribution of the work (in return for compensation for the author’s intellectual efforts). In this sense, a copyright can be said to be an economic right.

A “moral right” in the context of copyright law, on the other hand, is rather a personal right which attaches to the author, allowing the author to receive the appropriate credit when his/her work is used and it also dictates, to an extent, the way in which an author’s work is treated by others.

In South Africa, copyright law is regulated in terms of the Copyright Act, No. 98 of 1978 (as amended) (“the Act“), and is administered by the Companies and Intellectual Property Commission, as a branch of the Department of Trade and Industry. In terms of the Act, nine classes of works are eligible for copyright protection and they include literary works, musical works, artistic works, cinematograph films, sound recordings, programme-carrying signals, broadcasts, published editions and computer programs.

 

THE CONCEPT OF MORAL RIGHTS

Section 20 of the Act creates a legal obligation to give credit to works of an author and not to treat it in a derogatory way, and further defines a moral right as a protected right that applies to literary, musical and artistic works, cinematograph films and computer programmes (but excludes sound recordings, broadcasts and published editions) (“work/s”). At its heart, a moral right consists of the right to paternity and the right to integrity of the author’s work. The right to paternity allows the author to claim authorship of the work, whereas the right to integrity allows the author to object to any distortion, mutilation or modification of the author’s work to the extent that any such distortion, mutilation or modification would be prejudicial to the author’s honour or reputation. In other words, if the author reasonably feels that making certain changes in or to his/her works would undermine his/her creative intent or “vision” embodied in those works, he/she can prevent that change from being made, regardless of any economic rights that another person may own in that same work by virtue of a license or copyright.

An author’s moral rights to his/her works are, however, qualified by the economic interests which a copyright seeks to protect, and section 20 of the Act further provides that an author may not object to modifications to his/her works which are absolutely necessary for the commercial exploitation of those works.

It is important to bear in mind that a moral right can only subsist in the above works if such works enjoy copyright in South Africa in the first place.

 

WAIVER AND TRANSFERABILITY OF MORAL RIGHTS

Just like many personal rights, moral rights can be waived by the author and the author can choose not to enforce them. No formalities are prescribed in the Act for the waiver of moral rights, although good practice dictates that any waivers of moral rights be reduced to writing.

Whereas copyrights are freely transferrable, a moral right attaches to the author throughout the author’s lifetime and terminates upon his/her death (or in the case of an author which is a corporate entity, the dissolution of that entity) and cannot be transferred. What is interesting in this regard is that an assignment of copyright leaves the author’s moral rights unaffected and in many instances, the holder of the copyright will still be required to obtain the necessary waivers from the author. In other words, no matter who gets to exploit the economic rights being the subject matter of the copyright, the author will still have the right to be named and given recognition for his/her work (unless he/she waives such right).

 

INFRINGEMENT, ENFORCEMENT AND REMEDIES

A moral right could be infringed by, for example, not properly attributing the work of the author, or treating it in such a manner so as to lower the reputation or dignity of the author. Given the closely related nature of copyright and the moral rights that subsist in the copyright, the statutory remedies which apply to an infringement of copyright would also apply to an infringement of an author’s moral rights. The Act provides for a claim for damages or the imposition of an interdict. These statutory remedies are complemented by common law remedies to the extent that any conduct that violates the dignity and reputation of the author can give rise to a similar claim for damages or an interdict to curtail the infringement.

 

CONCLUSION

Authors in South Africa enjoy a reasonable measure of protection regarding the intellectual products of their labours. South Africans have, however, been slow to enforce these rights and to date, there have been very few reported cases dealing with this area of law. Perhaps the reason why moral rights are so rarely asserted are, firstly, it is a fairly unknown concept in South Africa, and secondly, many commercial agreements governing the use of intellectual property will often include a waiver of the moral rights of the author.

Should you have any queries concerning your business and its use of its own intellectual property and that of others, please feel free to contact us – we would be glad to assist you.

Insights Into Restraints Of Trade

It is a well-known commercial practice for employers to include restraint of trade provisions in their employment agreements despite prevailing uncertainty as to when and how (as well as to what extent) these restraint of trade provisions would be enforceable.

A restraint of trade is essentially an agreement in terms of which one party agrees to some form of limitation to their freedom to carry on their trade, profession or business. Restraint of trade provisions are most frequently encountered in employment contracts, where the employee undertakes not to compete with his or her employer during and/or after termination of his or her services to the employer. There are also other forms of agreements in which these provisions can be encountered, for example, in a sale of business, where the seller agrees with the purchaser not to carry on a similar business in competition with the purchaser within a reasonable proximity of the business premises and for a prescribed period of time. Partnership agreements may also include similar provisions in terms whereof each of the partners undertakes not to compete with the business of the partnership during and/or after leaving the partnership.

In terms of the well-known and oft-cited Appellate Division judgment in Magna Alloys and Research (SA) (PTY) Ltd v Ellis [1984] 2 All SA 583 (A),it was held that restraint of trade provisions are valid and lawful unless the party wishing to escape the provisions of the agreement in question can prove that they are contrary to public policy and therefore unenforceable.

The Magna Alloys precedent necessitates an enquiry as to when restraints of trade will be deemed contrary to public policy (which is by nature a vague concept). Fortunately in the later judgment in Basson v Chilwan and Others [1993] 2 All SA 373 (A) the court laid out several guidelines with which to determine whether or not a restraint of trade agreement is contrary to public policy, as follows:

  • Does the restraining party have an interest deserving of protection, during or after termination of the relevant contract (a “Protectable Interest”)?
  • If so, would that Protectable Interest be prejudiced by the restrained party’s freedom not being limited by the restraint?
  • If the above can be answered in the affirmative, then it furthermore needs to be decided whether the Protectable Interest of the restraining party (seeking to uphold the restraint agreement) qualitatively and quantitatively outweigh the interest of the restrained party to be economically active and productive?
  • Are there any other aspects to be considered to determine whether or not to uphold or reject the restraint?
  • Does the restraint go further than reasonably necessary to protect the interests of the restraining party seeking to enforce the restraint in question?

Generally speaking, according to the Basson judgment, if the answers to the first three questions above are in the affirmative, and the answer to the last question is in the negative, then the restraint of trade is reasonable and consequently not contrary to public policy, therefore making it enforceable against the restrained party. However, if the answers to the first three questions are in the negative and the answer to the last question is in the affirmative, then such restraint of trade would be contrary to public policy and therefore unenforceable. In some instances the court may find that a restraint of trade provision has gone further than is necessary to protect the interest of the restraining party but doesn’t go so far as to render it contrary to public policy. The court may then order that the restraint be partially enforced. By partially enforcing a restraint, the court would restrict its limitation to either a narrower proximity than the one that was initially included in the restraint of trade, or for a lesser period of time than the period that was initially agreed.

In order to determine whether a restraint would be reasonable, the concept of a Protectable Interest must be considered further, as either parties’ assertion or defence would primarily be dependent on whether there is any Protectable Interest that the restraining party could argue he is entitled to protect. A court would normally only entertain a restraint of trade dispute if it is satisfied that there is indeed a Protectable Interest. There’s no exhaustive list of what constitutes a Protectable Interest, although the judgment in Advtech Resourcing (Pty) Ltd t/a The Communicate Personnel Group v Kuhn and another [2007] 4 All SA 1368 (C), provides the following insights:

  • A Protectable Interest includes the restraining party’s ‘trade secrets’ (meaning any information that is capable of application in trade or industry provided that such information is only known to a certain number of people but not to the public and is of economic value). By way of example, technical processes, chemical formulae, computer software, price lists, credit records and business conversation, constitute trade secrets.
  • However, the mere fact that an employer had provided an employee with training and skill development does not mean that he or she owns the skill provided to an employee. This is illustrated by the following excerpt: “An employee who, in the main, uses his own expertise, knowledge, skill and experience [after leaving employment] cannot be restrained [from doing so]”.
  • Confidential information constitutes a protectable interest.
  • Customer goodwill or trade connections constitute a protectable interest.

Another question that needs to be considered is that of who bears the onus of poof in restraint cases. Most past judgments follow the approach that was laid down in Magna Alloys, in which it was held that the party alleging that the restraint is contrary to public policy, bears the onus of proving the unreasonableness of such restraint. In the new Constitutional dispensation, however, every person has a constitutionally enshrined right to choose and carry on his/her chosen trade, profession or business. With that background, some more recent commentaries have held that the restraint enforcer should bear the onus of proof. Some commentators remark that it does not matter who bears the onus of proof because the guidelines that were laid down in the Basson judgment are decisive.

In conclusion, restraint of trade provisions in agreements are lawful, valid and enforceable provided they are reasonable and not contrary to public policy, and the enquiry into public policy will often centre on a consideration of the Protectable Interest that a restraining party would wish to protect. Beyond this, although restraints of trade are very common in practice, it is notoriously difficult to predict whether a court would determine a particular restraint to be fair and reasonable in the circumstances. We recommend that any party to a restraint carefully consider its terms and limitations, and attempt to negotiate on these limitations if you foresee a time when this restraint may be detrimental to your ability to carry on your chosen trade or business.

The effect of Section 12J of the Income Tax Act on the South African venture capital regime

Section 12J of the Income Tax Act has been the talk of the town in many South African venture capital circles in the last few years, but ironically there has been a lot less action in the market than the government expected when implementing this tax incentive in 2009. This incentive seems very promising on face value, but at the moment there are still less than 10 approved Section 12J venture capital companies in the country. This is an exceptionally low number if we consider how popular a similar venture capital incentive in the United Kingdom has been over the years, which beckons us to take a closer look at the incentive to determine the reason for the market’s reluctance to explore this.

The rationale behind the incentive is quite simply to address the fact that one of the main challenges to the economic growth of small and medium-sized businesses in South Africa, is the inability of these businesses to secure equity finance to fund their growth.

In terms of Section 12J, any South African tax resident that invests in a venture capital company (VCC), approved and registered in terms of Section 12J, can claim income tax deductions in respect of the expenditure actually incurred to acquire shares in such VCCs, subject to certain conditions.

Section 12J VCCs are therefore intended to be a marketing vehicle that will attract retail investors to invest in VCC’s, whereas the VCC makes money by investing in smaller trading companies. These are entities which the VCC’s fund managers deem as having prospects of producing a favourable return on investment. These companies are generally referred to in this context as qualifying investee companies.

However, before a venture capital company can start trading as a Section 12J VCC, it has to apply to SARS to be registered as such, for the purpose of which the company must meet certain preliminary requirements. To meet these requirements, the company must:

  • be a South African tax resident and its tax affairs must be in order;
  • have as its sole object, the management of investments in qualifying investee companies;
  • not control (whether directly or through a related entity) any qualifying investee company in which it holds shares; and
  • be licensed as a financial services provider in terms of section 7 of the Financial Advisory and Intermediary Services Act, 2002.

The major risk for a Section 12J VCC and its investors alike, is that SARS can withdraw the approved VCC status if, during any year of assessment, the company fails to comply with the preliminary approval requirements as listed above. SARS may also withdraw the company’s VCC status, if the preliminary requirements are met but the company fails to satisfy the following additional requirements after the expiry of 36 months from the date of SARS approving the company’s Section 12J VCC status:

  • a minimum of 80% of the expenditure incurred by the VCC to acquire assets must be for shares in qualifying investee companies, and each investee company must, immediately after the issuing of the qualifying shares to the VCC, hold assets with a book value not exceeding R300 million in the case of a junior mining company or R20 million in the case of any other qualifying company; and
  • the expenditure incurred by the VCC to acquire qualifying shares in any one qualifying investee company may not exceed 20% of its total expenditure to acquire qualifying shares, which basically means that the VCC must have at least 5 investee companies in its portfolio.

What happens when a Section 12J VCC loses its status as such? Well, SARS can include in the VCC’s income in the year of assessment during which the status was withdrawn, an amount equal to 125% of expenses incurred to issue shares.

If you consider the fact that venture capital investments are generally regarded as high-risk, relatively illiquid investments, the picture seems even less rosy for investors if the drastic consequences of non-compliance looms as an additional risk to their investments.

However, in the 2014 National Budget Review, the government announced that it will propose one or more of the following amendments to the VCC regime:

  • making tax deductions permanent if investments in the VCC are held for a certain period of time;
  • allowing transferability of tax benefits when investors dispose of their VCC equity investments in VCC’s;
  • increasing the total asset limit for qualifying investee companies from R20 million to R50 million, and that of mining companies from R300 million to R500 million; and
  • waiving capital gains tax on the disposal of assets by the VCC.

These new changes are to be welcomed and have certainly sparked renewed interest in the market, which is still wide open for those that are willing to enter this relatively untapped opportunity. Whether the proposed reforms are substantial enough to give this incentive the required momentum to ignite the South African venture capital industry as intended by the government remains to be seen.