POPI News: Appointment of the Information Regulator

POPI News: Appointment of the Information Regulator

“Are you ready for POPI??” This question has been asked so many times in marketing material over the last couple of years. Answering this question has lately become very relevant, since the POPI Information Regulator has (at last) been appointed!!  Advocate Pansy Tlakula, former chairperson of the South African Independent Electoral Commission, has been appointed as the chairperson of the office of the Information Regulator.  The remainder of the office is made up of four others, two full-time members and two part-time members. Advocate Cordelia Stroom and Johannes Weapond will fulfil the full-time positions with Professor Tana Pistorius and Sizwe Snail as the part-time members.  The office of the Information Regulator will be effective from 1 December 2016 and members will hold office for five years. They will be eligible for reappointment after the first five-year period.

The office of the Information Regulator has been granted widespread powers, amongst others, to investigate alleged breaches of POPI as the office provides a platform for data subjects to approach with any complaints.

With the appointment of the Information Regulator we are likely to receive a date for the commencement of POPI relatively soon.  This will result in the remainder of the Act commencing and will grant responsible parties a “grace period” of one year from the effective date to become compliant with the Act.  The sections of POPI which have already commenced are:

  • Section 1, the definitions clause;
  • Part A of Chapter 5, which deals with the establishment, staffing, powers and meetings of the Information Regulator;
  • Section 112 which authorises the Minister and Information Regulator to make regulations; and
  • Section 113, the procedure for making regulations.

The Information Regulator has been granted a budget by the Minister of Finance. This budget is to be used for the establishment and capacitation of the office. R10 million has been set aside for the 2016/2017 financial year, R26 million for the 2017/2018 financial year and R27 million for the following financial year.

What we can expect to happen next:

  1. Regulations will be promulgated;
  2. And the commencement date will be announced.

Contact us for more information on all POPI questions.

When is a company subject to the Takeover Regulations?

When is a company subject to the Takeover Regulations?

What are the Takeover Regulations?

Since the Companies Act No. 71 of 2008 (as amended) (“the Companies Act“) came into effect on 1 May 2011, there has been a paradigm shift in the regulation of South African mergers and acquisitions (also known as “fundamental transactions”).  It is understood that the changes introduced into the Companies Act were intended to afford greater protection to minority shareholders in companies where certain transactions are concluded by such companies.  However, these new provisions have also brought with them some trepidation as for many small or medium-sized private companies, the administrative duties associated with the regulation of those transactions are fairly onerous and costly.

If a company intends concluding any transaction contemplated in Chapter 5 of the Companies Act, it is important to ascertain whether the Takeover Regulations apply to that transaction.  If so, various disclosures, approvals and reporting requirements will then need to be met or sought from the Takeover Regulation Panel (“TRP“).  The TRP is the regulatory body that was established under the Companies Act to regulate certain transactions.

Non-compliance with the Takeover Regulations

If there is non-compliance with these laws by a company, a complaint may be filed by an interested party with the TRP, who may investigate such complaint and, if deemed necessary, the TRP may issue a compliance notice to the infringing company.  If this compliance notice is not complied with, a court may impose an administrative fine on the infringing company that may not exceed the greater of 10% of its turnover for the period of non-compliance, or R1 million.

It is therefore vital to consider whether these laws are applicable in order to comply and avoid any penalties for infringements.  However, if the transaction has already taken place and the non-compliance has already happened, it is possible to apply for exemptions or condonations for late filing.

Who is subject to the Takeover Regulations?

The Takeover Regulations apply to a regulated company with respect to an affected transaction or an offer, but there are some exceptions.

In considering the applicability, it is first necessary to ascertain whether the company is a regulated company.  According to the Companies Act (sections 117(1)(i), 118(1) and (2) and Takeover Regulation 91), this is either:

  • a public company; or
  • a state-owned company (with some exemptions, see section 9); or
  • a private company:
    • that expressly elects to be regarded as a regulated company in its memorandum of incorporation, or
    • if more than 10% of its issued securities have been transferred within the previous 24 months (other than by transfer between related or inter related persons).

It is important to note that when using a shelf company and transferring the shares from the incorporator to a new shareholder/s, the initial transfer will not be subject to the Takeover Regulations, however the shelf company will be categorised as a regulated company for the following 24 months.

If a transaction involves a regulated company, the next step is to consider whether the transaction in question is an affected transaction as defined in section 117(1)(c) as follows:

  • a transaction (or series of transactions) amounting to the disposal of all or the greater part of the assets or undertaking of a regulated company (sections 112 and 118(3));
  • an amalgamation or merger involving at least one regulated company (sections 113 and 118(3));
  • a scheme of arrangement between a regulated company and its shareholders (sections 114 and 118(3);
  • the acquisition of, or announced intention to acquire, a beneficial interest in any voting securities of a regulated company (section 122(1);
  • the announced intention to acquire a beneficial interest in the remaining voting securities of a regulated company not already held by a person or persons acting together;
  • a mandatory offer (section 123); or
  • a compulsory acquisition (section 124).

According to section 117(1)(f), an offer means a proposal of any sort, including a partial offer, which, if accepted, will result in an affected transaction (except for a transaction which is exempt in terms of clause 118(3)).

However, the Takeover Regulations do not apply if:

  • an approved business rescue plan requires or contemplates the fundamental transaction;
  • the transfer of more than 10% of the issued securities is due to a company buy-back; or
  • the transfer is between related or inter-related persons (sections 118(3) and 121(b)(ii) and Takeover Regulations 91 (2)(b) and 83).

Exemption from the application of the Takeover Regulations

It is possible to apply to the TRP for an exemption and such application must include:

  • an explanation of the transactions involved;
  • a justification as to why the TRP has jurisdiction;
  • the argument as to why the applicant should be entitled to exemption (section 119(6); and
  • consent of all shareholders in the form of waivers of their rights pursuant to the takeover regulations.

The TRP is entitled to grant an exemption if:

  • there is no reasonable potential of the affected transaction prejudicing the interests of any existing securities holder of a regulated company;
  • the cost of compliance is disproportionate to the relative value of the affected transaction; or
  • doing so is otherwise reasonable and justifiable in the circumstances.

The TRP is not supposed to or required to consider the commercial advantages or disadvantages of any transaction or proposed transaction, but rather to ensure the integrity of the marketplace and fairness to the holders of the securities of regulated companies. In addition, the TRP must prevent actions by a regulated company designed to impede, frustrate or defeat an offer or the making of a fair and informed decision by the holders of that company’s securities.

This area of law is not always straightforward and easy to navigate, but the TRP is an approachable organisation if help is needed in understanding the applicability of the Takeover Regulations to certain transactions.  Our commercial teams have been involved in many transactions involving the Takeover Regulations and the TRP and are available to assist with any queries.

FICA – Potential Amendment of Schedules might affect credit providers

FICA – Potential Amendment of Schedules might affect credit providers

The Financial Intelligence Centre (FIC) has issued a notice in September 2016 regarding possible amendments to the existing Schedules to the FIC Act. The intention is to consider whether activities that currently fall outside of the ambit of the FIC Act should in actual fact be included.

According to the notice issued: “The proposal to include certain businesses or institutions is based, in part, on the Centre’s view that these businesses or institutions may present a higher risk of being used to carry out money laundering or terror financing activities.”

Some of the categories specified in the notice that will be considered to fall within the ambit of FICA going forward include:

*         Dealers in high value goods (like motor vehicles)

*         Co-operatives which provide financial services

*         Credit providers

*         Short term insurers

We have been in contact with the FIC Centre and they have confirmed that the consultation process will start soon. Next steps will therefore be for the Centre to consult with the relevant industry representatives such as the National Credit Regulator.

We will keep you updated on any news in this regard.

Close Corporations: a member’s authority to bind it and personal liability for its debts

Close Corporations: a member’s authority to bind it and personal liability for its debts

As a result of changes to South Africa’s company laws, effective as from 1 May 2011, it is no longer possible to register a new close corporation (“CC“) in South Africa.  However, there are many CCs that have remained in existence that still require regulation.  In this article, we have considered a few of the most common CC-related questions our clients have been faced with.

One of the main benefits of a CC is that it is often administratively easier to regulate than a company, while also being a juristic person distinct from its members who have limited liability.  The individual members’ interests in the CC are determined according to their percentage of ownership, as opposed to a company where shareholders acquire shares in the company.

The regulation of CCs is governed by the Close Corporations Act, 69 of 1984 (as amended) (“the Act“) and the terms set out in the association agreement that has been concluded between the CC and its members (if any).  If no such agreement has been entered into, the Act must be relied on as the default position regulating the CC and its members’ rights and obligations.

Can the conduct of a member of a CC bind the CC?

Members have the authority to act on their own and this can have the effect of binding the CC, unless the authority of the member in question has been restricted and the other party to the transaction knows or ought to have known of that restriction.  Section 54(1) of the Act states “Subject to the provisions of this section, any member of a corporation shall in relation to a person who is not a member and is dealing with the corporation, be an agent of the corporation…”.

The effect of this section is that each member of the CC has the ability to bind the CC in their individual capacity, except where there is an association agreement which states otherwise or it is expressly dealt with in terms of the default internal relations rules set out in section 46 of the Act.  Section 46(b) provides that members shall have equal rights with regard to the management of the business of the CC and with regard to the power to represent the CC in the carrying on of its business, provided that the consent of a member (or members) holding a member’s interest of at least 75%, shall be required for the following fundamental decisions:

  • a change in the principal business carried on by the CC;
  • a disposal of the whole, or substantially the whole, undertaking of the CC;
  • a disposal of all, or the greater portion of, the assets of the CC; and
  • any acquisition or disposal of immovable property by the CC.

Section 46(b) protects individual members to a degree, in that 75% or more of the members’ interests acting together are required to successfully bind the CC if they wish to give effect to any of the material changes or substantial transactions recorded in that section.

Can members be held personally liable for the debts of the CC?

The default position for personal liability in terms of the Act is that the members of a CC shall not merely by reason of their membership be liable for the liabilities or obligations of the CC (section 2(3) of the Act).  As such, members are not ordinarily held liable for the liabilities and obligations of the CC as the CC is treated as being independent of its members. As with a company, the members would not be liable for the liabilities and/or other obligations of the CC unless a member has signed as surety, guarantor or indemnitor for such debts and/or obligations of the CC.

However, in certain circumstances members are deemed to be personally liable for the liabilities and obligations of the CC, as set out in sections 63, 64 and 65 of the Act.  In summary, these sections provide for a member’s personal liability if a member disregards their duties, commits acts of gross negligence in the carrying on of the business of the CC and/or abuses the separate juristic personality of the CC.

In addition, members can agree to be held personally liable for debts of the CC but this will require the members to enter into a separate agreement for these purposes.  For example, in the case of a sale of a members’ interest or the business of a CC, one or more members may decide to agree to be held personally liable to the buyers for any liabilities of the CC that arose prior to the sale.

How to deal with oppressive conduct by members

The fact that members can act on their own and bind the CC in certain situations, regardless of the other members’ wishes, can lead to unfair and/or prejudicial situations.  If a member of a CC feels that his/her fellow members have unfairly prejudiced him/her in any way or that their acts have been oppressive, in terms of section 49 of the Act, that member can apply to the court for the granting of a remedial order in respect of such conduct.

Section 49 gives the court wide discretionary powers to make orders “with a view to settling the dispute” between the members of a CC, if it is just and equitable to do so.  Such an order could include ordering the offending member to purchase the member’s interest of the affected member (or members) at a fair price, whether he/she wants to or not, in order to compensate an affected member for the binding of the CC in a transaction or other arrangement that is deemed by the court to be unjust and/or inequitable.

This short outline provides some general advice relating to CCs, but there may be unusual situations where it is advisable to obtain specific advice from your attorney.

National Wills Week – Dommisse Attorneys

National Wills Week – Dommisse Attorneys

This year we’ll be participating in National Wills Week from 12 – 16 September 2016.
For anyone who wishes to have a basic will drafted at no charge, all they’ll need to do is contact leanne@dommisseattorneys.co.za to schedule an appointment.

The attending practitioner will send a short questionnaire that each person is required to complete and return prior to any consultation.

Please note that this is a free service and is offered on a first come first serve basis.

http://www.lssa.org.za/our-initiatives/advocacy/national-wills-week

Companies Act, 71 of 2008 Series Part 8: Financial assistance under the Companies Act

Companies Act, 71 of 2008 Series Part 8: Financial assistance under the Companies Act

The Companies Act, 71 of 2008, as amended, (“the Act“) regulates the provision of financial assistance by a company, either in respect of the acquisition of securities in that company in terms of section 44 of the Act, or the provision of financial assistance to directors or prescribed officers of that company in terms of section 45 of the Act. Under certain circumstances, and with the appropriate approvals, a company may be authorised to provide financial assistance in one of the two categories mentioned above.

For purposes of this article, we will only deal with Part 8.1: Financial assistance for acquisition of securities, and in a later article, we will deal with Part 8.2: Financial assistance to directors and prescribed officers.

8.1: Financial assistance for acquisition of securities

If a company is considering providing financial assistance for the purposes of the acquisition of securities, the provisions of section 44 of the Act must be adhered to. Securities include any shares, debentures or other instruments issued or authorised to be issued by a company.  This article, however, only discusses on the provision of financial assistance for the acquisition of shares in a company.

What is financial assistance for the purposes of the acquisition of shares?

In terms of section 44 of the Act, financial assistance is widely defined as including a loan, guarantee, the provision of security or otherwise, but does not include lending money in the ordinary course of business by a company whose primary business is the lending of money. In respect of the shares of a company, a company may provide such financial assistance to a person wishing to subscribe for shares in that company, or to a person who wishes to purchase shares in that company from an existing shareholder of that company.

What approvals are required?

The board may authorise such financial assistance to an acquirer of shares unless the company’s memorandum of incorporation (“MOI“) prohibits this. The nature of the board’s authorisation is specified in the Act. The board must be satisfied that (i) immediately after providing the financial assistance, the company would satisfy the solvency and liquidity test*; and (ii) the terms under which the financial assistance is proposed to be given are fair and reasonable to the company. The board’s approval for the granting of financial assistance for the purposes of share acquisitions is limited further – the shareholders are also required to pass a special resolution within the previous two years of the proposed financial assistance, approving, either specifically or in general, recipients for such financial assistance. Unless the financial assistance is in terms of certain employee share schemes, both board and shareholder approval is required, as indicated above, for the granting of financial assistance to a party for the purposes of acquiring shares in the company (or any related or inter-related company).

*Solvency and liquidity test: the assets of the company, fairly valued, equal or exceed the liabilities of the company, fairly valued and it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months after the date on which the test is considered.

What if you didn’t get these approvals?

If financial assistance is granted by the company in a manner which does not comply with the provisions of section 44 or any conditions or restrictions contained in the company’s MOI in respect of the granting of such financial assistance, then the decision of the board, or an agreement with respect to the provision of such financial assistance, is void to the extent of any such inconsistency. Practically, this means that any shares which were issued or sold on the basis of such unauthorised financial assistances are unauthorised acquisitions. Any director of that company who knowingly provides financial assistance in a manner which is inconsistent with the Act or the company’s MOI, could be held liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of such actions.  If you suspect that your company may have granted unauthorised financial assistance to any person for an acquisition of shares in the company, please feel free to contact our Commercial Team so that we can formulate a plan to try to rectify any such granting of unauthorised financial assistance.

Insights

The rationale behind the Act regulating the provision of financial assistance by a company for share acquisitions is primarily to protect the company’s value. One of a company’s purposes is to raise capital and not to distribute its own capital to the detriment of its shareholders. These specific safeguards on the board’s power and control over the Company are unalterable provisions under the Act and should be carefully considered and understood when considering financial assistance.

These provisions may also be more wide reaching than you may expect. Section 44 applies to the provisions of financial assistance “for the purpose of or in connection with” the acquisitions of shares. It also applies to “securities” which is a wider concept than “shares“. In addition, the financial assistance may be granted in the context of a related or inter-related company*. Such considerations may make a difference in your specific case and should be interrogated accordingly.

Quick tips

  • If you are a shareholder: make sure you understand what it is that you are approving in terms of financial assistance as contemplated in the Act and your company’s MOI and why you are being requested to do so.
  • If you are a director: make sure you understand what is expected of you in terms of the Act and your company’s MOI and your liability if you do not act accordingly.
  • If you are acquiring shares (whether by a subscription for new shares or a purchase of shares from an existing shareholder) using funds loaned from the company: make sure the necessary approvals are obtained otherwise the shares you hold will be unauthorised.

* Companies are related if (i) either of them directly or indirectly controls the other, or the business of the other; (ii) either is a subsidiary of the other; or (iii) a person directly and indirectly controls each of them or thee business of each of them.

Twin peaks to date

Twin peaks to date

INTRODUCTION

The 2008 Global Financial Crisis (“Financial Crisis”) may have come and passed and the worst thereof behind us but the world economy continues to face financial challenges. In efforts to plug the gaps experienced during the Financial Crisis and guard against similar financial crisis, the National Treasury (“Treasury”) drafted and proposed a Bill known as the Financial Sector Regulation Bill (“FSR Bill”) commonly known as “Twin Peaks” Bill.

By way of background, the FSR Bill was first introduced in the form of a policy paper, entitled “A safer financial sector to serve South Africa better” published by the Treasury in 2011. In December 2013, a first draft Bill was published for public comment. Taking into consideration comments made during the first round of public consultation, a revised version (second draft) was published for another round of public comment in 2014. The Bill is currently before the Standing Committee on Finance (“SCOF”) for their review and to allow SCOF to make recommendations before sending it to the National Assembly for further review.

In essence, the Bill seeks to bring regulation of services relating to banking, insurance, pension, collective investment schemes, credit industry etc. under the umbrella-regulation. This means that all these services will eventually fall under the ambit of a single sector (i.e. Financial Sector).

IMPLICATIONS OF TWIN PEAKS

As indicated above, the primary purpose of the Bill is to establish a twin peak approach designed to underpin a comprehensive regulatory system with the following two main aims:

  • strengthen financial safety and soundness of financial institutions by creating a dedicated Prudential Authority (PA); and
  • to better protect financial customers and ensure that they are treated fairly by financial institutions by creating a dedicated market conduct authority – the Financial Sector Conduct Authority (FSCA).

If approved, the Bill will bring about a number of changes in the manner in which the affected institutions conduct business. To reduce risks and simplify the implementation process, the Treasury proposed implementing the Bill in two phases as opposed to one.

During phase 1, the focus will be on who regulates. This phase of implementation will see two regulators (enforcement peaks), namely PA and FSCA, being established. While the PA (proposed SARB unit) will be concerned with the safety and soundness of individual firms and aim to ensure financial firms are run prudently, the FSCA will be concerned with how individual firms behave in treating their customers. The current Financial Services Board will cease to exist and its prudential responsibilities will be transferred to the PA.

Moving away from the current position in relation to ombud system, the Bill proposes a single and unified Ombudsman. In brief, there is currently an ombud for each industry or sector and that will be done away.

During phase 2, the focus will be on how the regulators regulate and what they regulate. These include anything around (i) issuing regulatory requirements, (ii) licensing, (iii) supervising regulated entities and (iv) taking enforcement actions.

Credit providers take a particular interest in the Bill as credit products and services will (in terms of the current draft) also be included within the ambit of the new law. This of course begs the question on how compliance with the National Credit Act will be enforced since the Bill does not take away the powers of the National Credit Regulator in terms of the NCA to regulate and enforce compliance.

Do all credit providers need to register?

Do all credit providers need to register?

It has been widely reported that all credit providers should now register with the National Credit Regulator (the “NCR”) as a result of the new threshold for registration as a credit provider of R0 (nil) which was published on 11 May 2016. But is it really required that every business that lends money, regardless of the amount, must now, strictly speaking, register as a credit provider with the NCR?

Section 40 of the National Credit Act 34 of 2005 (“NCA”) requires a person to register as a credit provider if the total principal debt owed to that credit provider under all outstanding credit agreements, other than incidental credit agreements, exceeds the threshold determined by the Minister of Trade and Industry. Prior to the recent amendments of the NCA a person had to register as credit provider if it was the credit provider of at least 100 credit agreements or the principal debt owed to him or her in terms of all current credit agreements exceeded R 500 000. After the amendment of the NCA by the National Credit Amendment Act 19 of 2014, a person was only required to register as a credit provider if the total principal debt owed to him or her in terms of all current credit agreements exceeded R 500 000 (meaning that the number of 100 credit agreements or not became irrelevant and even if the number of 100 was exceeded but the total principal debt owed in terms of the total agreements was less than R 500 000, then no registration was required). On 11 May 2016, however, a new threshold of R 0 (nil) was published and from 11 November 2016, 6 months after the publication of the new R 0 (nil) threshold, all credit providers (irrespective of the number of credit agreements) should register as credit providers with the NCR. Failure to register as a credit provider could result, amongst others, in the credit agreement between the credit provider and its debtor being declared void as an unlawful agreement.

This does, however, not mean that every single person or business that lends money must register as a credit provider. The following should be considered to determine whether to register or not:

  • Is the credit agreement an incidental credit agreement? Section 40(1)(a) of the NCA does not require the registration of a credit provider if the transaction relates to an incidental credit agreement.
  • Is the person a credit provider as defined in the NCA?
  • Is the transaction a credit agreement as defined in the NCA?
  • Will the credit agreement be concluded within, or will it have an effect within the Republic?
  • Are the parties to the credit agreement dealing “at arm’s length“?
  • Do any of the exceptions provided in section 4 apply? For example: the NCA does not apply to a credit agreement where the consumer is a juristic person whose asset value or annual turnover, together with the combined asset value or annual turnover of all related juristic persons, at the time the agreement is made, equals or exceeds the threshold value determined by the Minister (currently R 1 million).

To determine whether you are required to be registered before the due date of 11 November 2016, do not hesitate to contact us.

Companies Act, 71 of 2008 Series Part 7:  Distributions – a few important points to consider

Companies Act, 71 of 2008 Series Part 7: Distributions – a few important points to consider

When considering distributions by a company, we most often think of cash dividends, being one form of return on investment for investors. This is something most start-up clients consider being a future event in their life cycle and don’t often give much thought to upfront. We’ve set out a few important points to take into account when considering whether or not a company should declare a distribution.

What is a distribution?

Firstly, it is important to bear in mind that the shareholders of a company only have an expectation (and not a right) to share in that company’s profits during its existence. There is therefore no obligation on a company to declare distributions to its shareholders.

The Companies Act, 71 of 2008, as amended, (“the Act”) provides a very wide definition of a “distribution”, which goes much further than just cash dividends. This definition can be broken up into three categories, namely, the direct or indirect: (i) transfer by the company of money or other property (other than its own shares) to or for the benefit of one or more of its shareholders; (ii) incurrence of a debt or other obligation by the company for the benefit of one or more of its shareholders; and (iii) forgiveness or waiver by the company of a debt or other obligation owed to the company by one or more of its shareholders.

The definition is further extended to include any of the above actions taken in relation to another company in the same group of companies, but specifically excludes any of the above actions taken upon the final liquidation of a company.

The first category in the definition of a “distribution” includes cash dividends, payments by a company to its shareholders instead of capitalisation shares, share buy-backs and any other transfer by a company of money or other property to or for the benefit of one or more of its shareholders, which is otherwise in respect of any of the company’s shares. This last sub-category is intended as a “catch all” provision, making the definition that much wider.

Who can make a distribution and in what circumstances?

Section 46 of the Act sets out the requirements that a company must meet before making a distribution. A company must not make any proposed distribution to its shareholders unless the distribution: (i) has been authorised by the board of directors by way of adopting a resolution (unless such distribution is pursuant to an existing obligation of the company or a court order); (ii) it reasonably appears that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution; and (iii) the board of the company acknowledges, by way of a resolution, that it has applied the solvency and liquidity test and reasonably concluded that the company will satisfy same immediately after completing the proposed distribution.

For purposes of the solvency and liquidity test, two considerations must be taken into account. Firstly, whether the assets of the company, fairly valued, are equal to or exceed the liabilities of the company, fairly valued (this is often referred to as commercial solvency). Secondly, whether the company will be able to pay its debts as they become due in the ordinary course of business for a period of twelve months after the test is considered, or in the case of a distribution contemplated in the first category of the definition, twelve months following that distribution (this is often termed factual solvency). While the Act attempts to specify what financial information must be taken into account when considering the solvency and liquidity test, the provisions are not that clear, apart from requiring the board to consider accounting records and financial statements satisfying the requirements of the Act and that the board must consider a fair valuation of the company’s assets and liabilities. This leaves a lot of room for interpretation as to what can and should be taken into account when considering the solvency and liquidity test.

An important point to note here is that it is the board of directors of the company that must declare a distribution, and not the shareholders. The company’s Memorandum of Incorporation and/or shareholders’ agreement can place further requirements on the company in relation to declaring distributions, for example, a distribution must also be approved by a special resolution of the shareholders. This does not, however, change the fact that the distribution must first be proposed by the board of directors and ultimately be declared by the board of directors.

What happens if a distribution is authorised by the board but not fully implemented?

When the board of the company has adopted a resolution, acknowledging that it has applied the solvency and liquidity test and reasonably concluded that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution, then that distribution must be fully carried out. If the distribution has not been completed within 120 business days after the board adopts such resolution, the board must reconsider the solvency and liquidity test with respect to the remaining distribution to be made. Furthermore, the Act states that the company may not proceed with such distribution unless the board adopts a further resolution to that effect.

Directors liability for unlawful distributions

If a director does not follow the requirements for making a distribution and resolves to make such distribution (either at a meeting or by round robin resolution) despite knowing that the requirements have not been met, then that director can be held personally liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director failing to vote against the making of that distribution.

There are, however, limitations placed on a director’s potential liability, in that such liability only arises if: (i) immediately after making all of the distribution (no liability can arise for partial implementation), the company does not satisfy the solvency and liquidity test; and (ii) it was unreasonable at the time of the resolution to come to the conclusion that the company would satisfy the solvency and liquidity test after making the relevant distribution.

A director who has reason to think that a claim may be brought against him (other than for wilful misconduct or wilful breach of trust), may apply to court for relief. The court may grant relief to the director if he has acted honestly and reasonably or, having regard to the circumstances, it would be fair to excuse the director.

There is a limit on the amount that a director can be held liable for in relation to not meeting the requirements of a distribution – section 77(4)(b) provides that such amount will not exceed, in aggregate, the difference between the amount by which the value of the distribution exceeded the amount that could have been distributed without causing the company to fail to satisfy the solvency and liquidity test and the amount (if any) recovered by the company from persons to whom the distribution was made.

Conclusion

Distributions by a company of its assets to its shareholders, whether in the form of cash or otherwise, are carefully regulated by the Act. This is clearly to protect the interests of creditors and minority shareholders of the company. You will also have noticed that the Act does not deal separately with the different types of distributions and includes a wide variety of transactions which will be regarded as a distribution under the Act. We trust that the issues highlighted above will give you some insight and guidance on this topic. If you would like to discuss any of these topics in more detail, please feel free to contact our commercial department and we will gladly assist.

If you would like to discuss any of these topics in more detail, please feel free to contact our commercial department and we will gladly assist.

The Ins and Outs of Issuing shares to Employees

The Ins and Outs of Issuing shares to Employees

We are frequently asked to advise clients on the best way to incentivise their existing and future employees. This is an important consideration for any company (and particularly start-ups) who wish to, for example, attract and retain talent. There are a variety of ways in which employees can be incentivised, and it will always be important for the company to consider what the ultimate goal is that they wish to achieve by incentivising their employees. For the purposes of this article, we will only deal with one of these incentivisation options, namely: “Issuing shares to employees”.

In terms of the Companies Act, 71 of 2008 (as amended) (“the Companies Act”), any issuance of shares must be for “adequate consideration” as determined by the company’s board of directors. For example, where the founders of a company wish to award their long-serving employees with a stake in the company, the services rendered by those employees may be considered to constitute “adequate consideration” and the shares can be issued on this basis. Another example of incentivising employees is to offer identified employees a reduced salary together with an issuance of shares in the start-up company, which shares can be issued at a nominal value and could be considered “adequate consideration” in the circumstances. Alternatively, a company can issue shares to identified employees at the fair market value of such shares but the subscription price (being the fair market value) payable for those particular shares is loaned by the company to the employees (note that such loan would qualify as financial assistance and would require specific authorisation). The loan would then be repayable from any dividends that are declared and paid by the company to those employees as shareholders of the company.
Shares may also be issued for future services to be rendered by an employee to the company, but then these services must be rendered by the employee before he/she will be entitled to receive the shares. In such cases, the shares are held in trust and then transferred to the employee upon fulfilment of their service obligations in accordance with section 40(5) of the Companies Act.

More commonly, however, we are approached by start-up companies who wish to set up employee share ownership plans (generically referred to as “ESOPs”) for the purposes of issuing shares to (key) early-stage employees. Some larger or institutional investors require that companies commit to establishing an ESOP as a condition to their investment into the company. In other cases, a company may simply want to establish an ESOP to incentivise and reward their employees of their own accord.

ESOPs can be structured in a number of different ways, for example, employees may be offered direct shareholding in the company or options for the acquisition of shares in the future. Alternatively, a phantom / notional share scheme can be set up – for more information please see our previous article, EMPLOYEE SHARE OWNERSHIP PLANS: SOME ‘WHY’S’ AND ‘HOW’S’.

Once a company has decided that it wishes to incentivise some or all of its employees by way of one of the methods mentioned above, the next important consideration will be the terms and conditions upon which the shares will vest in the employees’ hands. The concept of “vesting” in broad terms means the moment when the employee becomes the full (or beneficial and registered) owner of the shares in question. Such shares may vest over any determined period of time, and may, for example, be subject to the employee meeting certain goals or milestones or remaining with the company for a particular period of time.

Regardless of the manner in which a company may decide to issue shares to its employees, it is key that the employee’s ability to transact with such shares is restricted in some manner. One of the more common restrictions placed on shares issued to employees is that such shares cannot be sold until the occurrence of a “liquidity event” – this is an event that allows the majority of shareholders to exit by selling their investments or realizing the value of their shares. The most common examples are: (i) the sale of all or a majority of the shares in the company; (ii) a sale of the company’s primary assets or business; (iii) a merger or acquisition of the company; (iv) an initial public offer (IPO); or (v) a change of control generally or a similar transaction.
Placing restrictive conditions on shares that are issued to employees is significant for two primary reasons. Firstly, if these shares are unrestricted and can be sold by the employee at any time, this somewhat undermines the motivation for retention of employees. While this purpose could also be achieved through the vesting of shares, there is a further reason why you should consider restricting the shares. In terms of the Income Tax Act, 58 of 1962 (as amended), any “income” that is derived from the disposal of shares that have been issued by a company to its employees by virtue of their employment is taxed in the hands of those employees as income tax. However, if these shares are “restricted” (i.e. cannot be freely disposed of), any “income” earned on a disposal of those shares by the employees will only be taxed in the hands of the employees upon the lifting of the restriction (for example, a “liquidity event” as described above), and the employees will only be required to pay such income tax at the time of disposal of such shares. Any disposal of shares may also attract capital gains tax, which employees should be aware of as well. Specialist tax advice in this regard should always be sought and we will gladly refer you to one of our trusted tax specialists for this purpose.

The Start-up Team have developed a ready-to-use suite of agreements for a simple, direct-shareholding based ESOP with the aim of providing a cost-effective and efficient service as one of our value-added offerings to our clients. If you are considering ways in which to incentivise your company’s valued employees, our dedicated Start-up Team would be happy to meet with you to discuss your needs and assist you in structuring the appropriate employee incentive scheme for your company.