Buying a Distressed Company – Bargain or Burden?

Things you need to know before buying a distressed company

Every now and then an opportunity comes along that looks very hard to resist. If you’re a seasoned entrepreneur, this might come in the form of a company that, although in such distress that the shareholders want out, still has genuinely valuable assets or a viable business model.

Buying the company at a discount and then selling off its assets is one way to turn a profit from such a situation. Another option is to buy the company and turn it around. This can be especially tempting when the company has liabilities that may prevent it from showing a profit for some time, which can translate into a considerable tax advantage.

Deals like this are not for the inexperienced or fainthearted – or for those who tend to get carried away by their own enthusiasm. Unfortunately, this perfectly describes most entrepreneurs – seeing the upside and getting swept up in your own enthusiasm is practically part of the job description. This is why you need a team of lawyers, accountants and other advisers on your side to provide a reality check.

The first rule of buying a company in distress is: Never, ever go soft on due diligence. Hire the most paranoid team you can find and have them tear the place apart. There are bound to be skeletons in various closets, and you want to shine clear, cold daylight on all of them.

The primary objective of the due diligence is to make sure there are no liabilities in the business that you’re unaware of, and no unquantifiable risks. It’s always the stuff you don’t know about that will trip you up, so do whatever is possible to ensure you know everything.

We usually ensure that a Purchaser has recourse to the amount paid to the Sellers (such as by retaining all or a portion of the purchase price, or placing it on escrow).  The big thing to beware of is any material risk that could expose you to a liability greater than the price you’re paying for the company. You can always ask for warranties from the sellers that they haven’t withheld any relevant information – but the warranty indemnity probably won’t be more than the purchase price.

You also need to beware of any evidence that the previous management has not been running the company properly in the past. If there is any suggestion that they’ve been playing fast and loose, SARS can re-open tax assessments from previous years – and then the entire basis for your purchase could be undermined.

Which brings us to the second rule of buying a company in distress: Get the best tax advice you can afford. The really interesting structures often have tax advantages – and if your goal in buying the company is to enjoy the tax advantage, you had better be sure it really exists.

If the due diligence confirms there is no SARS debt or other debt you can’t compromise, and that you have identified all the risks –then there is a chance you have a real opportunity on your hands. If you are confident that you can turn the company around and make it work, the rest is up to you.

Consumer rights in terms of the CPA

The Consumer Protection Act 68 of 2008 (CPA) provides for extensive protection of consumer rights. In preceding legislation we have seen provisions that also relate to consumer rights – these include for example the National Credit Act 38 of 2005 (NCA) and the Electronic Communications and Transactions Act 25 of 2002 (ECT Act).

The big difference however is that the consumer protection provisions of the NCA and ECT Act only apply in very specific instances – for example the NCA only applies to credit transactions and the ECT Act only applies to electronic transactions. The CPA on the other hand is different: the default position is that the CPA will apply (allowing consumers to rely on the CPA rights), unless an applicable exception exists. These exceptions are limited.

Generally speaking consumers have the following rights in terms of the CPA:

1. Right to equality
This right provides that consumers cannot be discriminated against on one of the discrimination grounds listed in the Constitution.

2. Right to privacy
The Constitution makes provision for the right to privacy in section 14 of the Constitution. The CPA gives effect to this right by providing for some privacy protection when it comes to direct marketing.

3. Right to choose
The CPA provision of the consumer’s right to choose extends to the consumer’s right to return goods.

4. Right to disclosure of information
The CPA aims to assist consumers by forcing suppliers to provide consumers with adequate information in order for them to make informed decisions.

5. Right to fair and responsible marketing
The CPA places a lot of emphasize on marketing activities. Suppliers must be fair in their marketing material and may not mislead consumers.

6. Right to fair and honest dealing
In terms of the CPA, a consumer can expected to be treated fairly and honestly.

7. Right to fair, just and reasonable terms and conditions
Similar to the NCA, the CPA provides for a list of terms that

8. Right to fair value, good quality and safety
Consumers are entitled to receive goods or services that are of good quality, in good working order and free of any defects.

Consumer rights will not mean much if they cannot be enforced. The CPA therefore makes provision for various forums through which the consumer can address alleged breach of the CPA – without necessarily going to court. Not all of these forums are operative as yet, however the National Consumer Commissioner has been appointed and the National Consumer Commission have received complaints from unsatisfied consumers as from 1 April 2011.

Be sure that you know your consumers’ rights. And be sure that you know when an opportunistic consumer is using the CPA to try to enforce rights that he or she does not have in terms of the CPA.

Forfeiture Provision Of The NCA Declared Unconstitutional

The Cape Town High Court delivered a judgment during April 2012 (Opperman vs Boonzaaier and Others Case No. 24887/2010) in terms whereof section 89(5)(c) of the National Credit Act 34 of 2005 (“NCA”) was declared unconstitutional. The majority of the Constitutional Court has now confirmed the order of invalidity.

Background factual information:
Opperman lent Boonzaaier roughly R 7 million in terms of three written loan agreements. Boonzaaier was unable to repay the debt and during the subsequent application for his sequestration, the question was raised whether section 89(5)(c) was unconstitutional. In terms of
this section a credit provider loses his right to claim back money which has been lent to a consumer if he was not a registered as a credit provider when making the loan. Section 40 of the NCA requires a person who is a credit provider under at least 100 credit arrangements or to whom the total principal debt owed in terms of all outstanding credit agreements exceeds R 500 000.00, to be registered as a credit provider in terms of the Act. If such a credit provider fails to register, the credit agreement would be void. In this case, Opperman was not registered as a credit provider as he was not aware of the requirement of registration.

Constitutional Court Judgment
The majority of the Constitutional Court found that section 89(5)(c) resulted in “arbitrary deprivation of property in breach of section 25(1) of the Constitution”. It was further confirmed that the deprivation was not a reasonable and justifiable limitation of the right to property, because the said section compelled a court to declare an agreement such as the one in this matter to be void and compelled the court to order that the unregistered credit provider’s right to restitution be cancelled or forfeited to the state. No discretion is allowed under section 89(5)(c) and by removing a credit provider’s right to claim restitution, he is being deprived of property. In light of the above, the section was found to be unconstitutional. This judgment will no doubt be viewed as a welcome relief to credit providers who, in good faith, lend large amounts of money without being aware of the requirement that they register as a credit provider under the NCA.

Director’s Duties – 5 things you need to know

There has been a lot of media coverage in the past couple of years devoted to directors’ duties under the new Companies Act of 2008, and the fact that directors can be held personally liable if they breach those duties. The effect can be fear and uncertainty – but the basic principles are easy to understand and live by.  There are five things every director should know:

1.     What exactly is a “fiduciary duty” anyway?

Fiduciary” comes from the same Latin word for faith and trust that’s given us “fidelity” and “confidence” (it’s also why there’s a tradition of calling dogs Fido). Basically, if someone places their faith and trust in you – for example by giving you their money to invest or their company to manage – you have a duty not to betray that trust. You have to be loyal and act in their best interests, not your own. It’s really that simple. The moment you find yourself thinking in terms of what’s best for you personally, take a deep breath and a long cold drink of water and think again.

2.     What is a “duty of skill and care”?

As a director, you don’t only have to act in good faith – you have to know what you’re doing. The expectation is not that you should be an expert, or never make a mistake – but you should have the skills that can reasonably be expected of someone in your position, and apply those skills. You can’t, for example, approve a deal because it feels right in your gut or the other person is in your church and you’re sure you can trust them. You need to do all the due diligence required to make sure it will benefit the company.

3.     It doesn’t matter how big or small the company is

 These duties apply equally to directors of small companies, large listed companies and non-profits. It gets more scary and complicated the more of other people’s money is at stake, but your basic duties and responsibilities to your shareholders remain the same.

4.     It doesn’t matter what it says on your business card

 You don’t have to carry the name of Director to bear these responsibilities. The law puts it in more complicated terms, but basically: If it looks like a duck, and walks like a duck, and quacks like a duck, it’s a duck. So if you attend board meetings, make important decisions, sign off on deals and do other things that directors do, the law will regard you as a director. You can’t avoid the responsibility by steering clear of the name.

5.     When in doubt, always opt for more transparency

The law is absolutely clear that you may not use your position to make any kind of secret profit, whether the company loses out or not. If you set up your own new company to take advantage of a major opportunity offered by a client, that’s a clear breach of your duties. But things that seem more innocuous can also be breaches: What if a major supplier offers you a discount when you renovate your house? Even if there’s no expectation of reward, this could still breach your duties. Honesty, as always, is the best policy: Tell the board and let them decide.

In many ways, the Companies Act just codifies in law what most people regard as basic ethics and common sense. If your habit is to act in good faith and care, you’re unlikely to have any problems. But anytime you’re in doubt, seek advice – – it’s always better to know what you’re getting into.

Strip the legal jargon from your documents – your consumer does not understand it!

‘Plain language’ or ‘easy speak’- call it what you want, but you need to use it: the Consumer Protection Act (CPA) requires all ‘suppliers’ to draft their customer facing documentation in a manner that their average consumer will understand. Some love this idea and others (lawyers
especially) hate it.

But what does this mean to you in your relationship with your consumer? Can the consumer demand to receive documentation in his or her home language? Does it mean that each and every consumer who enters your outlet must understand every clause in all of your agreements? The CPA deals with “plain language” in section 22 of the Act where it sets out that documentation must be provided in “plain language”, meaning that “an ordinary consumer of the class of persons for whom the notice, document or visual representation is intended, with average literacy skills and minimal experience as a consumer of the relevant goods or services, could be expected to understand the content, significance and import of the notice, document or visual representation without undue effort”.

From this it follows that if your documentation is reasonable, in that your average consumer will understand it, then it will pass the test even if not every individual consumer understands all clauses 100%. It is a given that your average consumer is unlikely to understand Latin terms, so don’t use them. The same goes for technical terms or warranty terms – explain these in a simple way so that your consumer will understand them.

It is interesting to note that the CPA does not require suppliers to translate their documents into more than one of the official languages. This approach differs from the approach in the National Credit Act (NCA), which requires credit providers to draft and adhere to a language policy – sometimes requiring that documentation be made available not only in English.

BUT: even if your documentation is written in plain language, if it was clear to you that the consumer did not understand the agreement at all, and you nevertheless continued to enter into the agreement, this will not comply with the CPA. In terms of section 40 it is unconscionable for a supplier knowingly to take advantage of the fact that a consumer was substantially unable to protect his own interests because of physical or mental disability, illiteracy, ignorance, or inability to understand the language of an agreement.

If you are in doubt about the language used in your customer facing agreements or terms and conditions, we can help you to translate your documentation from “pre – CPA” to “plain language as required by the CPA” (and NCA).

How to Kick Off Investor Negotiations

Dommisse Attorneys
July 2013

It can take months of pitching before you find the right investor for your business, but finalising the deal can be tricky. Corporate Finance attorney Adrian Dommisse of Dommisse Attorneys shares his tips to avoiding the pitfalls you may encounter during the negotiation.

Finding an investor can be a difficult and time-consuming process and once you’ve found one with the right strategy and values, you may be tempted to rush through negotiations to access the promised cash injection. However, there can be serious ramifications if the details of the deal are not negotiated on level playing fields.

Here are some issues for you to consider:

• Ask for a term sheet early

A term sheet is simply a summary of the deal in a few pages. It exposes the bare bones of the fundamental commercial terms of the investment and because it is so concise, you are less likely to miss some essential detail, as you tend to do when faced with pages and pages of legal documents. The term sheet can be an invaluable document because each board member or founder can get to grips with it quickly, and give input from their unique perspectives.

• Compare deals

Always compare the terms on which different investors would invest. Don’t be tempted (or persuaded) to commit to one investor unless they offer a genuinely better deal. Often an entrepreneur is focused on the valuation of the company, hoping for a higher valuation and therefore a higher investment. But don’t forget other important points – there may be a significant “negative” value such as founder restrictions, share claw backs, rights of investors to sell (their shares and yours!) and other terms that come along with a higher valuation.

• Determine which terms are binding

Before you put pen to paper on the term sheet, be sure to understand which parts are binding. Although the terms of a cash injection will not be binding until set out in comprehensive documentation, the investor may require you to commit to an exclusivity period, in terms of which you undertake not to negotiate with anyone else for a set period.

• Always check the fees

Once the investors instruct their attorneys to draft the investment documents, they will expect those fees to be for your account – usually deductable from the investment amount when it is advanced to you. However, what if there is a genuine disagreement on a fundamental term of the investment? Who pays those fees if the investment never closes? Make sure that you hash out all the details prior to signing and make sure that the legal fees are capped so that they won’t drain your investment funds.

• Determine if there are “arranging costs” involved

“Arranging” costs can be significant. If you are negotiating directly with the investor, this fee may not apply. You could argue that the investor’s profit will be from their investment (exit profit or distribution of profit), not from the company’s balance sheet at the commencement of the relationship. Having said that, it is not uncommon for investors to take a fee from the proceeds of the investment. There can be valid reasons for this, such as where a complex deal requires unique, expert skills to arrange. But you should investigate any such term in discussion with the investor to understand why they would rather do that than invest those funds with you. Check to see if this is common practice – again, by comparing deals.

Following the above process will help avoid disappointment, or even avert a failed deal later down the line, at your cost.

Director’s duties – five things you need to know

There has been a lot of media coverage in the past couple of years devoted to directors’ duties under the new Companies Act of 2008, and the fact that directors can be held personally liable if they breach those duties. The effect can be fear and uncertainty – but the basic principles are easy to understand and live by. There are five things every director should know:

1. What exactly is a “fiduciary duty” anyway?

“Fiduciary” comes from the same Latin word for faith and trust that’s given us “fidelity” and “confidence” (it’s also why there’s a tradition of calling dogs Fido). Basically, if someone places their faith and trust in you – for example by giving you their money to invest or their company to manage – you have a duty not to betray that trust. You have to be loyal and act in their best interests, not your own. It’s really that simple. The moment you find yourself thinking in terms of what’s best for you personally, take a deep breath and a long cold drink of water and think again.

2. What is a “duty of skill and care”?

As a director, you don’t only have to act in good faith – you have to know what you’re doing. The expection is not that you should be an expert, or never make a mistake – but you should have the skills that can reasonably be expected of someone in your position, and apply those skills. You can’t, for example, approve a deal because it feels right in your gut or the other person is in your church and you’re sure you can trust them. You need to do all the due diligence required to make sure it will benefit the company.

3. It doesn’t matter how big or small the company is

These duties apply equally to directors of small companies, large listed companies and non-profits. It gets more scary and complicated the more of other people’s money is at stake, but your basic duties and responsibilities to your shareholders remain the same.

4. It doesn’t matter what it says on your business card

You don’t have to carry the name of Director to bear these responsibilties. The law puts it in more complicated terms, but basically: If it looks like a duck, and walks like a duck, and quacks like a duck, it’s a duck. So if you attend board meetings, make important decisions, sign off on deals and do other things that directors do, the law will regard you as a director. You can’t avoid the responsibility by steering clear of the name.

5. When in doubt, always opt for more transparency

The law is absolutely clear that you may not use your position to make any kind of secret profit, whether the company loses out or not. If you set up your own new company to take advantage of a major opportunity offered by a client, that’s a clear breach of your duties. But things that seem more innocuous can also be breaches: What if a major supplier offers you a discount when you renovate your house? Even if there’s no expectation of reward, this could still breach your duties. Honesty, as always, is the best policy: Tell the board and let them decide.

In many ways, the Companies Act just codifies in law what most people regard as basic ethics and common sense. If your habit is to act in good faith and care, you’re unlikely to have any problems. But anytime you’re in doubt, seek advice – – it’s always better to know what you’re getting into.

The Consumer Protection Act (CPA) regulates your marketing activities

I have previously heard someone saying: “Now that the CPA is in effect, it will be almost impossible to be creative in one’s marketing material – future marketing will be boring!”

Whether this is true or not is debatable, but the bottom line is that marketers need to be careful: the CPA provides for some clear rules when it comes to marketing. Some marketing practices are being prohibited outright whereas other marketing practices are allowed, but regulated strictly. There are in addition some general rules that apply to all types of marketing.

The intention of the CPA’s marketing provisions is clear: you may not mislead your consumer! This means that you will need to consider your marketing material and be sure that your average consumer will understand the message and not be misled.

There are a number of CPA sections dedicated to marketing. The reason is obvious: in our country there are a lot of uneducated and vulnerable people who may in the past have been lured into purchasing products or services for which they had no use. Because marketers were so clever and portrayed a convincing, but untrue, message about certain products which ultimately induced consumers to buy them, the legislator deemed it appropriate to provide some protection to these vulnerable members of society by creating rules that apply to marketing activities. The rationale of these rules is therefore that people should not be persuaded to spend their hard-earned money on products or services that do not have the qualities being portrayed in the marketing material.

We will discuss the various different marketing provisions in more detail in future posts. For now it is important to take note of the following:

  • The general rule is that your marketing material may not be “false, misleading, or deceptive” in any way – whether direct or indirect;
  • Some forms of marketing are prohibited. These include bait marketing (where you “bait” potential consumers into your stores while you know that you do not have stock of the ‘bait item’ to sell to them) and negative option marketing (where the consumer will be deemed to enter into an agreement if the consumer does not clearly decline a particular offer);
  • Promotional competitions, loyalty schemes, promotions and catalogue marketing all have a lot of rules that apply to them and each time that you run any of these types of campaigns, you need to consider the rules very carefully to ensure that your campaign will comply with the CPA requirements;
  • Direct marketing is not prohibited by the CPA as some people may believe. BUT a lot of rules apply, and once the Protection of Personal Information Bill comes into effect, even more rules will apply.

About Dommisse Attorneys
Dommisse Attorneys can assist you with your marketing campaigns to ensure compliance in terms of the CPA. For more information you can contact us by sending an email to info@dommisseattorneys.co.za

POPI: Is “consent” the beginning and the end?

True or false: if you do not have the person’s consent, you cannot use his personal information? From a lot of articles available on the internet, it would seem that the answer to this question must be ‘true’. But is this really the case? Can it be true that unless, for example, I consent to you collecting on debt (money that I owe you and that you are entitled to collect from me in terms of the law) you may not process my personal information and you may not share it with debt collectors? Surely this cannot be the case.

The answer lies in section 11 of the Protection of Personal Information Bill (POPI), which is anticipated to soon come into effect. Section 11, “Consent, justification and objection”, forms part of the second condition for lawful processing, named “processing limitation”. The aim of this condition is, in general, to make the responsible party aware of the fact that that there are some limitations on the processing of personal information and gone are the days where a responsible party could process personal information as and how it pleased.

A lot of people make the mistake of only reading section 11(1)(a) which states that: “Personal information may only be processed if— (a) the data subject or a competent person (where the data subject is a child) consents to the processing”. These people then take the view that if there is no consent, the processing will not be allowed. However, section 11 also makes provision for other justification grounds – meaning that even though there is no consent, the responsible party can “justify” why he is processing the personal information through other means.

The other justification grounds include the following:
1. If the processing is necessary for concluding a contract to which the data subject is a party or it is necessary to perform under such contract;
2. If the processing complies with an obligation imposed by law on the responsible party (an example might be processing for purposes of complying with legislation such as RICA or FICA);
3. If the processing protects a legitimate interest of the data subject;
4. If the processing is necessary for the proper performance of a public law duty by a public body;
5. If the processing is necessary for pursuing the legitimate interests of the responsible party or of a third party to whom the information is supplied.

From this it is clear that even if you do not have the data subject’s consent to process personal information in a particular situation, the law may still allow you to process it if you are able to rely on one of the grounds listed above.

It is important to understand however that different rules will apply to electronic direct marketing. This is dealt with in a separate section of the Bill – section 69. We will provide more information on this in a separate post in due course

Promotional Competitions: The Do’s and The Dont’s

We have all received the phone call or sms to say: “Congratulations, you have won!” (Often some exotic holiday), only to find out that you have not won any prize! You are no winner! Oh no! Now you need to attend some meeting, or purchase “points” in terms of some kind of scheme. So where is the so called prize?

This recently happened to someone I know. He received a sms – informing him that he had won R950 000. So we phoned… and what a surprise, after some questions and statements from our side (including of course a reference to the CPA), the person on the other side hung up. And hung up again when we tried to phone again. And again.

So what does the law say?

Before the Consumer Protection Act 68 of 2008 (“CPA”) came into effect, promotional competitions were governed by the Lotteries Act 57 of 1997 and Regulations. These pieces of legislation were difficult to interpret, which resulted in a lot of confusion and difficulty in compliance with the requirements. Since the enactment of the CPA, promotional competitions are regulated by section 36 and regulation 11 of this Act. The CPA does not outlaw promotional competitions. BUT: it regulates promotional competitions – meaning that a lot of rules apply.

A few of the DO’s:

  1. Check your “offer” to participate (your marketing material) – you need to specify some information during this process (participants should know what they are in for);
  2. Compile competition rules in accordance with the CPA requirements;
  3. Instruct an independent party to oversee and certify the conducting of the competition;
  4. Retain some specified documentation for a period of 3 years.
  5. A few of the DON’TS
  6. Don’t tell anyone that they have won a competition if they have not actually won it;
  7. Don’t charge an entry fee (a requirement that a participant must purchase goods or services to enter will be allowed in certain circumstances);
  8. Don’t force the winner to be present at the prize draw;
  9. Don’t force the winner to participate in marketing activities;
  10. Don’t charge more than R 1.50 for an electronic entry.

We are geared to assist promoters with the review and drafting of their customer facing documentation for promotions, competitions and similar campaigns. We can also assist with the actual prize draw (or oversee the process) and report on your compliance with the provisions of the CPA.