The Edcon Ruling: What to take away from it

The Edcon Ruling: What to take away from it

1. BACKGROUND

Credit providers assist customers who cannot afford to make all payments in cash. In turn for the risk they take, they are allowed to charge certain costs and fees.  When credit agreements are within the ambit of the National Credit Act 34 of 2005 (“NCA” or “the Act“), the Act imposes maximum limits on these fees. Irrespective of the type of credit agreement, section 101 of the NCA provides for a closed list of the fees that a credit provider may charge the consumer in relation to a credit agreement. These fees include, amongst others, initiation fees, service fees, interest, credit insurance and/or default administration charges

2. INTRODUCTION

It has become common practice for retailers to make membership clubs available to consumers in exchange for a monthly “membership/club fee”. Typically, when a consumer becomes a club member he or she would earn points or similar consideration for different reasons – such as a percentage of the purchase price being earned in points. Depending on the type of club joined and/or amount of points earned by that club member, he or she would be entitled to convert his or her points into some form of benefit or product (for example, entertainment, travel, spa, gym etc.). For credit providers who want to offer similar “clubs” there is a challenge in that the NCA does not provide for this kind of “club fee”.

3. THE EDCON RULING

More recently, the National Credit Regulator (“NCR“) started to investigate this business practice and focused on a well-known credit provider retailer: Edcon Holdings Limited (“Edcon“). Following the investigation, they initiated action against Edcon by referring the matter to the National Consumer Tribunal (“NCT“) seeking an order declaring that Edcon has, among other things, repeatedly contravened the provisions of the NCA relating to prohibited charges – by charging a fee not allowed for in the NCA.

The NCT considered the matter from a broader legal perspective, namely whether the NCA allows a credit agreement to contain any fee or charge other than those permitted by the NCA. Edcon argued that the club membership was a stand-alone product, not intended to be part of the credit agreement.

As a starting point, the NCT concluded that the NCA unambiguously prohibits credit providers from charging any fee or charge other than those listed in and provided for in the Act.  The NCT found that Edcon was not allowed to charge its credit customers any fee or charge other than that permitted by the NCA and could therefore not charge the club membership fees. In conclusion, it was held that, by doing so, Edcon had engaged in repeated prohibited conduct in terms of the NCA.

The NCT emphasised that the business practice of charging “membership/club fees” is explicitly prohibited by the NCA and any credit provider who does business in this way may face dire consequences. From perusal of the ruling, the likely consequences that Edcon faces may include being directed to refund consumers charged club and membership fees from 2007 to date and/or an administrative fine on Edcon. According to media reports, Edcon has indicated that they will appeal the ruling.

4. CONCLUSION

The above ruling raises a red flag to many credit providers or credit retailers who may be involved in similar business practices. Retailers should take the following away from this ruling:

  • irrespective of whether customers voluntarily choose to purchase this type of (club) product, a membership/club fee may be seen as a cost of credit if it is inseparably linked to a credit agreement; and
  • review your credit agreements to ensure you do not include any provisions or charges not allowed in terms of the NCA.

Please note that not all club memberships will fall within the ambit of this ruling and club structures will need to be considered on a case to case basis. Please do not hesitate to contact us should you have any queries.

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.

Companies Act, 71 of 2008 Series Part 6: Share capital – what to consider?

The monies raised by a company through the issue of shares is commonly referred to as the share capital of that company. The Companies Act, 71 of 2008 (as amended) (“Companies Act“) regulates certain aspects regarding share capital, which every director, shareholder and potential investor should be aware of. Set out below are 8 of the most important things you should know in order to manage your company’s share capital and to help you make informed decisions about potential equity investments.

  1. Where is the share capital recorded?

A company’s memorandum of incorporation (“MOI“) must set out the classes of shares, the number of shares of each class that the company is authorised to issue and any specific preferences, rights, limitations and other terms associated with the shares. The share capital is therefore located in the MOI, which is theoretically a public document available for inspection from the Companies and Intellectual Property Commission (“CIPC“).

  1. The distinction between the authorised and issued shares of a company

The authorised shares are the shares which the company is entitled to issue in terms of its MOI. Authorised shares have no rights associated with them until they have been issued. The issued shares are shares that are authorised and issued to shareholders, and to which certain rights are then attached.

  1. Basic rights attaching to every share

Save as provided otherwise in the MOI of the company, a share affords every holder of such share the right to certain dividends when declared, the return of capital on the winding up of the company and the right to attend and vote at meetings of shareholders. These rights can, however, be limited, for example, dividend preferences or liquidation preferences may attach to one class of shares but not the others. Non-voting rights may also attach to a class of share. However, every share issued gives that shareholder an irrevocable right to vote on any proposal to amend the preferences, rights, limitations and other terms associated with that share. This is an unalterable right under the Companies Act.

  1. How many authorised shares is appropriate?

This of course depends on the circumstances, but there is no limit to the number of authorised shares a company can have in its share capital. When starting a business an entrepreneur will often acquire a “shelf company”, which typically has an authorised share capital of 1 000 shares. This is suitable if there are only one or two shareholders. If more shareholders are anticipated, the authorised share capital will need to be increased. It is advisable to have enough authorised shares to avoid having to create further shares (and go through the process set out in point 5 below) every time the company needs to issue further shares.

  1. Amendment of the share capital – how is the CIPC involved?

The authorisation, classification, number of authorised shares, and preferences, rights, limitations and other terms associated with the shares, as set out in the company’s MOI, may only be changed by way of an amendment of the MOI. Such amendment can be approved by resolution of the board of the company, or by special resolution of the shareholders of the company, depending on which method is provided for in the MOI. It is common practice to restrict the board’s powers in this regard and reserve such matters for approval by the shareholders (in the MOI).

Any amendment of the MOI must be submitted to the CIPC for acceptance and registration. This process could take anywhere between 1 – 3 months, depending on the CIPC’s capacity and any backlogs.

  1. What happens if shares are issued in excess of the authorised share capital?

In the event that more shares are issued than are authorised (or shares are issued that have not yet been authorised), the board may retroactively authorise such an issue within 60 business days of “issue” – otherwise the share issue is void to the extent that it exceeds the authorised share capital. In such circumstances, the company must return to the relevant person the fair value of the consideration received in terms of such share “issue” (plus interest) and the directors could be held liable for any loss, damage or costs sustained by the company as a consequence of knowingly issuing unauthorised shares.

While these consequences can be severe, the potential costs and damages to the company (and its board) can be limited in the event that all the shareholders are willing to participate in rectification steps that would need to be taken and simultaneously waive their rights to claim any return of consideration and damages, where such actions were not taken knowingly and not timeously retroactively authorised.

  1. Share capital may comprise of different classes of shares

Not all shares in a company need have equal rights and preferences. Some shares may have preferential rights as to capital and/or dividends, privileges in the matter of voting or in other respects. A company may, for example, create one class of shares for the founders of the company, another class of shares for its investors and a third class of shares for its employees, with each class having its terms tailored for specific purposes. Note that the preferences, rights, limitations and other terms of shares distinguish the different classes, but are always identical to those of other shares of the same class.

  1. Shares in a company incorporated under the “old” Companies Act, 61 of 1973 (as amended) (“1973 Companies Act”)

Any issued shares held in a company that was incorporated under the 1973 Companies Act and were issued before 1 May 2011, being the effective date of the Companies Act (“Effective Date“), continue to have all the rights associated with it immediately before the Effective Date. Those rights may only be changed by means of an amendment to the MOI of the company.

All shares of companies incorporated under the Companies Act are no par-value shares. Under the 1973 Companies Act, however, a company could have a par-value share capital. If par-value shares had been issued as at the Effective Date, such company may still issue further authorised but unissued par-value shares, but the authorised par-value share capital itself may not be increased. In the event that such a company wishes to increase its authorised share capital, it can either convert its existing par-value shares to no par-value shares and then increase such number of authorised shares, or alternatively, create a further class of no par-value shares thereby also increased the total number of authorised shares.

Concluding remarks

Although at first glance the exact composition and structure of a company’s authorised and issued share capital may not be considered a top priority for busy entrepreneurs to worry about, we trust that the issues highlighted above will give you some insight and guidance into how and why your company’s share capital should be of great importance to your shareholders and any potential investors. 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 you.