Minimal Mercy for Miscreant Marauders: Delinquency Orders for Directors and the Effects in terms of the Companies Act

Minimal Mercy for Miscreant Marauders: Delinquency Orders for Directors and the Effects in terms of the Companies Act

One of the most significant innovations of the Companies Act No. 71 of 2008 (“Companies Act“) includes an order declaring a director a delinquent in terms of section 162 of the Companies Act. This powerful protective remedy “ensure[s] that those who invest in companies are protected against directors who engage in serious misconduct of the type that violates the ‘bond of trust’ that shareholders have with the people they appoint as directors” (Gihwala and Others v Grancy Property Limited and Others, 2017).

Recent articles on our blog discuss director duties as set out in the common law and section 76 of the Companies Act. What this should make you recognise is that this represents the one side of the coin, being the duties that are owed to the company and its true stakeholders. On the other side of the coin, however, are the consequences of such actions. One is a declaration of delinquency or probation in terms of section 162.

The object of this section clearly establishes such an order as a protective remedy in the public interest. The remedy provides an applicant with protection from a director that proves unable to manage the business of a company or has failed or neglected their duties and obligations owed to a company. In other words, the remedy not only protects the applicant but serves to protect other companies from the delinquent director’s conduct as well.

This remedy takes the form of a court application for an order declaring a director a delinquent, the result being a prohibition on being a director for any company for seven years, or even indefinitely in serious cases, being placed on a register of delinquent directors and, as an “automatic inherent effect of such a declaration” (Kukama v Lobelo, 2012), a director found guilty of such conduct shall automatically be removed from any current board seat held.

What is interesting to note is that this amounts to an indirect manner for the removal of a director from a company and it does not matter what the subjective motive of the applicant is; if there is objective merit for delinquency this may be a viable way to remove a director, even if the sole motive of the applicant is to have the director removed by a court (Msimang NO and Another v Katuliiba and Others, 2013).

Following from the above, it is, of course, important to recognise who can bring an application for delinquency. Quite a wide net is cast in this regard, which may include the company itself, a director, shareholder, company secretary or a prescribed officer of a company. The right to initiate such an application goes even further and includes a registered trade union that represents the employees of the company or another employee representative, the Companies and Intellectual Property Commission, the Takeover Regulation Panel and, to a limited extent, an organ of state responsible for the administration of any legislation.

There is a distinction in the application of Section 162 as it relates to an order of delinquency and an order for probation. Whereas an order for probation requires a court to apply its discretion, an order of delinquency does not require such discretion, meaning that, for purposes of an order of delinquency, a court must declare a director delinquent if one of the following grounds are established as provided in the Companies Act, this being considered by the courts as a substantive abuse of power (in terms of sections 162(5)(a),(b),(d),(e) and (f)):

  • consenting to serve as a director, or acting in the capacity of a director or prescribed officer, while ineligible or disqualified in terms of the Companies Act;
  • while under an order of probation, acting as a director in a manner that contravened that order;
  • repeatedly being subject to a compliance notice or similar enforcement mechanism;
  • being convicted twice personally of an offence or being subject to an administrative fine or penalty in terms of any legislation; or
  • within a period of 5 years, being a director of one or more companies or being a managing member of one or more close corporations, or controlling or participating in the control of a juristic person (irrespective of whether concurrently, sequentially or at unrelated times) that was convicted of an offence or subjected to an administrative fine or similar penalty in terms of any legislation.

The Companies Act, furthermore, provides for more substantive abuses under section 162(5)(c) of the Companies Act, the confirmation of which will result in an order for delinquency as well and includes:

  • gross abuse of the position, while acting as a director;
  • taking personal advantage of information or an opportunity, or intentionally or by gross negligence inflicting harm on the company or a subsidiary of the company, contrary to section 76(2)(a) of the Companies Act; or
  • acting in a manner that amounts to gross negligence, wilful misconduct or breach of trust or in a manner contemplated in sections 77(3)(a), (b) or (c) of the Companies Act (unauthorised acts, reckless trading or fraud).

Of interest is the repetition of sections 76 and 77 of the Companies Act in the above-mentioned grounds, which refers to the fiduciary duties of directors and their personal liability. What this means is that, in addition to personal liability, it is possible for a director to also be declared delinquent. This remedy takes the common law duties of directors, which have been codified in section 76 of the Companies Act, and gives them teeth – quite significant teeth.

Regarding the grounds recorded in section 162(5)(c), case law has provided a significant amount of guidance and it is clear that the common law principles codified in sections 76 and 77 of the Companies Act continue to steer the courts’ approach, these being regarded as substantive abuses of office, leading to a lack of genuine concern for the prosperity of a company (Grancy Property Limited v Gihwala, 2014).

Regarding gross abuse of the position of director (see section 162(5)(c)(i) of the Companies Act), a court will have to use its discretion as to whether a gross abuse is present, this term not being defined in the Companies Act. However, an abuse must relate to the use of the position as director and not relate to the performance of the director. An example of such an abuse would include the usurping of confidential information or a corporate opportunity meant for the company and using this for the director’s personal advantage, whether for another company or personally (Demetriades and Another v Tollie and Others, 2015), this amounting to a breach of a director’s fiduciary duties, irrespective of whether the actions undertaken by the director have caused harm to the company or not. This seems to overlap closely with the common law corporate opportunity rule (which has been codified to a certain extent in section 76 of the Companies Act) and which dictates that any contract, opportunity or information that arises for a company, irrespective of whether it could be taken up or used by a company or not, belongs to the company and a director is prohibited from usurping the aforementioned for him or herself.

Taking personal advantage of information or an opportunity meant for a company (see section 162(5)(c)(ii) of the Companies Act) is a ground similar to the above-mentioned ground of abuse, however, it is narrower in that it applies only if a director usurped information or an opportunity meant for a company, for the personal advantage of the director as a natural person. To date, courts have found this ground to be present for two dominant types of conduct, one being the appropriation of a business opportunity that should have accrued to the company and secondly, insider trading.

The grounds established in terms of sections 162(5)(c)(ii) and (iv) of the Companies Act, being the infliction of harm intentionally or by gross negligence and/or breaching trust, whether directly or indirectly places an element of discretion on the court. In effect, conduct aimed at harming a company or recklessness while aware of the harm that certain conduct may cause, will be used by the court to navigate the relevant questions in this regard. Actions which could result in the presence of these grounds could include the conducting of a business by a director in competition with a company that he or she is also a director of, the misappropriation of company funds, the failure to keep proper accounting records and possibly the appropriation of financial benefits for certain directors to the exclusion of shareholders. What is important to note is that the court will take into consideration holistically the actions undertaken by a director and will have to establish whether or not such action amounts to wilful misconduct or gross negligence, thereby intimating of course that a bona fide mistake or error will not automatically result in an order for delinquency. What is required is more, namely gross negligence, wilful misconduct or a breach of trust.

Further common law rules that may influence the above-mentioned grounds (in addition to the corporate opportunity rule) may include the common law no-conflict rule and no-profit rule. In terms of the no-conflict and no-profit rule, which to an extent overlaps, a director owes a company a fiduciary duty not to place themselves in a position in which there may be a conflict between their personal interests and the interests of a company. Furthermore, profits made by a director acting in that capacity are for the company and cannot be retained by him or her, resulting in those profits having to be disgorged. It is important to note in such circumstances that ‘profit’ is not only limited to money but could be any advantage or gain experienced by a director and, furthermore, it is irrelevant whether a company could have secured the particular profit for itself.

This discussion should clarify that a director acts as an extension of a company and therefore has more strict obligations placed upon his or her shoulders when compared to an agent, for example. It goes further in that a core misuse of this position for his or her own benefit or a serious conflict can be responded to with severe consequences. Many individuals think that they can use a company and play the victim card thereby side-stepping personal liability, in legal terms, hiding behind the corporate veil. However, you can note from the above that the Companies Act does indeed have some teeth and, depending on the veracity of the grounds, a court will not and, to a certain extent, cannot hesitate when relevant grounds for delinquency are proven and if they do, may a Judge have mercy on your miscreant soul.

Mergers and amalgamations in terms of sections 113 and 116 of the companies act

Mergers and amalgamations in terms of sections 113 and 116 of the companies act

Corporate mergers and acquisitions play a significant role in many companies’ growth strategies. They are among the most effective tools utilised by forward thinking boards to scale and grow a business.

With the fast-paced society that we live in today and access to information being so readily available, businesses are scurrying to build shareholder value, taking advantage of potential complimentary industries and making the necessary corporate decisions to gain a bigger share of the markets they operate in.

Since the Companies Act, 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 amalgamations.

The Companies Act introduced a new form of statutory merger which exists in addition to, and not in substitution of, the pre-existing methods used by companies wanting to effect business combinations, i.e. a sale of shares or a sale of business as a going concern.

The statutory merger is governed in terms of section 113 and section 116 of the Companies Act and the merger agreement is a mandatory requirement in terms of section 113(2).

In addition to each amalgamated or merged company passing the solvency and liquidity test in terms of section 113(1), section 113(2) provides further mandatory terms and conditions that must be addressed in the merger agreement, namely:

  1. the proposed Memorandum of Incorporation of any new company to be formed by the amalgamation or merger, must be included in the merger agreement;
  2. the name and identity number of each proposed director of any proposed amalgamated or merged company must be included;
  3. the manner in which the securities of each amalgamating or merging company are to be converted into securities of any proposed amalgamated or merged company, or exchanged for other property, needs to be detailed;
  4. if any securities of any of the amalgamating or merging companies are not to be converted into securities of any proposed amalgamated or merged company, the consideration that the holders of those securities are to receive in addition to or instead of securities of any proposed amalgamated or merged company;
  5. the manner of payment of any consideration instead of the issue of fractional securities of an amalgamated or merged company or of any other juristic person the securities of which are to be received in the amalgamation or merger;
  6. details of the proposed allocation of the assets and liabilities of the amalgamating or merging companies among the companies that will be formed or continue to exist when the merger agreement has been implemented;
  7. details of any arrangement or strategy necessary to complete the amalgamation or merger, and to provide for the subsequent management and operation of the proposed amalgamated or merged company or companies; and
  8. the estimated cost of the proposed amalgamation or merger.

Further to the above, a thorough regulatory investigation is required to ensure compliance with the relevant regulatory bodies and to ensure that the necessary consents and/or approvals are obtained (i.e. Takeover Regulation Panel approval or exemption, Competition Commission approval, etc.).

A compliant merger agreement, addressing all the requirements in terms of the Companies Act, is imperative for a successful merger. Should you need assistance perfecting a merger, don’t hesitate to give one of our lawyers a call.

Disclaimer. The articles on our website are provided for general information purposes only. We have taken care to ensure accuracy, however the content is not intended as legal advice. Always consult an attorney on your specific legal problems.

POPIA: responsible parties and operators

POPIA: responsible parties and operators

Our previous POPIA articles have examined various aspects of the Protection of Personal Information Act 4 of 2013 (“POPIA“) at length, most notably, the various conditions for processing personal information.  In this post, we will examine the roles of “responsible party” and “operator” in terms of POPIA and what each of these roles entails, along with the rights and responsibilities of the roles.

The main purpose of POPIA is to regulate the use of personal information (as defined by POPIA and summarised below) and to provide for adequate security measures to protect personal information, and the different parties in a relationship will have to comply with these measures in certain ways. Therefore, these roles are important to consider as they have a profound impact on the relationships between responsible parties and operators and also affect the way in which information is processed and used.

What do these terms mean?

  • responsible party” means the party who determines the purpose of and means for processing personal information. This decision may be made alone or in conjunction with another party.
  • operator” means a person who processes personal information for a responsible party in terms of a contract or mandate, but does not come under the direct authority or control of the responsible party.
  • processing” means any activity (including automatic means) concerning personal information, and includes the collection, receipt, recording, organisation, collation, storage, updating or modification, retrieval, alteration, consultation or use, distribution by means of transmission, distribution or making available in any other form or merging, linking, and restriction, degradation, erasure or destruction of information.
  • personal information” is information relating to an identifiable, living person and is not limited to information relating to race, gender, marital status, pregnancy, ethnicity, age, health, disability, religion, language, culture, education and employment, criminal history, identity number, contact details, biometric information, personal opinion, etc.

What is the difference between a responsible party and an operator?

As set out above, responsible parties determine the purpose for processing information, what information is processed, for how long and how it is processed. Where an operator is involved, the responsible party will still determine the purpose for processing etc, but will outsource the processing of the information to the operator. The responsible party therefore still makes all decisions in relation to the information and the operator acts in accordance with these decisions and on the instructions from the responsible party.

The responsible party remains ultimately accountable for ensuring that POPIA is complied with by both itself and all operators providing services to the responsible party. The outsourcing or sub-contracting of any processing activities to operators does not absolve the responsible party from liability. If the operator contravenes POPIA, the responsible party will still be held liable by the Information Regulator.

The importance of contracts when appointing an operator

As with many other relationships, a contractual agreement between a responsible party and operator will prove very useful and high highly recommended in order to definitively address and govern the roles of each party and the boundaries of the relationship.

An agreement between the responsible party and operator should address, at the least, the following points:

  • That the operator only acts within the ambit of the agreement/mandate with the responsible party;
  • The purpose for processing of the information;
  • What information may be processed by the operator;
  • What the operator may or may not do with the information outside of the processing mandate;
  • A duty to protect the information received, not share it with third parties without consent, to keep the information received confidential and to otherwise act within the ambit of POPIA;
  • Limit the operator from appointing further operators without the responsible party’s knowledge or consent; and
  • Liability for the operator*.

Liability for the operator

As mentioned above, the responsible party will be held ultimately liable by the Information Regulator for a breach of POPIA by the operator. The Information Regulator will impose this liability on the responsible party where the breach occurred within the scope of the mandate agreement between the responsible party and the operator and will not be diverted to the operator where the breach is as a result of the operator’s failure to uphold the principles of POPIA.

Therefore, the agreement between the responsible party and the operator is extremely important for the responsible party as this agreement can result in the responsible party holding the operator liable for any claims that the Information Regulator and/or data subjects (the people whose personal information is being processed) bring against the responsible party as a result of a breach of POPIA by the operator. A liability clause will allow the responsible party to bring a claim for any loss suffered by the responsible party as a result of the operator’s negligence or breach of POPIA.

Some relief for a responsible party in this regard is where an operator breaches POPIA where the operator has exceeded its mandate. In these circumstances, the operator is seen to be acting as a responsible party in regard to the personal information as the operator is determining the purposes and means of processing.

Conclusion

We cannot emphasise the importance of an agreement between a responsible party and operator enough as such an agreement sets out the important details of the relationship between the operator and responsible party and aims to protect not only the responsible party, but also the operator by detailing the extent of the processing and other responsibilities that the operator undertakes.

Make sure that you know when you act as a responsible party and when you are acting as an operator as your responsibilities will differ along with your liability.

Observations on company names

Observations on company names

Choosing a name for your new company may seem simple, but what may not be clear is that you cannot call your company whatever you want, as South African law regulates what a company name can and cannot be. Section 11 of the Companies Act, 71 of 2008 (“the Companies Act“) sets out the criteria for company names. In essence, the name of your company may comprise of words in any language together with any words or letters / numbers / symbols and / or punctuation marks. However, the name of your company may not be the same (or similar to) the name of another company or close corporation, someone else’s defensive name (a name registered up to two years which is aimed at preventing trade marks from being included in the new company name), business name or registered trademark or a mark on any merchandise. Your company name must not falsely imply that the company is part of any other person / entity, is an organ of state, is owned by a person having any particular educational designation, who is a regulated person or is owned by any government or international organisation. Importantly, your company name must not include anything that may constitute propaganda for war, incitement of imminent violence or advocacy of hatred against any right entrenched in the Bill of Rights.

Registered vs trading names:

The registered name of a company is the name which has been reserved, approved and then registered with the Companies and Intellectual Property Commission (“the CIPC“). In terms of the Companies Act, a company is required to display its registered name (and registration number) on all forms, notices and correspondence with others and failure to do so constitutes an offence.

Despite that, it is common practice for entrepreneurs to acquire shelf companies or to register a company with a non-distinctive name and to simply trade under a different name. Although a trade name does not need to be registered, the assumption is that a reasonable level of investigation would have been conducted to ensure that a trade name is not already in use. In reality, this often leads to the infringement of third party trademarks or causes confusingly similar names to exist.

For the above reason, the Consumer Protection Act 68 of 2008 (“the CPA“) has introduced changes to the way in which “trading as” names (which the CPA calls “business names“) may be used. The provisions relating to business names are contained in sections 79 to 80 of the CPA, and will only come into effect upon a date to be determined by the Minister of Trade and Industry (“the Minister“) and published in the Gazette. This has not happened yet, but it is likely that when it does, the Minister will allow a certain amount of time after the published date for companies to comply with these new provisions.

The intention of the legislature in this regard, is to seek to enforce the consumer’s right to information concerning suppliers. The aim is to prevent a situation where a business would trade under one name but fail to disclose the identity of the actual entity behind the transactions, thereby frustrating the attempts by the consumers to seek redress in pursuing the correct entity.

What you need to know and the CPA’S requirements

In terms of section 79 of the CPA:

A person must not carry on business, advertise, promote, offer to supply or supply any goods or services, or enter into a transaction or agreement with a consumer under any name except:

  • the person’s full name as:
  • recorded in an identity document or any other recognised identification document, in the case of an individual; or
  • registered in terms of a public regulation, in the case of a juristic person; or
  • a business name registered to, and for the use of, that person in terms ofsection 80, or any other public regulation.

What the above means is that an individual or company (as the case may be) may not operate / carry on business with a business name unless it is registered in terms of the CPA. This information will then be publicly available on the business names register as maintained by the CIPC. The implication is that, should any business operate with any other name other than those as set out in section 79, the National Consumer Commission (“the NCC“) can issue a compliance notice and failure to comply will result in a fine or prosecution as a criminal offence.

As some assurance, however, the CPA provides a certain degree of relief for businesses which have been in trade before the business name provisions come into force – the NCC may not enforce the business name requirements against a business if it has been trading under the business name for a period of at least one year.

Procedure

Section 80 of the CPA provides for the procedure in registering the business name of a company. As mentioned before, these provisions are not yet in force since the business names registry and the registration process have not yet been established.

When the provisions come into force, a person may file a notice with the CIPC to register any number of business names currently used by your entities. If the business, under which the business name has been registered does not carry on business for a period exceeding 6 (six) months, the CIPC reserves the right to cancel such business name.

Possible difficulties

These provisions may cause difficulties for franchises because there are normally multiple franchisees trading under the same name as the franchisor. However, the registered name for each franchisee, may be completely different. The new requirements therefore force each separate franchisee to register the same business name leading to multiple entries of the same name being reflected on the records of the CIPC. This could be somewhat counter-intuitive since the confusion that it creates may defeat the purpose of the consumers’ right to information in the first place. Furthermore, franchisors may not be happy allowing each and every franchisee incorporating what is effectively their “trade mark” as the franchisees business names.

Going forward

Although these provisions have not come into effect yet, in the interests of avoiding the rush of changing branding and registering new names at the CIPC, the provisions above should be duly considered when choosing a business name as the criteria will most likely need to be adhered to in the near future.

Bitcoin, Blockchain, Cryptocurrencies and ICOs: Legal enigmas for start-up’s operating on the future frontier

Bitcoin, Blockchain, Cryptocurrencies and ICOs: Legal enigmas for start-up’s operating on the future frontier

The latest buzz words shaking up the technology, business, financial and legal establishments are not to be treated lightly. These terms are uniting (hard as it might be) all the major role players in their quest to evaluate the potential far-reaching effects it might hold for the future of commerce globally. It is difficult to ignore the fast-paced development of the latest technological advances, as we find ourselves amid the fascinating transition phases nestled between the Third and Fourth Industrial Revolutions. More importantly, as the universal compatibilities envisioned for this technology have now progressed from hypothetical online discussions between “tech-developers” and futurists to functioning real-life applications, passionate debates have erupted across a variety of diverse forums. Ranging from the corridors of legislators and financial regulators to the living rooms of the Stokvel run by Joe Soap, as people are curious (and watchful) about the industries based on the Future Frontier – and rightly so.

As the terminology is complex, we will not aim to explain what the Blockchain, Cryptocurrencies (which include BitCoin) or Initial Coin Offerings (“ICO”) are. We will also not attempt to define or address the application possibilities of these initiatives in this post, as the possibilities are vast and beyond the scope of this post. (For more information on the technical aspects relating to these terms, please see the links below explaining this in more detail.[1]) We will only briefly aim to highlight some aspects start-ups and potential investors should bear in mind when investigating the opportunities created by the technology found on this Future Frontier.

For Start-Up’s

Start-ups looking to venture into the industries of the Future Frontier are advised to note that there is still a lot of uncertainty as to the regulations governing and enforcing the practical application thereof. As such, carefully considering the current legislative frameworks in existence (and more importantly, the purpose behind it) might provide a helpful understanding of the things entrepreneurs should consider when developing their business models for the market. In a South African context, start-ups should consider the following legislative and regulatory concerns which might be applicable to them:

  • FICA, Money-Laundering and Know-Your-Client (KYC) legislation: due to cryptocurrencies trading far more anonymously over various encrypted platforms entrepreneurs are encouraged to familiarise themselves with the relevant FICA, Money laundering and KYC processes. Especially in industries where payments are being made by potential payment or payment systems operators;
  • Business of a Bank and Collective Investment Schemes: Business models based around the collecting and pooling of fees and/or accepting deposits for investments into cryptocurrencies and ICO’s might be considered to be Collective Schemes or structures conducting the business of a bank, both of which are strictly regulated by the SARB and FSB, respectively;
  • Financial Advisory and Intermediary Services Act (Twin Peaks Financial Sector Regulation Bill): any current or potential services aimed at the financial advisory or intermediary industries are strictly regulated by the Financial Services Board (and will soon fall under the Twin Peak Provisions);
  • Exchange Control Regulations: Strict requirements regarding the outflow of capital and funds exist in South Africa. As a result, certain apps or services designed to facilitate transfers of this kind without prior SARB approval, tax clearance from SARS or adherence to existing policies may pose some concern to regulators;
  • Companies Act: A very popular means to raise funds for start-ups focusing on Future Frontier industries is by way of an ICO. During an ICO the start-ups issue their own crypto- tokens to participants at a discount and often raise vast amounts of capital. However, an ICO might, depending on the rights attached to these crypto-tokens, in some cases be regarded as a thinly veiled offer of securities to the public. If that is the case, the Companies Act and accordingly, the strict laws relating to the issue of securities by way of an offerings to the public will be applicable. Since the Securities Exchange Commission of the USA recently declared this position (not without criticism), other jurisdictions may follow suit; and
  • Consumer Protection Laws: The loss of virtual cryptocurrencies value, tokens issued to paying participants without any underlying value and other types of blockchain transaction issues such as erroneous payments and systems breaches, hacks or Ponzi schemes are things to consider. If not adequately managed, this may create serious liabilities, not to mention reputational damage, to any start-up involved in these types of commercial venture.

These are merely some of the myriad questions start-ups are urged to consider as a starting point into the regulatory and compliance frameworks regulating the industries on the Future Frontier.

Investors

Warren Buffet once said the following: “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know”.

In keeping with this thought, we would therefore urge any investors considering investing into start-ups which focus on the Future Frontier industries to not stray too far from established investment principals. Especially in determining what the Investor does not know, conducting an adequate due diligence investigation (or “DD“) into the envisioned Start-up’s proof of concept, management of regulatory and compliance issues and the viability of their intended financial and business models should be considered a minimum requirement. Further to this, investors would do well to consider special escrow arrangements for any transfer of investment funds irrespective of whether these funds are done by way of crypto-funds/tokens and/or fiat currency. Also using respected and knowledgeable service providers may mitigate against any risks involved in these investments.

Conclusion

There are various levels of uncertainty regarding the practical and legal implications of these Future Frontier industries. This accordingly provides ample grey area for entrepreneurs and investors alike to either flower or flounder through. As such, we would recommend that any Start-Ups or investors contemplating to venture into these Future Frontier Industries to make sure that they have a clear view of the legal nature of the transaction at hand. If the legal nature of the transaction is clear, it enables the parties to take a measured approach to control the relative risk associated and build in the protective mechanisms that the law requires.

We hope to see legislators work with other industry experts to create a legislative framework that promotes certainty, without smothering the revolutionary initiatives and staggering opportunities presented by Future Frontier technology.

[1] For further detailed information regarding how Cryptocurrencies and the Blockchain function and operate please make use of the following recommend sources:

 

Conversations and agreements – when are they binding?

Conversations and agreements – when are they binding?

Introduction

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

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

Written contracts have various advantages, among others, they:

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

Electronic communication

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

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

Conclusion

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

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

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

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

Important take-aways

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

POPI: First meeting for the Information Regulator

POPI: First meeting for the Information Regulator

In our blog post on 7 November 2016 we referred you to the appointment of the members of the Information Regulator – which is an independent juristic person in terms of the Protection of Personal Information Act – commonly referred to as “POPI”. The Information Regulator will be responsible for monitoring and enforcing compliance with both POPI and the Promotion of Access to Information Act 2000 (PAIA).

The 5 members of the Information Regulator (Chairperson, 2 full-time and 2 part-time) have been appointed for a 5 year period that commenced the beginning of the month and according to a media statement issued by Adv. Tlakula (the Chairperson) on 2 December 2016, the Information Regulator held a meeting on 1 December 2016 to commence their function and duties. It has been confirmed that the full time member responsible for PAIA is Adv. Stroom-Nzama and the full time member responsible for POPI is Adv. Weapond.

The POPI commencement date has not been confirmed yet, but the general view in the industry is that 24 May 2017 is the likely day – as this will mean that compliance with POPI will be required as from the 25th of May 2018, which is also the date for compliance with the European Union’s General Data Protection Regulation.

In practice we are starting to see more clients focussing on POPI requirements and starting to create POPI awareness through training sessions and implementation of amended policies and practices. It would probably be unrealistic to think that POPI will mean a “quick fix” for all data concerns, but POPI will certainly play a big role to regulate the way in which companies manage data in future.

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.

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.