Key-man insurance policies vs buy and sell agreements: Which is more appropriate for your business?

Key-man insurance policies vs buy and sell agreements: Which is more appropriate for your business?

INTRODUCTION

There is an important distinction between a key-man insurance policy and a buy and sell agreement. While they are both used in the context of ensuring the ongoing profitability and sustainability of a business in the event of the untimely death, severe disability or critical illness of a key business partner, their underlying purpose is different. We briefly unpack these differences below.

KEY-MAN INSURANCE

The value of a business is largely dependent on the input of key employees or partners in the business. The sudden loss of a key individual may put the business at serious risk. As such, a key person can be seen as someone whose absence (through death, disability or critical illness) will have a material adverse effect on the future of the business. What a key-man insurance policy seeks to do, is to protect the business in the event of the premature death of a key individual or if such key individual becomes disabled or critically ill. Such a policy is taken out and paid for by the company and upon the death, disability or critical illness of the key individual (who may or may not be a shareholder), the policy proceeds are paid to the company (rather than to the deceased estate in the case of a death of the individual). This provides the company with cash flow to enable the business to continue operations while a suitable replacement is found.

BUY AND SELL AGREEMENTS

A buy and sell insurance policy is typically used to fund a buy and sell agreement. The buy and sell agreement itself contains several important provisions to facilitate the orderly transition of ownership of the business, should one of the owners die prematurely, become disabled or critically ill, which provisions may include (amongst others):

  • What events may trigger a buy-out by the remaining shareholders – will it only be the death, disability or critical illness of the shareholder concerned, or will it include other events such as retirement or bankruptcy?
  • What shares each of the remaining shareholders are entitled or required to purchase – all shares or only shares of a specific class?
  • In what proportions the remaining shareholders will purchase the shares – pro rata or in a specified proportion?
  • How the buy and sell agreement will be funded – by way of an insurance policy or other method?
  • How the shares of the company will be valued.

Where a company has numerous shareholders, a buy and sell agreement provides the mechanism to provide for the funds that the remaining shareholders will need to acquire the deceased shareholder’s shares. This has an important bearing on the sustainability of the business as it may not always be a good idea for these shares to be passed on to the heirs – they may not necessarily have the skill set nor the desire to work in the business.

TAX IMPLICATIONS OF KEY-MAN POLICIES

The tax implications relating to the treatment of premiums paid and the proceeds received from a key-man policy are often overlooked. We discuss the various tax consequences briefly below.

Income Tax:

In terms of the Income Tax Act, 58 of 1962 (ITA), a company may be able to claim certain insurance premiums paid on the life of the key-person as a deduction. Whether the premiums could be deducted, will depend on whether the conditions and requirements as set out in the ITA have been met and in each case the particular policy wording will need to be reviewed in order to determine whether it is likely that a deduction will be allowed.

Estate Duty:

Section 3(3)(a) of the Estate Duty Act, Act 45 of 1955 (Estate Duty Act), includes the proceeds from a life insurance policy on the life of the deceased as “deemed property” of the deceased estate, if it meets the requirements of this section, irrespective of who the owner of the policy was or who paid the premiums. However, the full proceeds are not always included in terms of these deeming provisions. The section further provides that where the policy proceeds are not recoverable by the estate, but by the company, and the company also paid the premiums, only the amount by which the proceeds exceeds the total premiums paid plus interest thereon, is deemed to be the property of the deceased estate. However, section 3(3)(a)(ii) of the Estate Duty Act contains an estate duty exemption for these policies, resulting in them not being included as the deemed property of the deceased estate, provided all the requirements listed for the exemption to apply, have been met. If this is the case, no estate duty will be payable on the policy proceeds.

Capital Gains Tax (CGT):

In terms of paragraph 55 of the 8th Schedule to the ITA, the proceeds of key-man policies are exempt from CGT in the following instances:

  • where the person is the original beneficial owner of the policy;
  • where the person, whose life is insured, is or was an employee or director and any premiums paid by the person’s employer were deducted in terms of section 11(w) of the ITA;
  • where the policy is a risk policy with no cash or surrender value;
  • where the policy’s proceeds are exempt from income tax under section 10(1) of the ITA.

TAX IMPLICATIONS OF BUY AND SELL AGREEMENTS

Income Tax:

If the policy to fund a buy and sell agreement meets the requirements of section 11(w) of the ITA, the premiums payable may be deductible and the proceeds may be subject to income tax, again depending on the nature of the receipt.

Estate Duty:

The insurance policy to fund a buy and sell agreement must have been taken out for the purpose of buying out the interest of the deceased person, or a part of the interest – otherwise the policy will not be exempt from the “deemed property” and will be included in the deceased estate.

The deceased must not have paid any of the premiums of the policy. If a deceased has paid premiums on a buy and sell policy, it is likely to be regarded as the deemed property of the deceased and in which case it may not qualify for the exemption referred to earlier.

CGT:

If risk policies are used to fund the buy and sell agreement, the proceeds are exempted from CGT in terms of paragraphs 55(1)(a), (c) and (e) of the 8th Schedule to the ITA.

Any life insurance payments to the original beneficial owners and where no premiums were paid by the deceased, have always been exempted from CGT in terms of the 8th Schedule to the ITA.

If a deceased shareholder cedes his or her policy to a new shareholder, the policy ceded is a 2nd hand policy and historically gave rise to CGT consequences when the ceded benefit is eventually paid out, which is now alleviated by paragraph 55(1)(e) of the 8th Schedule to the ITA, subject to the policies being pure risk policies.

CONCLUSION

Replacement of a key individual or ensuring the orderly transition of ownership of a business (as the case may be) can take time. Although the memorandum of incorporation (MOI) or the shareholders’ agreement of the company may contain provisions on what should happen to the shares on the death or disability of a particular shareholder, they often do not take into account, the practical aspects involved. Additional funding and/or a separate buy and sell agreement is therefore required to ensure that all the necessary requirements and relevant processes are carefully set out and planned for. It’s important to note that, in terms of the Companies Act, 71 of 2008, no other agreement may supersede the shareholders’ agreement or MOI, so the company will need to ensure that if it is a buy and sell agreement they want to enter into, such agreement is properly aligned with the MOI and shareholders’ agreement.

SOURCES:

Job offer: Senior Associate

Job offer: Senior Associate

About the Position

Description of Work: A senior associate who has a strong commercial background, can work independently and who will be responsible for their own client portfolio, developing client relationships and building a team.

Requirements:

  • 3/4 years post article experience in commercial law at a reputable firm.
  • Good understanding of commercial and legal aspects of transactional work.
  • Working experience in private equity, venture capital, mergers & acquisitions and generally the legal aspects of corporate finance is essential. Drive to be market-leading attorney is these fields.
  • Advanced computer knowledge with emphasis in MS Word, MS Excel and MS PowerPoint.
  • Excellent communication, reporting and interpersonal skills, verbal and written.
  • Ability to work independently and be proactive.
  • Ability to work within pressurized environment and adhere to tight deadlines.
  • Quality of work: accuracy, attention to detail.
  • Organisation: being meticulous in planning & prioritising work tasks.
  • Problem solving: anticipating and identifying problems, pro-actively solving them.
  • Leadership: managing, leading and building a team.
  • Consistently excel in the three core deliverables for senior team members: meeting and exceeding their own budget; managing team members to do quality work and also their targets; grow the value of the firm by bringing in new clients.

Competencies:
Primary competencies

  • High level transactional drafting and deal management experence.
  • Corporate finance transactions and specifically M&A work in mid-market environment; local and cross-border transactions
  • Fund raising (debt/equity).
  • Venture capital and private equity transactions – ability to negotiate and draft complex transactional documents without getting intimidated or overwhelmed.
  • Corporate restructuring.
  • Cross border transactions.

Secondary competencies

  • Joint venture deals – and the related sale of shares, shareholders’ agreements, partnerships.
  • Regulatory aspects with doing business across borders.
  • International expansion.
  • Ability to learn new areas of law and apply that to new jurisdictions.

Qualification:

  • LLB
  • LLM in commercial law and business courses will be advantageous but not a requirement.

Remuneration:

  • Market related

Desired Skills

  • Commercial Law
  • Mergers & acquisitions
  • Drafting legal documents
  • Staff management
  • Cross border transactions

Desired Qualification Accreditation

  • Degree

Kindly send your motivation and CV to: info@dommisseattorneys.co.za

Vehicle finance “Extra fee”: strip it or bill it?

Vehicle finance “Extra fee”: strip it or bill it?

The National Consumer Tribunal (“NCT“) recently came out guns blazing and caused a stir in the motor vehicle industry. The application by Volkswagen Financial Services SA (“VWFS“) for the review and setting aside of a compliance notice previously issued against them by the National Credit Regulator (“NCR“), was dismissed by the NCT during the month of April 2019.

First, some background: the NCR issued compliance notices against VWFS and BMW Financial Services in 2017. In terms of these compliance notices, the NCR held that the “on the road” fees (colloquially termed as “Service & Delivery Charge” or the like) by the respective vehicle financiers constitute prohibited charges in terms of the National Credit Act, 34 of 2005 (“NCA“) and ordered each of these financiers to refund consumers who paid such fees. VWFS subsequently applied to the NCT to review and set aside the compliance notice issued by the NCR against them. The NCT however rejected their application and confirmed the decision taken by the NCR in their compliance notice (in a somewhat amended form, but in principle the same). The NCT ruled that VWFS were to: (i) refund all affected consumers; and (ii) cease adding any such or similar fees on their (vehicle finance) credit agreements as from 10 April 2019.

VWFS have since indicated that they will appeal the decision of the NCT, the effect of which then suspends enforcement of the ruling until the appeal has been finalised by the relevant court. Simply put, VWFS need not to comply with the compliance notice until the matter has been settled by the relevant High Court.

Please follow the link below to access a copy of the relevant NCT ruling:

https://www.thenct.org.za/wp-content/uploads/2019/04/Volkswagen-Financial-Services-South-Africa-pty-Ltd-v-National-Credit-Regulator-NCT-94937-2017-5612.pdf

Incentivising employees: Phantom scheme or esop?

Incentivising employees: Phantom scheme or esop?

As we receive more requests from entrepreneurs who want to incentivise valued employees in an optimistic effort to either attract top talent, retain top talent or even benefit their business’ BEE status profile, we realised that the motive behind such incentives are not always aligned to the type of incentive instrument that entrepreneurs request. In this blog, we aim to provide you with a basic distinction between two popular incentive instruments, namely the phantom share scheme (“Scheme“) and the employee share ownership plan (“ESOP“) to assist you in electing the best instrument for your valued employees.

PHANTOM SHARE SCHEME

Beneficiaries of a Scheme are awarded notional shares or units (not real shares but rather units giving participant employees the right to certain cash bonuses). The notional shares are linked to the issued shares in the share capital of the company. The Scheme is essentially a cash bonus plan under which the amount of the bonus is measured by reference to the increase in value of the shares in the issued share capital of the company. Such notional shares ordinarily grant the holder the same economic rights and privileges equal to all other actual issued shares in the company on a 1:1 ratio.

Therefore, instead of issuing authorised shares in the share capital of the company, notional shares are created and then awarded to participating employees (with or without vesting conditions). No shares are factually issued or transferred to the employees. Employees do not become actual shareholders of the company. This is illustrated in the fact that  they do not receive rights such as ownership rights in the company; rights to inspect records of the company; rights to attend shareholder meetings, nor voting rights – which would result in less control or decision-making influence from beneficiaries. Employees do however, have the opportunity to receive cash bonuses in the actualisation of certain events, such as when profits are declared by the company or any other “liquidity event”.

A Scheme is an excellent tool for attracting top talent and motivating employees who do not have a particularly long serving history with the company. In this respect, the Scheme allows shareholders to retain complete control and ownership of the company. The flexibility of the Scheme ensures that an employee receives a cash-in-hand benefit without enjoying other shareholders rights.

EMPLOYEE SHARE OWNERSHIP PLAN (ESOP)

An ESOP structure allows participating employees to acquire actual shares in the share capital of the company. By virtue of holding actual shares, such employees will become part owners of the company, they will have voting rights in the company (involving them in decision-making) and they will benefit financially when dividends are declared, as well as during an exit or other liquidity events. An ESOP, as opposed to a Scheme, is potentially an excellent instrument for incentivising long standing employees who have material interests in the growth of the company. Our recommendation is that ESOP shares should only be awarded to trusted individuals as holders acquire much more extensive rights, for example, the right to inspect sensitive company documentation and records.

CONCLUSION

While other complexities may influence your election of setting up and implementing either an ESOP or a Scheme, we recommend that the instrument selected should be guided by each entrepreneur’s true intentions.

Decrypting crypto: The anticipation for South Africa’s crypto-regulations continues

Decrypting crypto: The anticipation for South Africa’s crypto-regulations continues

With cryptocurrency regulations seemingly just around the corner for South Africa,[1] the extent of their practical ramifications can be speculated over quite a bit. According to a recent survey, South African internet users topped the rankings for cryptocurrency ownership worldwide.[2] Already accounting for 10.7% of all local internet users,[3] this number could climb if regulations serve to alleviate trust and security concerns.[4] Furthermore, South Africa has consistently topped global rankings as the country with the highest internet searches for Bitcoin.[5] But what is the catalyst behind this popularity?

Arguably, the growth in demand cannot be ascribed to one particular factor. Events such as the firing of Pravin Gordhan as South Africa’s finance minister and the downgrade of South Africa’s local currency debt to that of junk status were seen as mentionable contributors to the surge in new users trading Bitcoin in 2017, constituting a 671% rise from January to November on eToro.[6] More recently, cryptocurrencies have received an increase in popularity amidst growing political and economic uncertainty.[7]

Contrary to what a Hollywood-portrayed high school would have you believe, there are downsides to popularity. Hypothetical risks in an unregulated market include:

  • a decreased demand for fiat currency, which in turn poses problems for the South African Reserve Bank’s (SARB) monetary supply control;
  • a financial stability risk if market capitalisation reaches the $1 trillion threshold (which, although constituting roughly 1.5% of the total global market capitalisation of the S&P 500 Index, is not entirely far fetched when one considers the 3 200% growth rate in market capitalisation in 2017),[8] which figure is seen as the psychological threshold that, when crossed, will lead to increased regulatory scrutiny by financial institutions and legislatures around the globe; and
  • potential threats to the national payment system.[9]

Due to its meteoric rise in popularity, regulations to address consumer protection become paramount.[10]

What will the scope of these regulations be, and how will they affect South Africa and its prevalent participation in the cryptocurrency market? It might still be too early to say for certain. However, the SARB has suggested a phased approach to regulation,[11] with the first phase constituting a registration process for persons offering crypto-asset services and arguably aligns nicely with the current regulatory overhaul for financial services.[12] The second phase contemplates a review of existing regulatory frameworks to determine whether new requirements need to be introduced or existing requirements need to be amended.

And lastly, the third phase contemplates an assessment of the effectiveness of the regulatory actions.[13] With the first phase expected to be implemented in the first quarter of this year,[14] interesting times lie ahead for both consumers and service providers of cryptocurrency.


[1] Ruggieri N “South African Reserve Bank Begins To Plan Crypto Regulations” (18-01-2019). EHTNews. Available at: https://www.ethnews.com/south-african-reserve-bank-begins-to-plan-crypto-regulations (accessed on 21-02-2019).

[2] Gogo J “Survey ranks South Africa top for cryptocurrency ownership” (20-02-2019). Bitcoin.com. Available at: https://news.bitcoin.com/survey-ranks-south-africa-top-for-cryptocurrency-ownership/ (accessed 21-02-2019); “Digital 2019: Essential insights into how people around the world use the internet, mobile devices, social media, and e-commerce” (31-01-2019). Wearesocial; Hootsuite. 205.

[3] Supra n2. 205.

[4] Rangogo T “Half of richer, online South Africans want to buy cryptocurrencies – here’s what’s holding them back” (06-11-2018) Business Insider South Africa. Available at: https://www.businessinsider.co.za/half-of-richer-online-south-africans-want-to-buy-cryptocurrencies-heres-whats-holding-them-back-2018-11 (accessed on 20-02-2019).

[5] Avan-Nomayo Osato “Cryptocurrency continues to thrive in South Africa” (07-07-2018). Bitcoinist. Available at: https://bitcoinist.com/cryptocurrency-continues-to-thrive-in-south-africa/ (accessed on 20-02-2019).

[6] “This graph shows just how popular Bitcoin is in South Africa” (05-01-2018). Business Tech. Available at: https://businesstech.co.za/news/banking/218099/this-graph-shows-just-how-popular-bitcoin-is-in-south-africa/ (accessed on 20-02-2019).

[7] O’Brien K “Cryptocurrency remains popular in South Africa, but scams and questions still loom” (05-08-2018). Bitcoinist. Available at: https://bitcoinist.com/cryptocurrency-remains-popular-south-africa-scams-questions-still-loom/ (accessed on 20-02-2019). 

[8] “Consulation paper on policy proposals for crypto assets” Intergovernmental Fintech Working Group: Crypto Assets Regulatory Working Group. 13-14.

[9] Jenkinson G “Report by South Africa’s Reserve Bank Makes Strides Toward Crypto Clarity in the Country” (22-01-2019). Cointelegraph. Available at:  https://cointelegraph.com/news/south-africa-is-making-strides-toward-crypto-clarity-with-the-reserve-banks-latest-report (accessed 20-02-2019).

[10] Rattue R “Cryptocurrency regulation essential for everyone” (15-02-2019). FAnews. Available at: https://www.fanews.co.za/article/cryptocurrencies/1407/general/1408/cryptocurrency-regulation-essential-for-everyone/26192 (accessed on 21-02-2019).

[11] Vermeulen J “South Africa’s plan to monitor Bitcoin exchanges” (20-02-2019). MyBroadband. Available at: https://mybroadband.co.za/news/cryptocurrency/296454-south-africas-plan-to-monitor-bitcoin-exchanges.html (accessed on 21-02-2019).

[12] Supra n10.

[13] Omarjee L “February deadline for public comment on cryptocurrency regulation” (27-01-2019). Fin24. Available at: https://www.fin24.com/Economy/february-deadline-for-public-comment-on-cryptocurrency-regulation-20190127 (accessed on 21-02-2019).

[14] Supra n13.

Arbitration: Is it a good idea?

Arbitration: Is it a good idea?

You may have seen an arbitration clause come up in one of your agreements and just thought that it fills the legal jargon section at the end of your contract. These are typically standard “boilerplate” clauses that have been developed over many years of contracting –these clauses are important and there is good reason for them being relatively standardised. However, missing or misusing one of them could land you in a bit of hot water. An arbitration clause is one that flirts with being a “boilerplate” clause but should be used with caution.

Arbitration is a private dispute settlement arrangement agreed to between people entering into a contract. The beauty of it is that the process can be, to a degree, managed by the people who choose arbitration as a means of dispute resolution. This means that arbitration can take a fairly broad variety of forms, although, most people prefer for it to take the form of a more traditional court. You can also choose for the arbitration to be final and binding on you, meaning that it cannot be appealed. This helps speed up the dispute resolution process, but it also exposes you to the risk that your arbitrator makes a bad decision, which you are stuck with.

A big question that should be asked when seeing this clause pop up is: “Is it worth it for me to use arbitration?” This article will spell out some of the pros and cons to arbitration versus the normal court process.

Cost complication

Arbitration is far more costly than a typical court process, as the people who want the arbitration must pay the costs of the arbitrator, and if that person is a highly skilled individual (which they tend to be) they don’t come cheap. If you go through the courts, however, this is a free public service, so you do not pay for the cost of the magistrate or judge to have your process heard.

Unless you expect your claim to be in the hundreds of thousands of Rands, it may be better to exclude an arbitration clause as it may not be worth the expense.

Time implication

Whilst the court process is cheaper, in the South African context, it is very slow as the courts are inundated with commercial matters. It can take in excess of 3 years from the date that a claim is lodged to the date that your matter is heard by a court and, even then, it can be delayed further. When it comes to arbitration, you are not relying on anyone else to get the matter moving and you can agree to expedited rules to govern the arbitration (meaning they are designed in such a way that the dispute is moved forward quickly). All in all, arbitration tends to be much faster than going to court.

Expertise

When it comes to our courts, magistrates and judges are distributed on a rotational basis and, whilst they are very skilled, they do not specialise in one area of commerce per se, but rather deal broadly with commercial disputes. With arbitration, however, you can pick an expert in a particular field as the arbitrator, which then ensures that there is less room for a decision that may not necessarily consider all the aspects of a particular field. So, if your matter is in, for example, international shipping, you can then elect a maritime lawyer with significant experience to be the arbitrator which should give you comfort that your matter will be decided fairly.

Whilst arbitration can be useful, it can also be an unnecessary burden. Consider this carefully when you see this clause in the next contract you sign.

What’s the current legal position regarding loans between family members and sale of shares on credit terms?

What’s the current legal position regarding loans between family members and sale of shares on credit terms?

Published: 10 December 2018

In August 2016, we published an article Do all credit providers need to register. In that article, we discussed various matters relating to the application of the National Credit Act (which will we refer to as the NCA) to various transactions, in particular when a credit provider would be required to register with the National Credit Regulator as a credit provider.

Following some judgments recently handed down by our courts, we want to discuss some of the matters from our previous article in more detail – namely whether the NCA requires one to register as a credit provider in cases where (i) a family member grants a loan to another family member and (ii) a shareholder or a company sells/issue shares on credit.

DOES THE NCA REQUIRE YOU TO REGISTER AS A CREDIT PROVIDER WHEN ENTERING INTO A CREDIT AGREEMENT WITH A FAMILY MEMBER?

Let’s quickly recap the discussion in our previous article: the NCA will most likely apply to a transaction:

  • that qualifies as a credit agreement in terms of the NCA, if none of the exceptions provided in the NCA applies; and
  • the agreement was concluded by parties dealing at arm’s length.

Accepting that a proposed transaction is a credit agreement and none of the exceptions apply, the point of departure in determining whether you would be required to register as a credit provider if you were to grant a loan to one of your family members, is to consider whether your proposed transaction is conducted at arm’s length.

The NCA does not define the term dealing at arm’s length but sets out an open list of arrangements which would generally not be considered as been made at arm’s length. A credit agreement between two natural persons who are in a family relationship who are co-dependent on each other or where one is dependent on the other, is not at arms’ length. The NCA does not provide any guidance as to when family members will be regarded as independent of each other. The Court considered this question in the case of Beets v Swanepoel [2010] JOL 26422 (NC) (“Beets judgment“). Based on this judgment it is our view that it is likely that a transaction is at arms’ length in instances where the parties independently strive to gain the utmost possible advantage from the agreement. Based on the courts’ interpretation of the phrase, parties would generally be considered as striving to gain the utmost possible advantage from the agreement if the (proposed) loan bears interest, charges or fee(s). This would usually be the case regardless of the familial relationship between the parties involved.

In the Beets case, the mother granted a loan to her daughter at a favourable interest rate. The daughter failed to honour her part of the agreement and the mother approached the court to claim the outstanding balance of the loan. The daughter argued that her mother (lender) ought to have been registered as a credit provider as required in terms of the NCA. She further argued that her failure to do so renders the loan agreement invalid. The court ruled in her (daughter’s) favour and held that the credit agreement was at arm’s length despite the mother-daughter relationship between the parties considering the fact that the parties were independent of each other. For that reason, the loan agreement between the parties was found to be invalid.

DOES THE NCA REQUIRE YOU TO REGISTER AS A CREDIT PROVIDER WHEN ENTERING INTO A SALE OF SHARES AGREEMENT ON CREDIT TERMS?

Turning to the next question relating to a sale of share agreement on credit terms. It’s undoubtedly a common practice that companies and/or shareholders occasionally enter into credit share sale agreements to issue/sell shares to prospective buyer(s) who may otherwise not have been able to pay the purchase price upfront. In such cases, the parties would make arrangements in terms of which the buyer would pay for the shares in instalments over a specific period. This practice was discussed in the recent SCA judgment of Du Bruyn NO and Others v Karsten (929/2017) [2018] ZASCA 143.

In this case, two close corporation members entered into an agreement in terms of which one of the parties sold his interests (the equivalent of shares in the company) which he held in three separate entities (i.e. CC’s) for an aggregate purchase price of R2 000 000, 00.  The purchaser however could not afford to pay the purchase price upfront and the parties agreed that the purchaser would pay the deposit of R500 000 and the balance to be paid in monthly instalments of R30 000 over a period of five years. The price payable over the five-year period was therefore more than the purchase price and the difference would indicate the credit costs.

The purchaser failed to make the payments as per the agreement and the seller instituted proceedings to claim the outstanding balance. Since the seller was not registered as a credit provider at the time of entering into the credit agreements, the buyer raised a defence that the agreements were null and void due to non-compliance with the NCA. The court declared all three credit agreements unlawful for failure to register as a credit provider- as required in terms of section 40 of the NCA.

CONCLUSION

The main takeaway point from the judgments discussed above is that one needs to carefully consider the relevant provisions of the law regulating the credit industry before granting credit to anyone, including a loan to a family member(s). There is however not always a clear-cut answer to these matters, and the facts of each scenario would need to be considered on a case-by-case-basis. As such, we would advise that you consider seeking legal advice before granting a loan to avoid any disappointment.

Pre-incorporation contracts: Contract out of personal liability

Pre-incorporation contracts: Contract out of personal liability

Published: 7 December 2018

Why use pre-incorporation contracts?

A company has no legal existence until it is incorporated in terms of the Companies Act, 71 of 2008 (as amended) (“the Act“). As such, any agreement it purportedly concludes prior to such incorporation is invalid and unenforceable. Fortunately, section 21 of the Act ameliorates this position by rendering agreements concluded by companies not yet incorporated valid. These are commonly called pre-incorporation contracts or pre-incorporation agreements (“PIA“). This has meant that potential company founders are given statutory authority to enter into agreements in the name of a company that is still to be formed. This is of huge practical importance given that a company that has not been incorporated yet can already secure business premises, contract for urgent corporate opportunities and even secure supplier agreements before it is incorporated. Such PIAs have also been said to encourage investor confidence. However, it is important for founders to protect themselves by contracting out of personal liability if the company is not subsequently incorporated or does not ratify the PIA post incorporation, among other reasons.

Personal liability in terms of section 21: Can it be avoided?

Section 21(1) of the Act provides that the individuals concluding a PIA may “enter into a written agreement in the name of, or purport to act in the name of, or on behalf of” a contemplated company. According to Venalex (Pty) Ltd v Vigraha Property CC and others [2015] 2 All SA 645 (KZD) if the PIA is concluded in terms of the Act, the individual(s) will be acting as an agent of a company not yet incorporated. Such individuals will in turn become “jointly and severally liable” if the contemplated company is not subsequently incorporated or fails to fully ratify the PIA post incorporation. In other words, all agents will be liable for any loss suffered by the third party because of the company’s repudiation. This is an unalterable provision of the Act meant to protect the third party to the PIA and means that agents cannot avoid such liability when using section 21 PIAs.

The only way to escape such liability is to structure the written PIA in terms of the common law principle, stipulatio alteri or contract as a principal (not an agent) for the benefit of a third party. This form, unlike the statutory section 21 version, does not provide the third party with disproportionate protection against the party(ies) acting for the benefit of the contemplated company. In terms of the stipulatio, there are no harsh consequences of personal liability for the parties acting for the benefit of the company that is yet to be incorporated. If the contemplated company is not incorporated, or it rejects the PIA upon incorporation, the contract simply falls away, unless otherwise provided in the written PIA.

How to ensure you are using the appropriate type of PIA

Structuring the agreement to clearly reflect the intentions of the parties as to the type of PIA can be done in various ways. In the Venalex case the court’s analysis concluded that the individuals acting on behalf of the company were not acting as agents in terms of section 21 of the Act, but that they contracted as “principals for the benefit” of the company that is to be incorporated, in terms of common law.

A way in which to determine if a court will declare an agreement to be a section 21 PIA or a common law stipulatio, is by establishing when the parties intended the PIA to give rise to contractual obligations. For example, when a newly incorporated company in a section 21 PIA ratifies the PIA (completely, partially or conditionally), such ratification happens retrospectively. In other words, performance obligations in terms of the PIA will be interpreted to have arisen from the time that the agent entered the PIA, not when the company ratifies it. If the PIA is not ratified or rejected within three months after the company is incorporated, there will be deemed ratification. If the company is not incorporated, or the PIA is rejected by the company, the agents become personally liable (together with the company, if incorporated) to the third party for any loss suffered.

In terms of the common law stipulatio, a newly incorporated company will have an election of whether to accept the PIA or to reject it. If the company accepts the PIA, then obligations to such contract will only arise from the day of such acceptance, not when the principals concluded the contract for the benefit of the contemplated company. If the company is not incorporated or it rejects the contract upon incorporation, the principals acting for the benefit of the contemplated company are not held personally liable, unless otherwise stated by the PIA specifically, and the contract will simply fall away. Lastly, the common law does not indicate a strict time period for election (in contrast to the statutory section 21 PIA), in that the election simply needs to be made within “a reasonable time”, without sanctions if not made. The stipulatio PIA can never be deemed accepted without the newly incorporated company’s knowledge if it fails to make an election within a reasonable time.

Conclusion

In conclusion, the court has previously stated that it will look at the written agreement when it exercises its discretion in determining whether the parties have concluded a section 21 PIA or a stipulatio alteri PIA, in the absence of such express provisions indicating their preference. Therefore, it is important to state clearly which form of PIA you are concluding. For the commercial attorney representing the person contracting on behalf of a company to be incorporated, it is important to structure the agreement in terms of the stipulatio. On the contrary, an attorney acting for the third party must insist on a section 21 PIA, given that it offers greater protection to such third parties.

Why do I need a contract?

Why do I need a contract?

Published: 7 December 2018

Many of our clients, justifiably, ask the question “Why do I need a contract?”. Most of the time this question is asked in situations where the business relationship has just started, and things seem to be going really well. I have often heard the phrase “There is no need to get lawyers involved – they just complicate things”. This can be true, however, there is also a lot of merit in getting good lawyers in to draft your contracts.

There are three major reasons why it is good to get a contract drafted by a professional. The first is that you don’t know your unknowns, the second is that contracts help with minor disputes and the third and final reason is that contracts help in situations of major disputes.

You don’t know your unknowns

I used to service my own car – it wasn’t a difficult job as I knew where to get the parts and my car is relatively simple to service. I stopped servicing my car myself when I started running into trouble with my car breaking down and I realised that I needed a professional to look out for things that I couldn’t see or didn’t know to look for. The same is true for contracts; you might feel comfortable with a handshake, conversation or email to seal the deal, but you don’t know what you are missing from a legal perspective.

There may be certain pieces of legislation you need to comply with like the Consumer Protection Act, 2008, the National Credit Act, 2005 or the Companies Act, 2008. You may not realise that you are unintentionally changing the terms of your deal by sending an email out (yes, emails can change your agreements). You might want to go to arbitration or mediation instead of going to court if you land up in a dispute. These are just a few examples of the minefield that can be out there when drafting contracts.

Minor disputes

The beauty of engaging a lawyer to draft your agreement is that you often thresh out issues that you wouldn’t necessarily have considered. This then gives you a solid base to work from when you run into a minor dispute. A minor dispute would be something that is not a deal-breaker but is often a misunderstanding as to who should be doing what. If you have not worked through this and written it down, then you end up engaging in a game of “he said / she said” which can turn into a major dispute. If we are all honest with ourselves, our memories are not perfect, so writing something down that is well thought out helps everyone have clear boundaries and often puts an end to those minor disputes quickly.

Major disputes

Major disputes come in where one person has done something that cuts to the core of the relationship, resulting in the relationship ending. This is probably where a clear and well drafted contract is most important. You might feel like you will never land up in a place like this, and the probability is that you won’t, but a contract is often drafted (like an insurance policy is taken out) for the “just in case” situations.

Where a contract is clear as to who should be doing what and you land up in a major dispute, this can result in the matter being settled before court proceedings are launched, as everyone knows where they stand. If you do land up in court proceedings, it could assist you in getting a better settlement as the vast majority of commercial matters never make it to a court hearing but are settled before they arrive there. If your opponent feels like they have some wiggle room, they may take their chances at a hearing rather than settling with you resulting in long drawn out (and expensive) court proceedings.

Overall, contracts are very useful tools in business and they can be of great assistance. It is important to have them drafted by a professional, although it may not seem like it at the time, and it is more important that they are clear and deal with all the important aspects of your relationship. This could save you and your business a lot of trouble down the line.

Key changes proposed by the draft companies amendment bill, 2018

Key changes proposed by the draft companies amendment bill, 2018

Published 30 October 2018

The current Companies Act, 71 of 2008 (“the Act“) succeeded in lessening multiple regulatory burdens under the old Companies Act, 61 of 1973 (“the Old Act“). On 21 September 2018 the Department of Trade and Industry (“the Dti“) released the draft Companies Amendment Bill, 2018 (“the Bill“) to initiate a formal process of changes to the Act. If the Bill is adopted, it will be the third time that the Act is amended, with the first two sets of amendments being implemented by way of the Companies Amendment Act, 3 of 2011 and the Financial Markets Act, 19 of 2012. According to the Dti, the Bill proposes changes that will bring the Act in line with the current international corporate trends and close identified gaps in the Act. In addition, the Bill jettisons certain cumbersome resolution requirements. We have selected a few key changes proposed by the Bill to discuss in a little more detail. The Bill is currently available for public comment until 20 November 2018. We encourage business and stakeholders to tender their comments to the Dti on or before the due date.

Key proposed changes

On what day does the amendment to a memorandum of incorporation (“MOI“) become effective?

The Bill makes it clear that all amendments to MOIs (excluding MOI amendments that change the name of the company) will take effect 10 business days after lodging your notice of MOI amendment with the Companies and Intellectual Property Commission (“the CIPC“). If the CIPC, after the 10 business days have lapsed, has not endorsed the notice of MOI amendment or failed to reject it with reasons, it will be deemed to be effective. Presently, under section 16 of the Act and as contained in the options provided on the CoR 15.2 Notice of Amendment of MOI form, the MOI amendment takes effect on the date that the CoR 15.2 form (together with supporting documents) is filed with the CIPC, the date on which the amended registration certificate is issued by the CIPC, when the MOI amendment includes a name change, (with an estimated turnaround time of 25 days in terms of the CIPC’s website) or such later date as is indicated on the CoR 15.2 form. The applicant may elect one of these options.

This change is welcomed as it shortens the CIPC’s turnaround time and places a duty on the CIPC to act expediently. However, care must be taken with the “deemed effect” when the CIPC does not provide feedback within 10 business days. The silence of the Bill seems to suggest that such “deemed effect” shall be incapable of being rescinded even if the CIPC, in hindsight, has valid reasons to reject the MOI amendment application. This can have long term negative effects on the company in that it will be governed by a defective MOI without knowledge, as no obligation is created on the CIPC to endorse or reject the MOI amendment after the 10 business days have lapsed.

Transparency regarding directors’ and prescribed officers’ remuneration

Stakeholders will be happy to know that the Bill proposes the amendment of section 30(4) of the Act. This section currently provides for the remuneration and benefits disclosure of “each director, or individual holding any prescribed office in the company”. The amended wording provides that each individual director or prescribed officer must be identified by name when reporting about their remuneration and benefits in the annual financial statements of the company. In addition, the Bill introduces a new section 30A in to the Act which outlines a format for a public company’s directors’ remuneration report, which must be compiled for each financial year and presented to shareholders at the annual general meeting.

These proposed changes should be welcomed as they strengthen transparency in South African companies.

Court’s power to validate the irregular creation, allotment or issuing of shares

Shareholders will not be happy to know that the Bill proposes empowering the courts, upon application by an interested person, to validate the irregular creation, allotment or issue of shares when it is just and equitable to do so. A similar provision existed in section 97 of the Old Act. Presently, shareholders or in other cases the board, if they have the power to authorise shares, may pass a resolution to retroactively authorise invalidly issued shares. Under section 38(3) of the Act, shares that are issued in excess of the authorised shares set out in the MOI (and not retroactively authorised) are a nullity.

This proposed change undermines the powers of the shareholders to govern the company by passing resolutions and decide internally whether to authorise invalidly issued shares or not. The discretion of the court is also far reaching in that no clear meaning can be ascribed to the terms “just and equitable”. The proposed change is therefore not welcomed as it limits the powers of the shareholders at the peril of the court’s wide discretion.

Regulation of share buy-backs

The Bill proposes tightening the regulation of share buybacks by requiring a shareholders’ special resolution to be adopted if shares are repurchased from a director or prescribed officer of the company, or a person related to such director or prescribed officer. In addition, the same special resolution will be required if the share buyback entails an acquisition of shares in a company generally, except for in identified circumstances. Such circumstances are where a pro rata (equal) offer is made to all shareholders (or to all shareholders of a particular class), or if the buyback is in the form of a transaction effected in the ordinary course on a recognised stock exchange on which shares of the company are traded. The present position under section 48(8) of the Act is that a shareholders’ special resolution for repurchasing shares is only required where the shares are held by a director or a prescribed officer of the company, or a person related to such director or a prescribed officer and where the buyback involves the acquisition by the company of more than 5% of the issued shares of any particular class of the company’s shares.

Fortunately, the Bill extends the circumstances where a special resolution is required. The implication of this is that any shares in the company that are repurchased must be approved by a special resolution (provided that the repurchase doesn’t fall into one of the exceptions), i.e. irrespective of whether they are held by a director or a prescribed officer of the company, or a person related to such director or a prescribed officer.

These proposed changes should be welcomed as they provide further protection for shareholders to vote on share buybacks. They also reduce regulations where it might be unnecessary to pass a special resolution for efficient operational reasons.

Financial assistance within a group

Lastly, the Bill proposes that shareholders’ special resolutions are no longer required where a company gives financial assistance to its own subsidiary. Under section 45 of the Act, such financial assistance must be authorised by the board and shareholders by passing a special resolution.

The shareholders will not be happy about this amendment since part of their voting power will be limited. In addition, “subsidiary company” is widely defined in the Act and it is unclear if “own subsidiary” will carry a narrower meaning. A decision to tender financial assistance to a subsidiary is material and shareholders should be given the opportunity to vote on it. Although, this proposed amendment lessens regulations it should not be welcomed since it takes away the right of shareholders to vote on this decision.

Conclusion

The identified proposed changes in the Bill which are meant to make the Act more compatible with international corporate trends are in relation to increasing corporate transparency. However, some proposed changes limit shareholders’ rights which will discourage investors and are arguably not aligned to international standards. The Bill provides much needed clarity about when an MOI amendment take effect. Lastly, the Bill lessens regulatory burdens for effective operational means in that resolution approvals are reduced. However, some of the Bill’s dropped resolution requirements, particularly in requesting special resolutions for actions of the company, and empowering the court to validate invalidly issued shares, may come at a cost to shareholders’ rights.