Direct and indirect share ownership on asset protection

Direct and indirect share ownership on asset protection

Generally, buying shares means buying fractional ownership of a company. The reality is that the shares you hold do not entitle you to financial returns unless certain liquidity events occur or as otherwise agreed upon. The most common example of a liquidity event is when directors of a company declare dividends to the shareholders. Assuming such dividends are financial in nature, you will be paid a monetary amount equivalent to your shareholding percentage. If you hold shares directly in your personal capacity, your portion of the dividends will be paid into your estate. Similarly, if a company is liquidated, after the debts and other liabilities of the company are paid in full, your shares would entitle you to a portion of the residual assets of the company. These proceeds would also be paid into your estate.

Alternatively, upon a dividend liquidity event when you hold your shares indirectly through another entity such as a trust or holding company, your portion of the returns will be paid into the estate of a trust or holding company. Such proceeds will not form part of your personal estate until, as a beneficiary of the trust in question, you succeed in your claim against the trust. At this point you will receive such payment into your personal estate. The same is true if you have shares through a holding company. The directors of that company must first declare dividends, if no other agreement exists, before you will be entitled to access the company funds.

The structure through which you hold your shares is crucial in protecting your assets. In this article, we focus on some basic legal outcomes that a direct and indirect shareholding structure have on protecting your assets from unforeseen risks such as debt, death, divorce and sequestration.

Direct share ownership: personal capacity

Holding your shares in a company directly does not mean that your estate will be responsible for the debts and other liabilities of the company (unless otherwise agreed in the shareholders’ agreement or surety agreements). This is stated in section 19 (2) of the Companies Act 71 of 2008 (as amended) (“the Act“), in terms of which a direct shareholder has limited liability. This means that a direct shareholder will only be liable for company debts to the extent of his or her investment in the company or through another agreement.

However, returns paid into the estate of a direct shareholder will always be exposed to personal liability claims as they remain in the direct shareholder’s personal estate. The shares held may be protected against attachment, unless pledged or subject to attachment through other processes such as the procedural workings of insolvency law (at which point most company’s founding documents will trigger forced sale events). However, the returns generated from the shares are susceptible to risk as they form part of the personal estate. For purposes of wealth creation, it is important to diversify your assets and not put all of your eggs in one basket. This can be crucial for individuals who are involved in business ventures which may leave them financially exposed.

Indirect share ownership: trust

As a point of departure, you will need to consider if the company’s founding documents allows for a trust to hold shares in the company. If this is provided for, a trust will enable an indirect shareholder, in the capacity of a trustee, to manage shares, as well as the proceeds thereof, to the benefit of the trust beneficiaries. Any returns received as a result of shareholding will vest in the estate of the trust and not in the personal estate of the trust founder. This position is confirmed in section 12 of the Trust Property Control Act 57 of 1988. The result of the separation of estates is that any claims brought against the personal estate of an indirect shareholder cannot be recovered from the estate of the trust, as this a distinct and separate estate.

As with various special purpose vehicles, there are exceptions. The above stated section 12 excludes beneficiary claims. If you have a claim against a trust (i.e. you are also a beneficiary of the trust through which you hold shares) creditors holding claims against your personal estate may succeed in attaching your claim to the trust using appropriate legal procedures. Furthermore, any financial returns suddenly transferred into a trust when a trustee is declared insolvent can set aside the trust transaction, subject to insolvency laws. Generally, creditors might find it difficult to set aside trust transfers if an indirect shareholder is solvent and you can present an honest record of using the trust. Therefore, sudden or suspicious transfers of shareholding returns into a trust to extricate an indirect shareholder from liability will fail at protecting your returns, as this may constitute a sham or alter ego trust.

Indirect share ownership: holding company

The Act allows for another special purpose vehicle, a holding company, to hold shares in another company. Usually, a holding company will not conduct any business of its own (although it can) as the purpose is normally restricted to creating wealth. Again, it is necessary to have sight of the founding documents of the company to ensure that a holding company is authorised to be a shareholder. As in the case of an individual shareholder, a holding company will not be liable for the debts and other liabilities of the company beyond the share capital contribution as it is regarded as a separate juristic person (except in instances of fraud or as otherwise agreed).

Upon the happenings of any liquidity event, if a holding company is a shareholder the proceeds will not accrue to a personal estate. Instead, payment will be made into the estate of the holding company. The indirect shareholder will not be authorised to access funds from the estate of the company for personal use unless dividends are declared, or through another arrangement in law.

Likewise, any claims against the personal estate of the indirect shareholder cannot be extended to the holding company, as such estates are separate. If the indirect shareholder’s shares in the holding company are attached through proper legal proceedings, the estate of the company will still be protected, and the founding documents of the holding company might enforce a forced sale event upon successful attachments. An exception here is if the company is being used inappropriately to divert funds solely for the frustration of claims from creditors. This conclusion is reached on a case-by-case basis.

Conclusion

There are many complexities to protecting shares or the value generated from such shares against external claims. Careful consideration must be given to the terms in the founding documents of the company, relevant legislations, transactional documents, the shareholding structure and personal circumstances of each client. With an experienced commercial attorney on your side, you can structure your shareholding with ease to protect your assets and ensure other desired outcomes.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.