THE MOST SIGNIFICANT CHANGES TO SOUTH AFRICA S COMPANY LAWS BROUGHT ABOUT BY THE COMPANIES ACT, 2008

THE MOST SIGNIFICANT CHANGES TO SOUTH AFRICA S COMPANY LAWS BROUGHT ABOUT BY THE COMPANIES ACT, 2008

BY CARL STEIN, DIRECTOR Table of contents SECTION ONE Abbreviations 3 SECTION TWO Introduction 5 2.1 Background 5 2.2 The company law reform process 6 SECTION THREE The most significant changes 9 3.1 Structure of the Act 9 3.2 Regulatory agencies 10 3.3 Continued existence of companies incorporated under the 1973 Act 10 3.4 The Memorandum of Incorporation 10 3.5 Categories of companies 10 3.6 (RF) companies 11 3.7 Adoption of the enlightened shareholder value model 12 3.8 Phasing out of the CC and the advent of the new small company 14 3.10 Increased accountability and transparency 18 3.11 No par value shares and the solvency and liquidity test 19 3.12 Modernisation and harmonisation 20 3.13 Related and inter-related persons 21 3.14 Fundamental transactions and the appraisal remedy 22 3.15 The new takeover regime 23 3.16 The business rescue regime 23 3.17 Stakeholders rights and remedies 25 3.17.1 The class action 25 3.17.2 The derivative action 26 3.18 Increased rights and remedies for employees and trade unions 26 3.18.1 Employees 26 3.18.2 Trade unions 27 3.19 The Companies Tribunal and alternative dispute resolution 27 3.20 Enforcement 28 3.21 Sanctions 28 3.9 Increased exposure of directors to personal liability true or false? 16 1

SECTION ONE Abbreviations Act the Companies Act, No. 71 of 2008, as amended by the Companies Amendment Act, No. 3 of 2011; 1973 Act the Companies Act, No. 61 of 1973; 2004 Policy Paper the DTI s paper entitled South African Company Law Reform for the 21st Century: Guidelines for Corporate Reform published in May 2004; AFS annual financial statements; AGM annual general meeting; Articles articles of association; BR business rescue; BR plan business rescue plan; CC close corporation; CC Act the Close Corporations Act, No. 69 of 1984; Constitution the Constitution of the Republic of South Africa, 1996; Commission the Companies and Intellectual Property Commission; DTI the Department of Trade and Industry; Explanatory Memorandum Memorandum on the objects of the Companies Bill, 2008 as tabled before Parliament; IP intellectual property; JM judicial management; JSE The JSE Limited, formerly called The Johannesburg Stock Exchange; King Code or King III the Code of Governance Principles for South Africa published by the King Committee on Governance in 2009; Master the Master of the High Court; Minister the Minister charged with regulation of the Act, presently the Minister of Trade and Industry; MOI memorandum of incorporation; NPA the National Prosecuting Authority; NPC non-profit company; PLC personal liability company; Regulations the regulations prescribed by the Minister in terms of the Act that appear in Government Notice No. R351, Government Gazette No. 34239 dated 26 April 2011; SOC 26 state-owned company; SRP the Securities Regulation Panel; Tribunal the Companies Tribunal; TRP the Takeover Regulation Panel. 2 3

The Companies Act, 2008 SECTION TWO Introduction 2.1 Background It is always easier to decipher a statute, especially one as complex as an Act, once the reasons behind its enactment, particularly the broader social, political and economic reasons, are understood. For centuries the limited liability entity, that manmade being created to shield its owners and controllers from any personal liability that may arise from its activities, has played an important role in all free market economies. Today it is an essential spoke in the free enterprise wheel. The vast majority of the private sector of every first world country on earth conducts its business operations through the vehicle of a limited liability entity. Company law governs the manner in which the most popular of all limited liability entities, the company, is created, how it must conduct its activities throughout its existence and how it must eventually cease to exist. Company law thus has a direct impact on the manner in which both local and global business is transacted. It is therefore critical that South Africa s company laws are structured in a manner that seeks to stimulate and support economic growth, investor confidence and foreign investment. In the more than 37 years since the 1973 Act was enacted, the manner in which business is conducted throughout most of the world has undergone radical change; some of the main reasons being the demise of communism, the ease of global travel and transportation of goods, and the telecommunication revolution, particularly within the realm of electronic communication. These factors, among others, have resulted in an exponential increase in global and crossborder transactions, as well as the emergence of stock markets as the vehicles through which trillions of dollars are channelled into companies to enable people to invest their money throughout the world. Globalisation of businesses has also led to increased demands by businesses for harmonisation of the laws governing cross-border transactions, of which company law forms an integral part. This process commenced some years ago, and today one finds that the fundamental laws governing companies throughout most of the 4 western world are becoming increasingly aligned with one another. We have also witnessed the emergence of the private sector as the key player in industries which were hitherto either monopolised or dominated by stateowned entities, such as power, telecommunications and transport. Unfortunately, the dominance and influence of the multi-national corporation led to abuse of their powers by some, to the severe detriment of the public at large. Perhaps this was inevitable because, at that time, multi-national corporations were not accountable to the general public to the same extent as government bodies were. In any event, following the multi-billion dollar Enron scandal of 2001, governments and regulators around the world reacted to this abuse by adopting a far more aggressive approach towards large companies. They did so in a number of ways, including regulating listed companies far more strictly and imposing more severe penalties on directors and officers who abused their powers or neglected their duties. The trend over the past two decades has also been to make companies far more accountable to their various stakeholders, including their employees, minority shareholders (being the general public in the case of listed companies), the communities in which they conduct their business activities and even society as a whole, where appropriate, by requiring them to make far more disclosures of their business activities, introducing more stringent accounting requirements and introducing more laws to ensure that directors discharge their duties honestly, responsibly and diligently. In the result, transparency, accountability and proper corporate governance now play a pivotal role in modern business practice. These factors did manifest themselves in some ways in South Africa before the Act came into operation, such as the publication of the King Code and its predecessors, King I and King II, and the amendments to the 1973 Act made by the 2006 Corporate Laws Amendment Act, which introduced more stringent requirements in relation to the independence of directors and auditors, as well as more onerous accountability standards on large companies. 5

In addition, a host of new laws having a bearing on this subject have found their way into our statute books. These include the Financial Intelligence Centre Act, 2001; the Securities Services Act, 2004; the Auditing Profession Act, 2005; the National Credit Act, 2005 and the Consumer Protection Act, 2008. Another consequence of the increasingly dominant role of the multinational corporation throughout global society is that the major portion of planet earth s exploitable or usable resources, which are rapidly reducing, are today controlled by human beings through the vehicle of companies. Since the law recognises a company as a separate person, distinct from its shareholders and directors, government and society now demand that companies take greater responsibility for the natural environment in which they operate and towards the communities that are affected by those operations. M E King SC The synergy and interaction between King III and the Companies Act 71 of 2008 in Modern Company Law for a Competitive South African Economy (page 446, at page 449), puts it this way: It is estimated that of the 100 largest economies in the world by gross revenue, 51 are multinational companies and only 49 are governments. The impact that these great multinational companies have on the earth is huge. Companies are far greater agents for change than governments, if for no other reason that there are millions of companies in the world and only a few hundred governments. They have a duty to their stakeholders to act and to be seen to be acting as good corporate citizens. Governance of companies has consequently become of critical importance in the twenty-first century, more particularly as it has been called the Century of the Environment, or the Century of Land, Air and Water. 2.2 The company law reform process Before its repeal, the 1973 Act was subjected to a plethora of amendments, which occurred virtually every year since its enactment. In general, however, these amendments did not materially alter the fundamental philosophies and principles on which the 1973 Act was based. So by 2000 we already had an outdated cut and paste piece of legislation. Unlike most western countries, South Africa has been somewhat dilatory in updating its companies legislation because, until now, there has not been a major overhaul of the 1973 Act. In the early 2000s, it became apparent to government that there was an urgent need to reform South Africa s company laws. The Minister put it this way: The new horizons in the commercial world, developed in a short period of 25 years resulting from a generation change, has undoubtedly made the present Companies Act somewhat archaic in many respects and certainly cumbersome in operation. In 2003, the government, through the Department of Trade and Industry ( DTI ), embarked on a process to develop a clear, facilitating, predictable and consistently enforced [company] law, as stated in the 2004 Policy Paper. The 2004 Policy Paper is the only comprehensive government publication that explains the motivations, purposes and goals of the new legislation in detail. In the 2004 Policy Paper, the DTI identified five economic growth objectives, together with specific goals related to each of them, as being necessary to achieve a company law regime that would provide a protective and fertile environment for economic activity : Simplification Company law should promote the competitiveness and development of the South African economy by: simplifying the procedures for forming companies; reducing the costs associated with the formalities of forming a company and maintaining its existence; providing for a company structure that reflects the characteristics of a close corporation, as one of the available options; establishing a simple and easily maintained regime for non-profit companies; and not addressing co-operatives and partnerships in the reformed company law. Flexibility Company law should promote innovation and investment in South African markets and companies by providing for: an appropriate diversity of corporate structures; and retaining the distinction between listed and unlisted companies. Efficiency Company law should promote the efficiency of companies and their management in the following ways: company law should shift from a capital maintenance regime based on par value, to one based on solvency and liquidity; there should be clarification of board structures and director responsibilities, duties and liabilities; there should be a remedy to avoid locking in minority shareholders in inefficient companies; the mergers and takeovers regime should be reformed so that the law facilitates the creation of business combinations; and the judicial management system for dealing with failing companies should be replaced by a more effective business rescue system. Transparency Company law should encourage transparency and high standards of corporate governance by: ensuring the proper recognition of director accountability, and appropriate participation of other stakeholders; subjecting public announcements, information and prospectuses to similar standards for truth and accuracy; protecting shareholder rights, advancing shareholder activism and providing enhanced protections for minority shareholders; and requiring minimum accounting standards for annual reports. Predictable Regulation Company law should promote investment in South African markets and companies by providing for a predictable and effective regulatory environment in the following ways: de-criminalising company law sanctions where possible; removing or reducing opportunities for regulatory arbitrage; enforcing company law through appropriate bodies and mechanisms, either existing or newly introduced; and striking a careful balance between adequate disclosure in the interests of transparency, and over-regulation. An additional goal was harmonisation company law should be made compatible and harmonious with best practice jurisdictions internationally. Each of these goals has been specifically addressed in the Act. We now have a piece of legislation that either realises each of these goals in whole or in part, or that provides mechanisms to enable them to be realised. For example, the Act does contain a remedy to avoid locking in minority shareholders in inefficient companies, but it is only available in limited circumstances. Insofar as the new mechanisms are concerned, only time will tell whether or not they will achieve their desired results. For instance, concerns that the new business rescue regime, though commendable in theory, will not make companies or their management more efficient have been expressed. Having formulated its blueprint in the 2004 Policy Paper, the DTI then spent over two years consulting with and drawing on the experiences of many businessmen, professionals, stakeholder representatives and institutions, as well as legal experts from other commonwealth countries and the USA. In fact, the first few drafts of the Act and the Regulations were written by an American lawyer. A first draft Companies Bill was published in early 2007. This Bill was followed by a number of further drafts before it was approved by Parliament in November 2008. It was signed by the State President, and thus became law, on 9 April 2009. Fortunately, the Act then provided that it would not come into operation for at least another year, because it soon became apparent that there were a multitude of errors in the Act which had to be remedied. This necessitated the enactment of the 60 page Companies Amendment Act No. 3 of 2010. Virtually all errors were rectified and most of the material concerns were addressed. The Act (as amended) finally came into operation on 1 May 2011. 6 7

SECTION THREE The Most Significant Changes 3.1 Structure of the Act The Act has replaced the whole of the 1973 Act except for Chapter 14 (SS337 to 426) which governs the windingup and liquidation of insolvent companies, and which remains in force and unaltered. There are proposals currently being considered by government to develop uniform insolvency legislation, which presumably includes a complete overhaul of the Insolvency Act, 1936. In order to avoid any future conflict with this proposed legislation, government has decided to retain Chapter 14 of the 1973 Act until these new insolvency laws are enacted. The Act does contain provisions governing the winding-up of solvent companies, the corresponding provisions of which in the 1973 Act have been repealed. While the Act does contain numerous new concepts, rights, obligations and remedies, the fundamental common law principles of company law (being the law derived from historical sources, augmented by the courts over many years through case law) remain intact, with some exceptions. In this regard, the 2004 Policy Paper states: It is not the aim of the DTI simply to write a new Act by unreasonably jettisoning the body of jurisprudence built up over more than a century. The objective of the review is to ensure that the new legislation is appropriate to the legal, economic and social context of South Africa as a constitutional democracy and open economy. Where current law meets these objectives, it should remain as part of company law. This approach is now evidenced by S158(a) of the Act, which compels a court to develop the common law as necessary to improve the realisation and enjoyment of rights established by this Act. The Act is far more user-friendly than its predecessor. It is written in succinct, modern English. The number of its sections has been halved from about 450 to 225 and virtually all the outdated and formalistic provisions of the 1973 Act have been removed. More importantly, the administrative and regulatory procedures are also simpler. The format of the Act is similar to the 1973 Act. There are, however, few similarities between the Schedules to the two Acts. The Act has five Schedules. From a business perspective, the most important are Schedules 2 and 5. Schedule 1 deals with non-profit companies. Schedule 2 governs the conversion of CCs to companies. Schedule 3 contains amendments to various statutes which are necessary to harmonise their provisions with those of the Act. The bulk of these amendments relate to the CC Act (see Schedule 3A). They also include amendments to the Patents Act, 1978, Copyright Act, 1978, Share Blocks Control Act, 1980, Trade Mark Act, 1993 and Co-operatives Act, 2005 (see Schedule 3B). Schedule 4 contains a list of 15 other statutes which the Commission (Cipro s successor) must also administer and enforce, which include the CC Act, the Copyright Act, the Patents Act and the Trade Marks Act. Schedule 5, headed Transitional Arrangements, contains provisions which have been designed to ensure that the transition from the old to the new Act is as smooth and orderly as possible. Item 2(5) of the Transitional Arrangements should prove to be of assistance in this regard. It provides that if, as a 8 9

consequence of the coming into effect of the Act, a conflict, dispute or doubt arises before 1 May 2013 concerning the particular manner or form in which, or time by which, a company incorporated under the 1973 Act is required to - prepare its AFS, convene an AGM or provide to its shareholders copies of its AFS, any notice or any other document; or file any particular document; or take any other particular action required in terms of the Act or its MOI, the company may apply to the Companies Tribunal for directions, and the Companies Tribunal may make an order that is appropriate and reasonable in the circumstances. Lastly, there are the Regulations. They are integral to the Act; it cannot function without them. There are over 130 matters in respect of which the Act empowers the Minister (presently the Minister of Trade and Industry) to make or prescribe Regulations, ranging from Regulations relating to the functions of the regulatory agencies to procedural and technical matters. These regulatory powers cover a wider spectrum of matters than those in respect of which the Minister was empowered to make Regulations under the 1973 Act. The bulk of the Regulations are devoted to public offers of securities (in particular, the contents of a prospectus), the Takeover Regulations (see 3.15) and Companies Tribunal proceedings (see 3.19). 3.2 Regulatory agencies The Act creates the following regulatory agencies, which the DTI believes will together provide for a more predictable and de-politicised regulatory and enforcement system : Companies and Intellectual Property Commission ( Commission ), which replaces, but has greater powers and more functions than, the Companies and Intellectual Property Registration Office ( CIPRO ). Takeover Regulation Panel ( TRP ), which replaces, but also has greater powers and more functions than, the Securities Regulation Panel ( SRP ). Companies Tribunal ( Tribunal ), which is the only new regulatory agency. It is described in 3.19. Financial Reporting Standards Council ( FRSC ), which is retained but only as an advisory committee to the Minister on accounting-related matters. 3.3 Continued existence of companies incorporated under the 1973 Act A pre-existing company is defined in the Act as including a company that was registered as such in terms of the 1973 Act. From 1 May 2011, every pre-existing company continues to exist as a company, as if it had been incorporated and registered under the Act, with the same name and registration number. In addition, a share issued by a pre existing company before this date continues to have all the rights associated with it. For regulatory compliance purposes, the Act makes the transition from the old to the new quite a seamless process for pre-existing companies. In particular, nothing need be filed by a pre-existing company with the Commission in order to comply with the Act except for changes to its memorandum and articles of association. 3.4 The Memorandum of Incorporation The constitution of every type of company now comprises only one document, called the company s Memorandum of Incorporation. The MOI replaces both the memorandum of association and the articles of association of pre existing companies. Pre-existing companies have until 31 April 2013 to amend their memoranda and articles of association to bring them into harmony with the Act. 3.5 Categories of companies All companies incorporated under the Act are either profit companies or non-profit companies. A non-profit company ( NPC ) is a company incorporated for a public benefit or an object related to one or more cultural or social activities, or communal or group interests. There are no categories of NPCs. Its name must end with the expression NPC. A Profit company is defined as a company incorporated for the purposes of financial gain for its shareholders. This is the same definition as that in the 1973 Act. There are four categories of profit companies: A state-owned company ( SOC ). This is the only new category. SOCs include companies which are owned by or are accountable to the national or a provincial government, or to a municipality. The SOC has been created for one reason only to facilitate separate statutory treatment of SOCs in order to avoid conflict, overlap or duplication with other legislation which is applicable to SOCs only. Except for these matters, the Act generally treats a SOC in the same way as a public company. Its name must end with the expression SOC Ltd.. A private company. A profit company is a private company if its MOI prohibits it from offering any of its securities to the public and restricts the transferability of its securities. This is a similar test as that for a private company under the 1973 Act. For this reason, most Articles of private companies contain a provision that gives the directors the discretionary right to refuse to register a transfer of its shares. The 1973 Act also restricted the number of shareholders of a private company to 50. This restriction has been lifted, so a private company can now have any number of shareholders. Its name must end with the expression Proprietary Limited or (Pty) Ltd.. A personal liability company ( PLC ). A profit company is a PLC if it meets the criteria for a private company and its MOI states that it is a PLC. The directors of a PLC are jointly and severally liable, together with the company, for any debts and liabilities of the company. A PLC is thus an unlimited liability company that is used mainly by professional practices such as architects, engineers and lawyers. It is the same type of company as that referred to in S53(b) of the 1973 Act. Its name must end with the expression Incorporated or Inc.. A public company. If a profit company cannot be categorised as a SOC, a PLC or a private company, it is deemed to be a public company, by default. Its name must end with the expression Limited or Ltd. 10 11

3.6 (RF) companies S19(1)(b) of the Act states that a company has all of the legal powers and capacity of an individual, except to the extent that the company s MOI provides otherwise. The effect of this provision is that it is now virtually impossible for a company (as opposed to its directors) to act beyond its capacity, or ultra vires, unless the company s MOI restricts its capacity in some way. Companies that have restricted capacity are commonly called special purpose vehicles ( SPVs ). They are created to perform a specific function, and can do nothing else. For example, SPVs are used in Black Economic Empowerment transactions and employee share incentive schemes for the sole purpose of warehousing shares in other companies until such shares are paid for or until the expiry of a lock-in period, which is usually at least three years. Under the 1973 Act, the method used to restrict a company s capacity was to insert these restrictions in its memorandum of association. Similarly, under the Act, a company s capacity is restricted by inserting such restrictions in its MOI. Unlike the 1973 Act, however, the Act ensures that the general public is alerted to a company s restricted capacity by requiring that such a company s name be immediately followed by the expression (RF), which stands for ring fenced or restricted function. Once a company meets this and certain other disclosure requirements, any person (including a third party) is deemed to have knowledge of the company s restricted capacity. The consequence is that, in legal proceedings, a third party cannot argue that it did not know that the (RF) company had exceeded its capacity in, say, entering into a particular contract. 3.7 Adoption of the enlightened shareholder value model As the power and influence of the private sector, in particular the multinational company, has grown, the fundamental philosophical question as to the role of a company in society has become increasingly vexed. During the past 20 to 30 years, strong arguments have increasingly been made, and by and large accepted, that companies should be compelled to care about more than just maximisation of profits for their shareholders. Intense debates on this subject preceding the Act s finalisation saw discussions of different models of a company s (and, therefore, its directors) duties and responsibilities. These debates and models are evidence that company laws are integral to the macro-economic policies of South Africa s various political groupings and, therefore, to the South African economy as a whole. There are three fundamental models: The classic model, which holds that a company s duties are, essentially, to promote and protect the interests of its shareholders only, to the exclusion of all its other stakeholders, including its employees.the 1973 Act was based on this capitalistic model. The pluralist model, which sets the interests of stakeholders as an end in themselves, requiring a company to continuously balance the interests of all its stakeholders, and to prefer the interests of one stakeholder above those of another only where it is in the best interests of the general body of stakeholders to do so. This holistic approach was advocated by the Congress of South African Trade Unions in debates on the Act. The enlightened shareholder value model, which, like the classic model, puts the interests of shareholders first but holds that, in pursuing shareholders best interests in the long term, the interests of all other stakeholders, including employees, suppliers and creditors, as well as the environment and the community at large, must be considered. The triple bottom line concept that it is good for business for companies to be good corporate citizens and to consider social, environmental and economic interests was favoured by the 2002 King II Report on Corporate Governance. King III goes somewhat further by recommending that companies strive to achieve the correct balance between its various stakeholder groupings, in order to advance the interests of the company. The principles of the King Code are not legally binding except, to some extent, in the case of companies listed on the JSE. The enlightened shareholder value model has been adopted by the Act, as it has by most western countries including the UK in its 2006 Companies Act. The DTI s stated approach in the 2004 Policy Paper was that, in developing new companies legislation, it would be guided by a legislative framework that: reflects the recognition that the company is a social as well as an economic institution, and accordingly that the company s pursuit of economic objectives should be constrained by social and environmental imperatives. On the face of it, the definition of a profit company in the Act as a company incorporated for the purposes of financial gain for its shareholders contradicts this philosophy. It certainly does evidence the fact that the primary duty of the directors of a profit company remains that of maximising profits for its shareholders, but this duty is severely tempered by a host of other provisions which confer rights on, and impose obligations of companies towards all their other stakeholders. The Act has partially codified the common law fiduciary duties of directors (see 3.9), the most important of which requires that directors act in the best interests of the company. Protagonists of the pluralist approach argued that the Act should spell out exactly what this duty entails, and that it should include social and environmental responsibilities. The position taken by government was to embrace the enlightened shareholder value model, but not to legislate on the specifics as to what a director s duty to act in the company s best interests means. Instead, government has chosen to leave it to our courts to determine the ambit of directors duties through the development of our common law. It also concluded that the manifestation of the enlightened shareholder value model in various new provisions of the Act, particularly those which give stakeholders significant new rights and remedies (see 3.17), coupled with the rights and remedies given to stakeholders by numerous other statutes, provided sufficient protection for them. It decided that this approach, coupled with the self-regulating principles of the King Code, should encourage companies to comply with not just the letter of the law, but with the spirit of good corporate governance. Protagonists of the pluralist approach also argued that a voluntary, self-regulating approach such as the enlightened shareholder value model disregards the fact that companies are legally bound by the Bill of Rights in terms of S8(2) of the Constitution. Therefore, a specific duty should be included for directors to realise and comply with fundamental human rights in the Constitution and the Bill of Rights to the extent that companies are required to do so. This did not happen, but there are nevertheless a number of provisions of the Act which refer to sections of the Constitution. For example, S7(a) states that one of the purposes of the Act is to promote compliance with the Bill of Rights in the application of company law. The adoption of the enlightened shareholder value model has resulted in a host of new provisions being introduced into the Act to give effect to it. It is epitomised in S7(a) [see above] and SS7(b)(iii) and (d), which state that two other purposes of the Act are to: promote the development of the South African economy by encouraging transparency and high standards of corporate governance as appropriate, given the significant role of enterprises within the social and economic life of the nation ; and reaffirm the concept of the company as a means of enhancing economic and social benefits. Section 7 is given legal backing by S5(1), which states that the Act must be interpreted and applied in a manner that gives effect to these purposes. Another innovation occasioned by this new approach is the obligation of certain companies to have a social and ethics committee. John F Olson South Africa moves to a global model of corporate governance but with important national variations in Modern Company Law for a Competitive South African Economy, page 219, describes the Act s corporate social responsibility model as follows: Over the past twenty years, corporate governance has seen a surge in interest with regard to corporate responsibilities to society. Often, these interests have not been embedded in statutes but instead have been implemented through guidelines and codes. The Companies Act directly provides a clear framework for the empowerment of stakeholders and includes a directive that companies operate to enhance not only 12 13

shareholder-profits but also societal welfare. To ensure that these purposes are fulfilled, the South African Government is provided greater power in governance decisions than is typically found in most other general corporate statutes. The Act also gives substantially greater rights and remedies to stakeholders, including minority shareholders, and thus encourages stakeholder activism. Two of the most striking even alarming in some instances aspects of the Act are: the number of remedies it provides, in particular the number of remedies it provides to minority shareholders and directors; and the number of methods by which its remedies may be enforced. In both of these respects, the Act generally goes further than the companies legislation of other western countries, including the USA and the UK. Unfortunately, this could lead to increased litigation and a fair amount of remedy shopping. 3.8 Phasing out of the CC and the advent of the new small company The 1973 Act was designed primarily to cater for the requirements of large companies; it ignored the economic and administrative difficulties faced by small businesses. It is for this very reason (ie, to cater for small businesses) that the CC Act was enacted as far back as 1984. In stark contrast, the Act attempts to cater for the requirements of companies of all sizes a one size fits all approach. The Minister put it this way: South Africa faces the same challenges in company law as other countries, namely how to regulate both the biggest and smallest companies under a single Act. Government has decided to phase out the CC and instead provide [in the Act] for a company structure that reflects the characteristics of a CC. It has, however, kept its options open by leaving the CC Act intact for the time being, but on the basis that new CC s are forbidden; no new CCs may be formed, nor may companies be converted into CCs. It is envisaged that this mechanism will eventually result in CCs becoming obsolete. In the 2004 Policy Paper, the DTI explained its rationale for the scrapping of the CC as follows: the current division between close corporations and companies offers limited opportunities for progression from one form of company to another and has resulted in distrust by financiers of close corporations it is necessary to move away from the largely artificial separation between the different business forms, to recognise only one formal business vehicle and to provide for a simple, easy company formation process. CCs today comprise the overwhelming majority of all limited liability entities in South Africa. They outnumber private companies by about eight to one. Given the indisputable popularity and success of the CC as a limited liability vehicle for use, in the main, by small businesses, one of the DTI s top priorities was to ensure, as best it could, that the new small private company, which has effectively replaced the CC, is at least as easy and cheap to create, maintain and administer as a CC in all its facets, yet is as much a private company as any other. Not an easy task. There are two fundamental differences between a private company and a CC: a private company issues shares which evidence a person s participation in the equity and control of a private company. A CC does not issue any type of instrument. One merely holds a member s interest in a CC, akin to having an equity participation in a partnership; and a private company has shareholders and directors. The powers of, and in relation to, a private company are separated between those of its shareholders and those of its directors. A CC has members only, who have absolute power in relation to all aspects of the CC and its business. The DTI was thus faced with this problem: How do you create a private company which closely resembles a CC without abolishing the essential requirements that a company must have shares and directors? The burden of a small company having to have shares is not removed by the Act but is alleviated in three ways: for the first time, the Act allows directors to be given the power to determine nearly all aspects of the share structure of a company, including the number of, and the rights attached to, a company s authorised and issued shares, as well as the power to buy-back the company s shares; almost all of the complex provisions of the 1973 Act which placed severe restrictions on the ability to alter a company s share structure have been removed; and the provisions of the Act governing shares are more flexible than those of the 1973 Act. These innovations simplify and therefore cheapen the approval and administrative processes in relation to most aspects of a company s shares considerably. As far as the division of powers between shareholders and directors is concerned, the DTI s solution was this: allow directors to have substantially the same powers as shareholders, except that ultimate control of a company must remain with the shareholders exclusively at all times. The Act has implemented this solution by giving directors far greater powers than they had under the 1973 Act, but also by: giving shareholders the overriding right to revoke, restrict or modify most of these new powers at any time simply by amending the MOI; and ensuring that the most crucial powers of control of a company are still vested exclusively in its shareholders, namely the power to amend the MOI, to elect at least 50% of the directors, to remove directors, to issue shares to directors, to implement any fundamental change to the company or its business and to wind up the company. Because these increased powers of directors are unprecedented in South African companies legislation, a person reading the Act for the first time is left somewhat confused as to the division of powers of, and in relation to, the company between its shareholders and directors. Until now, this division of powers was quite clear cut. Shareholders alone had the power to determine the make-up of every aspect of the company s shares or other equity instruments. They also had the sole right to decide on issues that were outside the ordinary course of conduct of the company s business. Directors, on the other hand, were charged with the duty, and had the power, to manage and control the company s day-to-day business operations, including representing the company in transacting with third parties. The answer to this confusion lies mainly in the use of the phrase Except to the extent that a company s Memorandum of Incorporation provides otherwise (and variations of it), which forms the precursor to numerous sections of the Act. These sections form part of what are defined in S1 of the Act as alterable provisions, by which is meant in the present context that any power given to directors in terms of any provision of the Act which embodies these words may be revoked, restricted or modified by shareholders at any time. In other words, shareholders can decide at any time not to give the directors a particular power but if they do not make that decision, the directors will automatically be vested with the power in question, by default. Moreover, and importantly, a positive act by the shareholders is required their decision must be formally adopted by way of incorporation of it in the MOI pursuant to the passing of a special resolution. If shareholders do not revoke, restrict, or modify any of these powers in this manner, they will, by default, give directors the greatest powers the Act allows. This alterable or default mechanism achieves two crucial goals: The powers of shareholders and directors can be either partially or substantially inter-changed (or even merged if the shareholders and directors are the same person/s), resulting in a control structure which is flexible enough to reflect most (but not all) of the characteristics of the control structure of a CC. The MOI of a small company can be a much shorter and far simpler document than that of a large company because its shareholders will not wish to amend any of the alterable provisions of the Act in most cases. In this context, therefore, the MOI of the small company will be the relevant sections of the Act itself. This is essential because the biggest delay in, and cost of, incorporating a small company would otherwise be the drafting of its MOI. There are over 50 alterable provisions in the Act. The default or alterable provisions mechanism alone does not, however, enable the small company to effectively adopt the applicable sections of the Act as its MOI because the MOI must deal with more than just the respective powers of its shareholders and directors. It must also deal with other matters, the most important of which is corporate governance the governance of meetings and decisions of shareholders and directors. To cater for the small company once again, the sections of the Act which deal with these governance matters are far more comprehensive and detailed than the corresponding provisions of the 1973 Act. In fact, the 1973 Act 14 15

was silent on most of these matters; they were generally dealt with in the Articles. The main sections of the Act to which this reasoning has been applied are SS58 to 65 (meetings and resolutions of shareholders) and SS66 to 73 (constitution, powers and meetings of the board). Many of these sections also have considerable flexibility to cater for the numerous forms of governance structures which a small or medium sized company may wish to adopt. For example, S65 allows the MOI to require a higher percentage than 50,1% of voting rights to approve an ordinary resolution and/or a different (ie, a higher or lower) percentage than 75% of voting rights to approve a special resolution, but there must always be a margin of at least 10% between these two percentages. The combined effect of the alterable provisions mechanism and the detailed governance sections of the Act is that the small company s MOI can be a simple, short document which effectively states that the company adopts the applicable sections of the Act as its MOI. This will simplify, cheapen and accelerate the formation and registration procedure for a small company considerably. The MOIs of public and medium to large private companies will be lengthy documents. Five standard form long and short MOI s for profit and non-profit companies are contained in Forms CoR 15.1A and B (profit companies), and Forms CoR 15.1 C, D and E (non-profit companies), which are annexures to the Regulations. It is clear from the above that the MOI of an unlisted company, whether it be a public or a private company, is now a crucial document that investors, creditors and other stakeholders must carefully review as a matter of course in order to ascertain, among other things, whether or not the customary rights and powers of shareholders remain intact. 3.9 Increased exposure of directors to personal liability true or false? The Act has evoked protests over a number of its provisions which impose personal liability on directors. The main criticism is that these provisions will militate against a person accepting appointment, or continuing to act as a director, especially as a non-executive director, because the risk of personal liability is too great relative to the fees which directors normally earn for their services to a company. The distinction between an executive and a non-executive director lies only in the director s level of involvement in the day to day management of the company. Apart from the different degrees of care and skill which arise from specialist skills and/or the degree of involvement in daily management, there is no difference in law between the duties and liabilities of executive directors and non-executive directors. This criticism emanates mainly from the fact that, for the first time, the duties and liabilities of directors under the common law have been partially codified in the Act. These partially codified duties and liabilities prevail over any conflicting common law duties and liabilities. If there is no such conflict, the common law remains applicable. In most respects, the common law duties and liabilities of directors have not been altered by this codification to the detriment of directors. Quite the opposite, in fact the codified duties of directors are more lenient than those of the common law in some important instances. That said, the financial exposure which directors face under the Act if they do not properly discharge their duties (ie if they do not do their jobs properly) is very different to the position under the 1973 Act. A director faces much greater personal financial risk under the Act in these circumstances for four reasons: a director s statutory duties (ie, those imposed on a director in terms of the Act and other statutes, which are in addition to those imposed by the common law) have been increased, so it is now more difficult for directors to do their jobs properly. For example, the solvency and liquidity test (see 3.11) is now a cornerstone of the Act. In every case where this test must be applied, the directors have the duty to satisfy themselves that it will be met; powerful new remedies are available to an aggrieved shareholder or other stakeholder, such as an employee, against directors who do not do their jobs properly (see 3.17); remedies against directors which were available to stakeholders under the 1973 Act are not only retained, they are also wider in their scope and easier to implement in some instances (see 3.17); and the new enforcement regime (see 3.20) should prove to be more efficient and effective, so recalcitrant directors will find it more difficult to avoid personal liability for not doing their jobs properly. There are two fundamental reasons for this new approach towards directors. Firstly, as a consequence of the powerful role that directors now play in global business coupled with the abuse of their powers by the directors of some multi national companies, government has followed the worldwide trend towards requiring greater accountability by directors for corporate wrongdoings by providing all stakeholders (not just shareholders) with new and expanded remedies against recalcitrant directors. Secondly, the punishment must be a meaningful deterrent and be capable of being enforced. Criminal sanctions for contraventions of the 1973 Act proved to be ineffective, so they have been almost entirely replaced by financial sanctions except for the most serious offences. These threats to a director s personal financial position are, however, countered by a number of defenses and remedies which the Act gives to directors, some of which have been severely criticised as being far too lenient towards directors. These include the so-called business judgement test in S76(4)(a) and S77(9), which permits a court to relieve a director from any form of personal liability (other than liability arising from willful misconduct or willful breach of trust) if the court finds that the director is liable but has acted honestly and reasonably, or if it would be fair to excuse the director. Directors have considerable powers. However, with great powers comes great responsibility. So, if directors are found wanting in the proper discharge of their duties, they must receive a meaningful punishment. The challenge which faced the architects of the Act was to strike a careful balance between adequate monetary sanctions and over-exposure to financial risk. This is vital, particularly because there is a dearth of non-executive directors in South Africa who have the necessary experience and skills required to properly discharge their duties. Only time will tell whether this balance has been achieved. Directors may also draw some comfort from S78(7) of the Act, which permits a company to purchase insurance to protect a director against any liability arising, other than any liability arising from: lack of authority, reckless or fraudulent trading, or defrauding a stakeholder; or wilful misconduct or wilful breach of trust on the part of the director. Accordingly, S78(7) now permits a company to take out director s indemnity or D&O insurance (including insurance against negligence) at its cost, even if the director receives the proceeds of the policy, other than for the most serious contraventions of his/her duties. The 1973 Act prohibited a company from doing so. Given the increased risk of personal liability, however, it is possible that the premiums on such insurance policies will be increased. 3.10 Increased accountability and transparency The Act divides the accountability and transparency obligations of companies into two main parts: Part C of Chapter 2 (SS23 to 33), which applies to all types of companies. These sections provide that all companies must have a registered office, file an annual return, keep accurate and complete accounting records and financial statements, and maintain certain records which must be open for inspection by all stakeholders for at least seven years. They also incorporate one of the DTI s goals the prescription of minimum standards of content and efficacy for the financial statements of all types of companies. The financial statements of all companies (which include annual financial statements and interim reports), must now satisfy prescribed financial reporting standards. The Regulations provide for three different sets of financial reporting standards, namely International Financial Reporting Standards ( IFRS ), IFRS for Small and Medium Enterprises and South African Statements of Generally Accepted Accounting Practice. As was the case under the 1973 Act, every type of company must prepare annual financial statements ( AFS ). Under the Act, however, only public companies, SOCs and other profit or non-profit 16 17

companies determined by the Minister, having regard to the economic or social significance of the company, as indicated by any relevant factors, including its annual turnover, the size of its workforce or the nature and extent of its activities, are obliged to have their AFS audited. The Minister has so determined by providing in the Regulations that every company must calculate its public interest score for each financial year in order to determine, among other things: whether or not it is obliged to have its AFS audited; and which set of financial reporting standards it must comply with in preparing its financial statements. If a profit company s public interest score is 350 or more, it must have its AFS audited. The public interest score is determined by four factors, namely a number of points equal to the average number of its employees during a financial year, the aggregate amount of its liabilities to third parties at financial year end (one point for every R1 million or portion thereof), its turnover during the financial year (one point for every R1 million or portion thereof) and the number of its direct or indirect shareholders who are natural persons at financial year end (one point for every individual). If a private company is not required to have its AFS audited, then its AFS must be independently reviewed, except where every shareholder is also a director of the company. Independent review connotes a less onerous, less costly examination of financial statements than an audit and may, in the case of small companies, be performed by persons other than practising chartered accountants. Chapter 3 (SS84 to 94), which deals with the appointment by a company of a company secretary, an auditor and an audit committee. Only public companies and SOCs are obliged to appoint a ompany secretary and an audit committee (in addition to an auditor because they are also obliged to have their AFS audited). No private or other type of company is obliged to appoint a company secretary or an audit committee, even if it is obliged to have its AFS audited. For the rest, Chapter 3 is, by and large, a re-enactment of the equivalent provisions of the 1973 Act which were introduced into the 1973 Act in 2006. 18 The Act also contains two new important accountability and transparency provisions, namely: S122, which imposes new disclosure requirements in relation to sizeable acquisitions and disposals of securities of regulated companies, being companies that are subject to the TRP s jurisdiction and which include all public companies, whether listed or unlisted; and S72(4), a rather radical requirement which, when read with regulation 43, compels each SOC, listed public company and any other company that has, in any two of its previous five financial years, scored above 500 points on its public interest scorecard (being 150 points more than the score at which a company is obliged to have its AFS audited) to appoint a social and ethics committee. There will certainly be a large group of private companies which will be obliged to do so. Applications may, however, be made by any company to the Tribunal for an exemption from this requirement. This committee, which is appointed by the board, has the duty to monitor the company s activities in relation to five aspects of a company s social responsibilities, namely social and economic development, good corporate citizenship, the environment, health and public safety, consumer relationships, and labour and employment. 3.11 No par value shares and the solvency and liquidity test A fundamental principle on which the 1973 Act was based was that a company must continuously maintain its share capital at the level of funding contributed by its shareholders, called the maintenance of capital rule. This rule has been virtually abolished and substituted by the solvency and liquidity test in S4 of the Act. In fact, the notion of share capital no longer exists for company law purposes though it will, of course, continue to exist for accounting purposes. The maintenance of capital rule is the reason why, under the 1973 Act, a share could have a par value, why the issue price of a share had to be paid upfront and in full, why a share could not be issued at a discount, why all amounts received by a company upon issue of its shares had to be credited to a special account in its books of account called a share capital, share premium or stated capital account, why a portion of a company s profits equal to the par value of a redeemable preference share had to be transferred to a capital redemption reserve account upon its redemption, and why any reduction of any of these accounts was forbidden unless stringent requirements were met. All these complex restrictive measures had one primary objective: to protect creditors against unscrupulous shareholders by ensuring that the amount of a company s share capital was continuously maintained at the same level as that at which it was contributed by its investors. Put another way, a company could not weaken its financial position by paying a dividend or making another distribution to its shareholders unless its assets exceeded the sum of its liabilities and the aggregate amounts of these various accounts. The theory was that creditors would be protected to a considerable extent by rendering these amounts untouchable by anyone, including shareholders, unless these stringent requirements were met or until the company was finally wound-up. However, the 1973 Act had a fatal flaw it never insisted that a company should have a minimum amount of share capital; it never introduced thin capitalisation provisions. In order to avoid the very restrictive capital maintenance provisions of the 1973 Act, it very quickly became common practise for a company to issue its shares at their par or nominal value of, say, one cent per share and for the balance of an investor s contribution to the company, however large, to be made by way of an interest-free, unsecured loan, such amount being credited to what is commonly called a shareholder s loan account. The law governing a shareholder s loan to a company is no different to that governing any other loan by anyone else to a company, which means that shareholders can have their loans repaid by the company just as easily as any independent third party who makes an arm s length, unsecured loan to the company. In short, therefore, the notion of share capital having to be continuously maintained at the level contributed by its shareholders in order to protect creditors simply did not work. In general, the amount and make-up of a company s share capital became irrelevant to a third party in deciding whether to lend money or grant credit to a company, except to inform that third party of the number, classes and rights of the company s authorised and issued shares. Almost all of the 1973 Act s provisions which supported or enforced the maintenance of capital rule have been abolished. The most fundamental of them was the concept that a share could have a par or nominal value. Henceforth, a company (other than pre-existing companies and banks) may only have shares of no par value. The Act permits the continued existence, for an unlimited period, of par value shares that were issued by pre-existing companies before 1 May 2011. However even if a pre-existing company did have issued par value shares on 1 May 2011, it can no longer: increase the number of its authorised par value shares; or issue any class of authorised par value shares from which it did not issue any shares before 1 May 2011. The Regulations contain detailed provisions governing the conversion of par value shares into no par value shares. Shareholders of any pre-existing company may elect to do so at any time by passing a special resolution to this effect. The solvency and liquidity test recognises the practicalities of modern business and thus gives far greater protection to creditors. It has two elements: A solvency element, which tests whether a company s assets exceed its liabilities and thus requires an examination of the balance sheet; and A liquidity element, which tests whether a company is able to satisfy its debts as they become due and payable, and thus requires an examination of the cash flow statement. Both elements are considered to be essential because they address two different concerns. The solvency element attempts to ensure that a creditor is not prejudiced by the company denuding itself of material 19

assets or incurring excessive liabilities. The liquidity element attempts to ensure that creditors will be paid timeously. It is not uncommon for a company whose assets substantially exceed its liabilities to go insolvent because it has run out of cash. The biggest shortcoming of the maintenance of capital rule was that, while it did embody some of the characteristics of the solvency element, it never addressed the liquidity element at all. The solvency and liquidity test was, in fact, introduced into the 1973 Act in the 1990 s but it was applicable in only three instances, namely: financial assistance by a company to acquire its own shares (S38), share buy backs (S85) and distributions to shareholders (S90). Under the Act, the solvency and liquidity test must be applied in each of the following seven instances: the provision of financial assistance in connection with the acquisition by a company of its own securities (S44); loans to directors and inter-group loans (S45); Distributions of any nature, including dividends (S46). issues of capitalisation shares with a cash alternative (S47); share buy-backs (S48); amalgamations or mergers (S113); and where a foreign company wishes to transfer its registration to the RSA and thus become a domesticated company (S13). Of course, the most frequent of these instances is the making of distributions by companies to their shareholders. The Act defines a distribution very widely. For example, a distribution includes the forgiveness of a debt owed to the company by a shareholder. The Act does not accord any special treatment to dividends; it treats dividends in the same way as any other distribution, no matter what the source or nature of the dividend may be. In particular, the Act does not differentiate between distributions of assets as opposed to cash, nor between distributions of capital as opposed to income. Another positive consequence of the abolition of the maintenance of capital rule is that the sections of the 1973 Act which gave effect to it were lengthy and complex. The sections of the Act which give effect to the solvency and liquidity test are short and simple in comparison. In this context, therefore, considerable simplification of the legislation has been achieved. 3.12 Modernisation and harmonisation By the turn of the century, most of the provisions of the 1973 Act had already become outdated, even archaic in some instances. In many respects, the 1973 Act also did not meet the standards that most first world countries had already adopted as part of their companies legislation, colloquially called international best practise. This was particularly apparent within the spheres of public companies and communications. The Act contains a number of new provisions which specifically address the modernisation of these two subjects. As regards public companies, the Act recognises the modern day methods of making public offers of shares by legislating for initial public offerings, primary offerings and secondary offerings. It also contains a modernised, far more comprehensive set of Takeover Regulations and provides for the fairly common listed company practice of issuing capitalisation shares. Following the example of the Banks Act, it has also introduced the concept of amalgamations and mergers to facilitate transactions amongst, and restructurings of, large groups of companies. As ar as communications are concerned, electronically generated copies of documents may be substituted for the original, notices may be given by electronic transmission, documents and records may be stored and access to them provided electronically, and documents may be signed by way of electronic signature. The Act even goes so far as to make it compulsory for shareholders meetings of public companies to be reasonably accessible within South Africa for electronic participation by shareholders. It also provides for the establishment of e-government an electronic communication system to facilitate the automated reservation of names, incorporation and registration of companies, and the filing of information. An important example of modernisation is the prolific use of the word securities instead of shares throughout the Act. Securities is given a very wide meaning, namely: any shares, debentures or other instruments issued or authorised to be issued by a profit company. The Act thus recognises that, in contemporary markets and business, there are numerous instruments apart from shares which give their holders varying forms of economic and voting interests in a company. The Act also brings our companies legislation into harmony with overlapping legislation, including the Securities Services Act, 2004, the Auditing Profession Act, 2005, the Banks Act, 1990 and the Electronic Communications and Transactions Act, 2002, thereby reducing regulatory arbitrage. Reference is made to over 25 other statutes in the Act. 3.13 Related and inter-related persons Related and inter-related persons is a new expression in our companies legislation but is long-standing and widely used in the regulation of financial markets around the world, including the JSE. In fact, the JSE has an entire chapter of its Listings Requirements devoted to transactions between related parties. It is the most frequently used expression in the Act (it appears over 80 times) and has a section of the Act (S2) exclusively devoted to it. This expression covers both natural and juristic persons (Note: the Act deems a juristic person to include a trust) and is used mainly in the context of relationships amongst or between a company s shareholders or directors and others, called related or inter-related persons. Related persons of a natural person include his/her spouse, children, grandchildren, parents, grandparents, siblings and in-laws. Two companies are related if, amongst other things, one is a subsidiary of the other or if either of them controls the other or if one company controls both of them. Inter-related persons are three or more persons who are linked to one another by any one or more of these relationships. This expression is mainly used in the context of safeguarding stakeholders of a company, particularly minority shareholders, against shareholders or directors taking unfair advantage of these relationships. It does so by, among other things, subjecting them to certain disclosure requirements or by treating all of them as a single person for numerous purposes. For example, in many instances which involve voting rights, the voting rights that a shareholder and that shareholder s related and inter-related persons control are aggregated and are deemed to be controlled by that shareholder alone. 3.14 Fundamental transactions and the appraisal remedy The expression fundamental transactions is used to connote certain transactions that fundamentally alter a company due to a fundamental change in its business, its securities or its shareholders. The Act provides for the following three types of fundamental transactions: the disposal of all or the greater part of a company s assets or undertaking (the equivalent of S228 of the 1973 Act); a scheme of arrangement between a company and its shareholders (the equivalent of SS311 and 312 of the 1973 Act); and an amalgamation or merger. An amalgamation or merger is a new concept. It was introduced to provide flexibility and enhance efficiency in the economy. Also known as a statutory merger and a business combination, it is flexible enough to enable any number of companies to agree to merge or amalgamate their respective businesses in virtually any manner they choose. It enables most forms of business combinations, however complex, to be implemented by way of a single relatively simple procedure. In particular, it caters for merger transactions between companies that have a number of subsidiaries. It also creates flexibility for groups of companies which wish to restructure themselves and/or their businesses internally quickly and easily. An amalgamation or merger can include the expropriation of the shares of minority shareholders in one or more companies which are party to it. The Act has simplified the law considerably by introducing a common approval procedure for all three fundamental transactions. All of them require the prior approval of independent shareholders by way of a special resolution. Approval by a court as the upper guardian of the minorities is not required for any of them unless 20 21

at least 15% of independent shareholders votes are cast against the special resolution and any dissenting minority shareholder requires the company to seek court approval. In this instance, the company must make the court application, at its cost. In addition, all three fundamental transactions are supported by the new appraisal remedy for dissenting minority shareholders, which goes some way to achieving government s goals of providing a remedy to avoid locking in minority shareholders in inefficient companies. A serious disadvantage of being a minority shareholder has always been the inability to sell one s shares (unless, of course, the company is listed). In most instances, the only willing buyer is the majority shareholder or, perhaps, another minority shareholder. Not many people have the appetite to invest in a company over which they have very little control or influence unless they are able to realise their investment fairly easily. It is not surprising, therefore, to find that S164 of the Act gives minority shareholders the right, called an appraisal right, to force the company to buy-back their shares at their fair value, and for cash, where its majority shareholders have passed a special resolution to enter into a fundamental transaction. The appraisal remedy is an important factor which majority shareholders and boards of directors, as well as potential acquirers of public companies, particularly listed companies, will now have to consider when deciding whether or not to propose a fundamental transaction to minority shareholders. If they do not, they face the risk that the company will be left with no minority shareholders or little cash, or both. 3.15 The new takeover regime The Act has entirely replaced the Securities Regulation Code ( SRP Code ) and the Rules of the Securities Regulation Panel ( SRP Rules ) with SS117 to 127 of the Act and the Takeover Regulations. With some notable exceptions, the fundamental concepts and principles contained in the SRP Code and the SRP Rules remain largely the same, but the takeover regime has been rewritten for a number of reasons, including the failure of the SRP Rules to deal with a number of critical issues, either at all or in sufficient detail. The new provisions also modernise various aspects of the SRP Rules and place a much stronger emphasis on adequacy and transparency of information, as well as proper corporate governance, including directors responsibilities and the independence of the board of the target company and its advisers. Three significant changes to the SRP Rules are: the Act embodies the same fundamental principle as that in Rule 8.1 of the SRP Rules, namely that an acquisition by any person of 35% or more of a company s voting securities triggers an obligation of the acquirer to make an offer to acquire all of the company s remaining voting securities. Unlike the SRP Rules, however, a further mandatory offer is not triggered by any subsequent acquisition of further securities if the 40%, 45%, 49,9% or 50% voting level is breached. These so-called creep provisions of the SRP Rules have been repealed; the Act contains provisions which address partial offers in detail for the first time; and there are new disclosure requirements in relation to share dealings in S122 (see 3.10). 3.16 The business rescue regime The business rescue ( BR ) regime has replaced the judicial management ( JM ) regime in the 1973 Act. JM was an attempt to provide an alternative to liquidating a near insolvent company. For various reasons, it was an abject failure. BR is a second attempt at achieving the same objective. Government s persistence with this concept is based, apparently, on empirical evidence to the effect that attempts to rescue companies that are already insolvent meet with less success than attempts to rescue companies that can begin almost immediately after a company (ie, its board) first realises that it is in severe financial difficulties. The Minister explained the need for BR as follows: [The Act] introduces the principle that the idea of business rescue schemes rather than summary liquidation are more preferable, with the idea in mind that it is better to try and save a business in distress rather than summarily close it down because creditors exceed debtors, the possibility of restoration being more equitable for all interested parties than the current somewhat immediate, maybe too early in some instances, brutal settlement and distribution process [of liquidation]. Both BR and JM provide for the control by a third party of companies that are in severe financial difficulties and for their temporary reprieve from creditors claims, but differ from one another in most other respects. Unlike JM, BR is not restricted to nursing a company back to solvency. It is also a system to temporarily protect a company against the claims of creditors so that its business can be restructured and thereafter be sold for maximum value as a going concern, thus giving creditors and shareholders a better return than they would have received had the company been liquidated. A successful BR procedure therefore does not necessarily require that all creditors be paid in full or that all shareholders retain their investment. The Explanatory Memorandum describes BR as a regime which is largely self-administered by the company, under independent supervision, and subject to court intervention at any time on application by any of the stakeholders. In these and some other respects, the BR regime resembles the Chapter 11 bankruptcy procedure of the USA. The most significant difference between BR and JM is that it is no longer necessary for a company to get a court s approval in order to obtain the protections that BR offers, including a freezing of creditors claims. All that is now required is a directors resolution that effectively declares that the company is in dire financial straits and that also appoints an independent person, selected by the board, called a practitioner. A practitioner has the duty to investigate the company s affairs and then decide whether or not there is any reasonable prospect of rehabilitating the company. If the practitioner decides that there is such a prospect, s/he must then prepare a BR plan. If the company s creditors (and shareholders, if their rights are affected) approve the BR plan, the practitioner must then oversee its implementation. This fundamental policy change from court supervision to self-regulation will undoubtedly save significant costs and thus enable financially distressed small companies to now consider BR as a viable alternative to last-resort liquidation. BR has met with more criticism than any other aspect of the Act. Big businesses generally feel extremely uncomfortable about BR because, like liquidation, it constitutes a drastic intrusion into the rights of creditors. The main complaint is that the BR system is too debtor friendly the Act makes it too easy for a company to claim BR protection. Critics argue that the threshold for claiming BR protection, namely a resolution of the company s board, is too low and although it is possible for shareholders, creditors or other affected persons to have the BR resolution of the board set aside, the hurdles they must clear to do so (which include a mandatory court application) are too high and too costly. The answer to this criticism is that the BR regime is primarily designed to cater for the small company. In order to be effective, it must be a cheap and speedy process for the financially distressed small company. Allowing a creditor to set aside the BR resolution too easily could defeat this objective. Nevertheless, there is little doubt that the BR system does have potential for great abuse by unscrupulous directors. It is therefore vital that the practitioner is an independent, properly qualified and competent person. Critics argue that the board should not have the power to appoint the practitioner for this reason; the process for this appointment should be more independent. Critics also believe that some of the powers given to the practitioner are too great. The most controversial is the power to suspend any agreement, or any part 22 23

of any agreement, to which the company is a party entirely, partially or conditionally for the duration of the BR proceedings (S136(2)). Their concern is that this disregards the firmly entrenched legal principle of sanctity of contract, which could have severe negative repercussions for creditors. For example, the practitioner has the power to suspend only one particular provision of an agreement, and leave the rest of it intact. So, the practitioner could, for example, cherry pick a loan agreement by electing to suspend those of its provisions which oblige the borrower to repay the capital and to pay interest but by also electing to leave the loan itself intact. Similarly, the practitioner of a company that is unable to pay its rental on hired premises could elect to suspend its obligation to pay rental but remain in occupation of the premises. Protagonists argue that S136(2) is necessary to enable the company to temporarily escape liability under contracts that are too onerous or are impossible or very difficult to comply with and must be suspended for the BR plan to succeed. Furthermore, they argue that the practitioner has fiduciary duties which s/he must discharge, so s/he must have good reason to suspend a contract. 3.17 Stakeholders rights and remedies Under the 1973 Act, minority shareholders had very few rights or remedies against an abusive majority shareholder or an antagonistic board of directors. The few rights they did have were often likened to those of a minor child; the majority shareholder was king and the common law dictated that directors owed their primary duties to the company they served and the general body of its shareholders. Government has recognised the economic necessity to create and foster investor confidence in South African companies by introducing some significant new rights and remedies for minority shareholders, most of which already exist in similar or modified forms in the company laws of most first world nations. In fact, the Act gives greater powers and enforcement rights to minority shareholders in some respects than they have in the USA and the UK. The class action (see 3.17.1) is probably the most significant and, when combined with the derivative action (see 3.17.2), the most lethal of them. In line with the enlightened shareholder value approach, the Act also gives other stakeholders, particularly employees, rights and remedies they never had before. The new rights and remedies of employees and trade unions are listed in 3.18. The Act has introduced, among others, the following six new remedies: stakeholders may apply to court for relief from abuse of a company s separate legal personality (S20(9)); a regime to protect whistle-blowers who disclose irregularities or contraventions of the Act (S159); a shareholder has a general right to apply to a court for a declaratory order as to that shareholder s rights, and to obtain an appropriate remedy (S161); stakeholders may apply to a court to have a director declared delinquent or placed under probation (S162); in certain circumstances, shareholders may require that their shares be valued and bought back by the company for cash, called the appraisal remedy (see 3.14); and in certain circumstances, stakeholders may commence or pursue legal action against anyone in the name of the company, called the derivative action see 3.17.2 (S165). In addition, the so-called minority oppression action has been retained in S163 (the equivalent of S252 of the 1973 Act), but its scope has been widened considerably. In particular, S163 now permits a shareholder or a director to seek relief from a court for abuse by directors of their powers, and gives a court an extremely wide discretion as to what it may order if it rules in favour of the applicant, including removing a director from office or placing a director under probation. 3.17.1 The class action Class actions have achieved notoriety due to their success in the USA in enabling thousands of people having a common complaint against a large corporation to be paid millions of dollars as compensation for wrongs inflicted on them by the corporation. The nature of these wrongs has varied widely, from product liability claims against cigarette manufacturers to the largest claim ever: the $40 billion claim against the directors of Enron in 2001. The class action is a legal procedure, not a remedy, its purpose being to give access to justice to people who would otherwise be unable to fund the costs of legal proceedings on their own. For this reason, it could play a crucial role in assisting stakeholders to pursue their remedies under the Act, including those against directors. The class action has been unequivocally adopted by the Act, which permits legal proceedings to be brought by anyone as a member of, or in the interest of, a group or class of affected persons (S157(1)(c)). This is the same wording as that of S38 of the Constitution, and there has been a Supreme Court of Appeal judgment on the subject. If South Africa follows the trend in the USA and Australia, then we will soon find lawyers willing to take on class action cases at little or no cost to the client in exchange for a percentage of the amount recovered, and the emergence of businesses that provide funding for class actions on a similar basis. Unfortunately, if overseas experience is followed, the availability of the class action could also result in an increase in litigation activity. 3.17.2 The derivative action A major obstacle for stakeholders of a company, particularly minority shareholders, has always been that, with some limited exceptions, the law does not give them any direct right to claim, on behalf of the company, compensation from its directors personally for having breached their duties to the company. Their only recourse under both the common law and the 1973 Act was an indirect action, called the derivative action. If a shareholder (and only a shareholder) believed that a director had breached his/her duties to a company, and if the remaining directors condoned the breach, that shareholder could apply to court for an order forcing the board to take the necessary legal action against the director. The derivative action in S266 of the 1973 Act proved to be a dead letter, largely because of the costs and delays involved in applying to court and the fact that the onus of proof which a shareholder had to discharge before a court would come to the shareholder s assistance was heavy. The Act broadens the scope of the derivative action significantly. It permits derivative proceedings to be initiated, not only by any shareholder, but also by any director, prescribed officer or employee representative such as a trade union. They may also be initiated by way of a class action. Furthermore, the derivative action is no longer restricted to actions for wrongful acts of directors only. Now, the wrongdoer can be anyone who has harmed, or may harm, the company s legal interests, an extremely wide term. The procedure is also cheaper and speedier for the complainant. Most significantly, the complainant no longer has to apply to court. Instead, all that the complainant must do is serve a written notice on the company demanding that it institutes legal proceedings against the alleged wrongdoer. Unless the claim is frivolous, vexatious or wholly without merit, the board is then obliged, at the company s cost, to appoint an independent person or committee to investigate the demand and report back to it on its likely success. After considering the report, the board must either commence legal proceedings against the alleged wrongdoer or inform the complainant why it will not do so. In the latter case, the complainant may then apply to court for leave to sue the alleged wrongdoer directly. The new derivative action, in combination with the class action, heralds the dawn of more aggressive stakeholder activism in South Africa. Undoubtedly, directors will be more exposed to the threat of personal liability because of these new actions. 24 25

3.18 Increased rights and remedies for employees and trade unions 3.18.1 Employees The Act is strikingly different to its equivalent in most other first world countries in its treatment of employees in that it gives employees greater rights than are given to employees in these other countries. In furtherance of the goal that company law should ensure appropriate participation of other stakeholders, employees have the following new rights and remedies: any document that the Act requires to be provided to an employee must be provided either in the prescribed form for it or, if no form is prescribed, in plain language, which means that it must be written in a way that a person with average literacy skills and minimal experience in company law matters will understand; they may institute class action proceedings via their trade unions; they are entitled to the protections afforded by the whistle-blower provisions in S159 if they disclose irregularities or contraventions of the Act, over and above those afforded to employees by the Protected Disclosures Act, 2000; they may apply to court for an order declaring a director delinquent or under probation; they may apply to court for relief from abuse by a company of its separate legal personality; they may institute derivative proceedings against a company s board (see 3.17.2); during BR proceedings (see 3.16), employees must continue to be employed on the same terms and conditions as those which applied before BR proceedings began and are preferred unsecured creditors of the company for remuneration which became due and payable to them at any time before BR proceedings began. They may also participate in all court proceedings, form a committee of employees representatives and vote with creditors to approve a proposed BR plan. They also have the right to make an offer to buy out creditors and/or shareholders if a proposed BR plan is rejected by the other creditors; and they may lodge complaints with the Commission or the TRP (see 3.20). 3.18.2 Trade unions Trade unions had no rights or remedies under the 1973 Act. They now have the following: they may take proceedings to restrain the company from doing anything inconsistent with the Act; if the board adopts a resolution to provide direct or indirect financial assistance to a director, the company must provide written notice of that resolution to any trade union representing its employees; they must, through the Commission, be given access to a company s financial statements for purposes of initiating a BR process; they may apply to court for an order declaring a director delinquent or under probation. They may institute derivative proceedings against a company (see 3.17.2); a trade union representing employees has similar rights to those of employees in BR proceedings; they may lodge complaints with the Commission or the TRP (see 3.20). 3.19 The Companies Tribunal and alternative dispute resolution The Act creates only one new regulatory agency, called the Companies Tribunal. In early drafts of the Act, this agency was called the Companies Ombud. Its name was changed because it has a dual function, namely to: serve as a forum for voluntary alternative dispute resolution in any matter arising under the Act (hence the prior reference to the Companies Ombud ); and adjudicate on, and grant administrative orders in respect of, approximately 15 separate and distinct matters specified in the Act and the Regulations, some of which are described below. In this context, it has powers similar to that of a court because the affected persons are obliged to comply with its orders. The Act provides an informal, relatively cheap and speedy procedure to enable people to resolve disputes relating to, and to obtain relief for contraventions of the Act as an alternative to applying to court or filing a complaint (see 3.20). This alternative dispute resolution procedure, which is entirely voluntary, entails referring the matter to the Tribunal for resolution by mediation, conciliation or arbitration. Over the past two decades, these alternative methods of resolving disputes have become increasingly popular throughout the western world, including South Africa. Numerous organisations, such as the Arbitration Foundation of South Africa, have been established which provide support, facilities and expertise for this purpose. There are also legal practitioners who specialise in informal dispute resolution and its sub-disciplines, such as mediation and arbitration. The Tribunal has the power to adjudicate on, amongst others, the following matters and to make the following orders: it may exempt any person from the application of a provision of the Act that would apply to that person because that person is a related or inter-related person, if that person acts independently of a related or inter-related person; it may exempt an agreement or transaction from any prohibition or requirement of an unalterable provision of the Act if, among other things, it finds that the agreement or transaction serves a reasonable purpose; and if a company has one or two director/s only, it may determine whether a director has become ineligible or disqualified to be director. If it does so determine, it may remove such a director from office. 3.20 Enforcement In line with government s goal that company law should be enforced through appropriate bodies and mechanisms, either existing or newly introduced, the Act establishes a new enforcement regime which largely replaces the criminal law enforcement regime of the 1973 Act. The duty to enforce the Act has shifted from the State (in the form of the National Prosecuting Authority ( NPA )) to the Commission and the TRP. The TRP must enforce the relatively few provisions of the Act over which it has jurisdiction, namely affected transactions and offers (see SS117 to 127 and the Takeover Regulations), while the Commission must enforce all the remaining provisions of the Act, as well as the 15 other statutes listed in Schedule 4 of the Act. The Act gives the Commission and the TRP powers of enforcement that they never enjoyed under the 1973 Act. At the heart of the enforcement system lies a new procedure, called a complaints procedure. Any person may file a written complaint with the Commission or the TRP. The complaint must allege that a person has either contravened the Act or that the complainant s rights under the Act or a company s MOI have been infringed. The Commission or the TRP may also initiate a complaint 26 27

itself, on request by another regulatory authority or if directed to do so by the Minister. Upon receipt of the complaint, the Commission or the TRP must designate an inspector or investigator to investigate the complaint unless the complaint appears to be frivolous or vexatious or establishes no grounds for remedy under the Act. The Act contains detailed provisions relating to the powers of investigators and inspectors, who have the right to issue summonses, interrogate persons they reasonably consider to be relevant to the investigation and even obtain warrants to enter and search premises and seize anything that has a bearing on the investigation. On completion of an investigation, the Commission or the TRP may, among other things, refer the matter to the NPA if it believes an offence has been committed or issue a compliance notice to the offender. A compliance notice may, among other things, require the offender to cease or correct the alleged contravention, restore assets to any person or even provide a community service. It remains in force until the Commission or the TRP issues a compliance certificate. If the offender fails to comply with the compliance notice, the Commission or the TRP may apply to a court for the imposition of an administrative fine or refer the matter to the NPA for prosecution as an offence. One of the few offences provided for in the Act is failure to satisfy a compliance notice. 3.21 Sanctions The architects of the 1973 Act believed that criminal sanctions would be the most effective deterrent to contraventions of the 1973 Act. They were wrong. The 1973 Act contained over 120 provisions which levied criminal sanctions. Most of them proved to be ineffective. Unlike the 1973 Act, the Act attempts to balance civil, criminal and administrative sanctions in order to ensure that the sanction, whatever it may be, is the most appropriate and effective in the particular circumstances to which it is applied. There has thus been a fundamental policy change by government in that, except for the most serious contraventions and for actions which hinder the administration of the Act, criminal sanctions for contraventions of the Act have been almost entirely replaced by a system of administrative fines and/or civil liability on the part of the offender. For example, a court now has the power to levy an administrative fine of up to 10% of an offending company s annual turnover in certain circumstances, subject to a maximum fine of R1 million. The Act contains numerous provisions that impose civil sanctions, particularly in cases that involve the misconduct of directors. For example, S218(2) provides that [A]ny person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention. 28 29

Johannesburg 165 West Street, Sandton, Johannesburg PO Box 785812, Sandton 2146 South Africa Telephone +27 11 669 9000 Fax +27 11 669 9001 Cape Town SA Reserve Bank Building, 60 St George s Mall, Cape Town PO Box 248, Cape Town 8000, South Africa Telephone + 27 21 480 7800 Fax +27 21 424 1688 IN ASSOCIATION WITH COULSON HARNEY Nairobi Unit A, Nairobi Business Park, Ngong Road, Nairobi PO Box 10643-00100, Nairobi, Kenya Telephone +254 (0)20 252 7920/1 Fax +254 (0)20 253 4356 Web www.coulsonharney.com