THE NEW COMPANIES ACT

Transcription

1 21 Richefond Circle, Ridgeside Office Park, Umhlanga Ridge, Durban l Dx 50, Durban P O Box 913, Umhlanga Rocks, 4320 Tel: l Fax: Website: Circular No. 1 April 2011 THE NEW COMPANIES ACT The Companies Act 71 of 2008 (New Companies Act) will commence on 1 May This note has been prepared on the basis of the New Companies Act, as amended by the latest version of the Companies Amendment Bill and as read with the final Companies Regulations. We understand that the Companies Amendment Bill has been signed into law but as at the date of preparation of this note, have not had sight of a consolidated, final New Companies Act. The New Companies Act changes existing South African company law in a number of ways. Most notably, it enhances the rights of persons who have, to date, had limited or no protection under company law. Employees and the trade unions which represent them are among them. The New Companies Act also requires that it be interpreted and applied in a manner which gives effect to its purposes, which include the promotion of compliance with the Bill of Rights in the Constitution. Provisions in the New Companies Act which benefit stakeholders may in due course be interpreted more widely to achieve this purpose. This note focuses primarily on profit companies, including private, public, personal liability and state-owned companies. Separate notes with specific focus on close corporations, external companies and non-profit companies will be circulated in due course. Any reference in this note to the securities of a company is, amongst other possibilities, a reference to shares and debentures issued or authorised for issue by a profit company. TYPES OF COMPANIES The New Companies Act provides for all forms of companies which could be incorporated or registered under the Companies Act 61 of 1973 (Old Companies Act): - private companies; Partners: Roger Green B Com. LL.B. Alastair Hay B.Com. LL.B. Michael Posemann B.A. LL.B. Peter Nel B.A. LL.B. Dip. Tax Ian Cox B.A. LL.B. Michael Jackson B.Com. LL.B. LL.M. (Cambridge) Dip. Environ. Law Peter Feuilherade B.A. (Hons) LL.B. Dip. Insolvency Law Richard Hoal B Soc.Sc. LL.B. Dip Maritime Law Andrew Clark B.Com. LL.B. Helen Jackson B.A. LL.B. Robin Westley B Soc.Sc. LL.B. Zanokuthula Nduli LL.B. Assisted by: Victoria Stott B.Com. LL.B. Themba Zikhali LL.B. Simon Watson LL.B. LL.M. Keren Oliver LL.B. Keran Smallie B.A. LL.B. Consultant: Graham Cox B.Com. LL.B.

2 public companies; - personal liability companies (currently incorporated under section 53(b) of the Old Companies Act); - non-profit companies (associations not for gain currently incorporated under section 21 of the Old Companies Act); and - external companies. The New Companies Act has also created the new category of state-owned companies. A state-owned company is a company: - listed as a public entity in schedule 2 or 3 of the Public Finance Management Act (for example, Airports Company of South Africa and the SA Post Office Limited); or - owned by a municipality and otherwise similar to a public company described immediately above. State-owned companies are subject to the enhanced accountability requirements in the New Companies Act discussed below. However, there is scope for the exemption of any state-owned company from one or more provisions of the New Companies Act. It is interesting to note that, under the New Companies Act, private companies are not confined to having a maximum of 50 shareholders. Public companies wishing to avoid certain compliance obligations under the New Companies Act may wish to convert to private companies. AUDITING REQUIREMENTS AND FINANCIAL STATEMENTS Under the New Companies Act, it is only compulsory for the following companies to have their annual financial statements audited: - public companies; - state owned companies; - profit or non-profit companies of such significance that public interest dictates that auditing is desirable (i.e. they have a sufficiently high Public Interest Score); - profit or non-profit companies which are in the business of holding significant assets in a fiduciary capacity for unrelated persons; - certain categories of non-profit companies (the inclusion of these companies goes to the protection of public interest). A company s Public Interest Score is determined with reference to a point system set out in the Regulations. A company which, having regard to the: - average number of employees of the company during the financial year;

3 number of individuals who the company knows to have a beneficial interest in the any of the company s issued securities, directly or indirectly, as at the financial year end; - value of the turnover of the company during the financial year; and - value of the company s liability to third parties as at the financial year end, has a Public Interest Score of 350 or more points in a particular financial year, must have its annual financial statements for that financial year audited. The term beneficial interest is so broad as to include a right to receive or participate in any distribution in respect of a company s securities, including by way of ownership or even agreement. A company which, having regard to the factors set out immediately above, has a Public Interest Score of between 100 and 349 points (both inclusive), must have its annual financial statements audited only if they were internally compiled. In terms of the Regulations, annual financial statements are internally compiled unless they are prepared by an independent accounting professional on the basis of financial records provided by the company in question, in accordance with relevant financial reporting standards. In terms of the New Companies Act, any profit or non-profit company may elect to have its annual financial statements audited. This election may be made: - by the board of directors; - by way of an ordinary shareholder resolution; or - in the Memorandum of Incorporation of the company. Certain measures can be taken in the Memorandum of Incorporation of the company to restrict board and shareholder power to subject the company to the requirement that its annual financial statements be audited. All other profit and non-profit companies are required to have their annual financial statements independently reviewed. In terms of the Regulations, independent reviews must be carried out in accordance with ISRE 2400 by a registered auditor, a person otherwise in good standing with a professional body accredited in terms of the Auditing Professions Act or a person qualified to be an accounting officer of a close corporation, depending on the Public Interest Score of the company in question. The reviewer must also be truly independent of the company, in terms of personal financial interests in the company and involvement in management. The independent review of a company s annual financial statements may not be carried out by an independent professional who was involved in the preparation of those statements. Subject to two exclusions, including where the company has a sufficiently high Public Interest Score to oblige it to have its annual financial statements audited, a company whose shareholders are all also directors of the company are exempt from the requirement that its annual financial statements be audited or independently reviewed.

4 - 4 - Companies existing as at 1 May 2011 (Pre-existing Companies) which have their financial year end before 1 May 2011 may complete the publication, auditing and approval of their annual financial statements for that financial year in accordance with the requirements of the Old Companies Act. The provisions of the New Companies Act will apply to each subsequent financial year. The New Companies Act provides that if a company provides any financial statements to any person for any reason, they must conform to a number of standards set out in the New Companies Act. For example, the statements must: - satisfy the financial reporting standards designated for that type of company in the Regulations (the Regulations include a table detailing different types of companies and the financial reporting standards applicable to each); - present fairly the state of affairs and business of the company; - explain the transactions and financial position of the business of the company; and - not be incomplete in any material particular, although there is scope to provide summaries of financial statements. In addition to annual financial statements, the term financial statements includes interim or preliminary reports and financial information in a circular which an actual or prospective creditor or holder of securities may reasonably be expected to rely on. Notably, trade unions are entitled to access company financial statements for the purposes of initiating business rescue proceedings, albeit under the oversight of the Companies and Intellectual Property Commission (Commission, successor to the Companies and Intellectual Property Registration Office, but charged with a more proactive role). Business rescue is discussed later in this note. SOCIAL AND ETHICS COMMITTEES Every state owned company and listed public company is obliged to appoint a social and ethics committee. Any other company which, in any two of the previous five financial years, has attained a Public Interest Score of over 500 points, must appoint a social and ethics committee. Such companies may make application (Exemption Application) to the Companies Tribunal established in terms of the New Companies Act for an exemption (the maximum duration of the exemption is five years). In addition, subsidiaries of holding companies with social and ethics committees assuming responsibility for subsidiaries are exempt from this requirement. Pre-existing Companies which are obliged to appoint a social and ethics committee must do so within 12 months after the effective date of the New Companies Act or the date on which its Exemption Application was declined.

5 - 5 - Social and ethics committees must comprise of at least three directors or prescribed officers (executive managers, who may or may not be directors) of the company, at least one of whom must be a director who is not involved, or has not been involved for the past three financial years, in the day-to-day management of the business of the company. Members of social and ethics committees are responsible for monitoring the company s activities in relation to, amongst other things: - the company s standing in terms of the goals and purposes of the Employment Equity Act and the Broad-Based Black Economic Empowerment Act; - the company s contribution to the development of the communities in which its activities are predominantly conducted or within which its products or services are predominantly marketed; - the company s compliance with the Consumer Protection Act; and - the company s contribution toward the educational development of its employees. If a company which is obliged to appoint a social and ethics committee fails to make the appointment, the Commission may exercise powers to compel a meeting of the shareholders of the company to appoint a social and ethics committee. The directors who knowingly permitted the failure to appoint a social and ethics committee may be held liable for the cost of convening the meeting of shareholders in these circumstances. ENHANCED ACCOUNTABILITY AND TRANSPARENCY The New Companies Act contains provisions aimed, as the name suggests, at enhancing the self-regulation and accountability of certain companies (Chapter Three Provisions). The Chapter Three Provisions are binding on: - public companies; - state-owned companies; - private, personal liability and non-profit companies which are required to have their annual financial statements audited under the New Companies Act; and - private, personal liability and non-profit companies which elect, in their Memoranda of Incorporation, to abide by the Chapter Three Provisions. That said, the following obligations set out in the Chapter Three Provisions only apply to public companies, state-owned companies and companies which elect to discharge them voluntarily: - the appointment of a company secretary who or which will have broad responsibilities, including the company s compliance with relevant laws;

6 the appointment of an audit committee responsible for, amongst other things, the oversight of the appointment of auditors to carry out auditing as well as non-audit services for the company. All companies subject to the Chapter Three Provisions are obliged to appoint an auditor who or which complies with a number of requirements aimed at ensuring that the auditor is truly independent of the company. Individuals (including individuals representing an audit firm which has been appointed as auditor of a company) may not serve as the auditors or designated auditors of a company for more than five consecutive financial years, but have to be replaced at the expiry of this period. This is bound to create difficulties for audit firms seeking to maintain continuity for their clients. The obligation to rotate individual auditors or designated auditors does apply to Pre-existing Companies, but the 5 year rotation period will be calculated from 1 May Appointments made pursuant to the Chapter Three Provisions are to be made by company in annual general meeting. Whether this will compel private, personal liability and non-profit companies which are subject to the Chapter Three Provisions, to hold annual general meetings, remains to be seen. ACCESS TO INFORMATION The New Companies Act has widened the range of persons who or which have access to company records. Any person who holds a beneficial interest in any securities issued by a profit company has a right to inspect and copy: - the Memorandum of Incorporation of the company and any amendments to it; - any rules of the company; - the company s records on directors (which will include the identity or passport numbers of each director, an address for legal service of each director, as well as details concerning other directorships each director may hold); - reports presented at annual general meetings of the company; - annual financial statements; - notices and minutes of shareholder meetings; - written communications despatched by the company to holders of any class of securities; and - the securities register of the company. A person can be said to hold a beneficial interest in the securities of a company if they have a right or entitlement, through ownership, agreement, relationship or otherwise, alone or together with another person to: - receive or participate in any distribution in respect of the company s securities; - exercise or cause to be exercised, in the ordinary course, any or all of the rights attaching to the company s securities; or

7 dispose or direct the disposition of the company s securities, or any part of a distribution in respect of the securities. A beneficial interest does not include an interest held by a person in a unit trust or collective investment scheme. However, given the breadth of the definition of beneficial interest, it is arguable that the beneficiaries of an employee trust holding shares in a company will be regarded as having a beneficial interest in the securities of that company and have access to all of the information listed above. ANNUAL GENERAL MEETINGS It is no longer compulsory for private companies to have annual general meetings, although the Memorandum of Incorporation of a private company may stipulate otherwise. See also what was said above under the title Enhanced Accountability and Transparency concerning the potential for the obligation to hold annual general meetings to be extended to private, personal liability and non-profit companies which are subject to the Chapter Three Provisions. Only public companies are obliged to hold annual general meetings. As under the Old Companies Act, these must be held initially within 18 months after the incorporation of the Company and thereafter within 15 months of each previous annual general meeting, although the requirement that annual general meetings also be held within 9 months after the company s previous financial year end has fallen away. Under the New Companies Act, the business to be conducted at annual general meetings is essentially the same as that required under the Old Companies Act, except for companies which are subject to the Chapter Three Provisions and which are obliged to appoint a company secretary, an auditor and an audit committee at their annual general meeting. ANNUAL RETURNS Companies are still required to submit annual returns. Under the New Companies Act, these have to be submitted within 30 business days after the anniversary of a company s date of incorporation. Under the Old Companies Act, annual returns have to be filed by the end of the month following the month in which the anniversary of the date of incorporation of the company occurs. In terms of the New Companies Act, a company is required to designate, in its annual returns, a person responsible for the company s compliance with the accountability requirements of the New Companies Act (including obligations relating to the keeping of and granting of access to company records, the keeping of accounting records, the preparation and auditing or independent review of annual financial statements and where applicable, the Chapter Three Provisions).

8 - 8 - Companies which are obliged to have their annual financial statements audited are required to submit copies of their latest approved and audited financial statements to the Commission together with their annual return. Other companies may file a copy of their audited or reviewed annual financial statements, or a financial accountability supplement with their annual return. The required contents of financial accountability supplements will be indicated in a prescribed form yet to be made available to the public. The Regulations charge the Commission to establish a system for selecting and reviewing a sample of financial accountability supplements and financial statements filed with annual returns and empower the Commission to issue compliance notices to companies to ensure better compliance with the record keeping and financial reporting provisions in the New Companies Act. Under the New Companies Act, the Commission may deregister a company if it fails to file an annual return for two or more years in succession and, on demand by the Commission, has failed to give reasons for the failure to file the annual returns or to show satisfactory cause for the company to remain registered. The power to deregister companies because of failure to file annual returns is already exercised under the Old Companies Act, but the period during which failure will be tolerated is considerably longer (six months is the limit under the Old Companies Act). DIRECTORS The common law obligations of directors remain intact and have, to some extent, been codified in the New Companies Act. Under the New Companies Act directors are not only liable to the company for loss, damages or costs sustained by the company as a direct or indirect consequence of a breach of a director s obligation, but potentially also to any person who has suffered loss as a result of the director s contravention of the New Companies Act provisions dealing with directors duties. In addition, under the New Companies Act, any person may file a complaint with the Commission alleging that a director has acted in a manner inconsistent with the New Companies Act. Upon receiving the complaint, the Commission may investigate the complaint and effect one of a number of remedies, including the issue of a compliance notice to the director in question. Failure to adhere to a compliance notice is a criminal offence. It is important to note that, for the purposes of the New Companies Act provisions which spell out directors obligations, the term director includes alternate directors, board committee (including any social and ethics committee) or audit committee members and prescribed officers (executive managers who are not directors). The New Companies Act provides that a company may indemnify its directors in respect of liability which may arise under the New Companies Act, except where, amongst other things, liability arises from wilful misconduct or a wilful breach of trust. A company may take out insurance to cover any such indemnity. The New Companies Act provides that a director will be excused from a failure to act in the best interests of the company or to exercise due care, skill and diligence if the director:

9 took reasonably diligent steps to become informed about the matter in question; - had no material personal financial interest (and had no reasonable basis to know that any related person had a personal financial interest) in the matter in question, or disclosed any such interest in the manner prescribed in the New Companies Act; and - the director had a rational basis for believing and did believe that the decision the director made or supported was in the best interests of the company. The New Companies Act has continued a common law reprieve for directors by providing that, in exercising his or her powers and performing his or her duties, a director is entitled to rely on the performance of a number of persons including legal counsel, accountants and other professionals in relation to matters which the director reasonably believes are within that person s professional or expert competence or as to which that person merits confidence. What is said above highlights the importance, for directors, of keeping a paper trail in relation to their executive decisions. Notably, remuneration for directors for their service as directors may only be paid in accordance with a special resolution approved by the shareholders within the previous two years. This will apply to remuneration payable on or after 1 May FOUNDING DOCUMENTS Under the New Companies Act, the founding document of a company will be its Memorandum of Incorporation. The Memorandum of Incorporation will take the place of both the Memorandum of Association and the Articles of Association of the company and, in terms of the New Companies Act, will be binding: - between the company and each shareholder; - between or among the shareholders (thus settling current uncertainty as to whether the articles of association of a company are binding as between or among shareholders); - between the company and each director of the company; - between the company and each prescribed officer of the company (executive managers who are not directors); and - between the company and any other person serving as a member of a committee of the board of directors. The Memorandum of Incorporation is void to the extent that it is inconsistent with or contravenes the New Companies Act (a limited exception applies for companies subject to listing requirements or other public regulation which determines the contents of their Memoranda of Incorporation). A Memorandum of Incorporation may and should, for commercial purposes:

10 deal with matters not addressed in the New Companies Act; - alter the effect of provisions in the New Companies Act which expressly permit alteration (Alterable Provisions), such as those relating to the variation of the requirements for passing ordinary and special resolutions; - impose a more onerous standard than is provided in the New Companies Act in provisions which are not Alterable Provisions; - contain any restrictive conditions applicable to the company and any special requirement(s) for the amendment of any such condition; and - prohibit the amendment of any provision in the Memorandum of Incorporation (the presence of these final two types of provisions in a company s Memorandum of Incorporation must be indicated by the inclusion of the expression (RF) in the name of the company, which makes it crucial for other persons dealing with such a company to have sight of its Memorandum of Incorporation). A company s Memorandum of Incorporation may stipulate that a percentage higher than 50% plus one vote is required to pass an ordinary resolution of the company generally, or an ordinary resolution of the company on any particular matter(s). It may also stipulate that a percentage other than 75% is required to pass a special resolution in other words, either a higher or a lower percentage may be stipulated. There must always be 10% between the highest stipulated percentage for the passing of an ordinary resolution and the lowest stipulated percentage for the passing of a special resolution. As a result, the lowest percentage which may ever be stipulated for a special resolution is 60%. Any reference to percentage is a reference to a percentage of voting rights exercised on the resolution in question. As with Articles and Memoranda of Association, companies incorporated under the New Companies Act must file their Memoranda of Incorporation with the Commission at the time of incorporation. Any amendments to a Memorandum of Incorporation must also be filed with the Commission. The New Companies Act expressly recognises Shareholder Agreements, but provides that they are void to the extent that they are inconsistent with the New Companies Act or the Memorandum of Incorporation of the company. This is a complete change from the status quo, where most Shareholder Agreements provide that in the event of any inconsistency between the Shareholder Agreement and the Articles of Association of the company, the Shareholder Agreement will prevail. The Memorandum and Articles of Association of a Pre-existing Company are deemed to be the Memorandum of Incorporation of the company. Pre-existing Companies have two years from the effective date of the New Companies Act to align the provisions of their Memoranda and Articles of Association to the provisions of the New Companies Act. The best way to do so will be to draw up and file a complete Memorandum of Incorporation replacing the Memorandum and Articles of Association. Within this two year grace period and prior to filing a new Memorandum of Incorporation, the provisions of the company s Memoranda and Articles of Association which are in conflict with the New Companies Act will prevail to the extent of the conflict.

11 Similarly, Shareholder Agreements concluded before the commencement of the New Companies Act continue to have the same force and effect, despite any inconsistency with the company s Memorandum and Articles of Association and, when replaced, Memorandum of Incorporation, or the New Companies Act. Given the way the New Companies Act is drafted, it appears that this protection will cease as soon as the shareholders make any change to the Shareholders Agreement. Lastly, it is worth noting that the New Companies Act provides for the making of rules by the board of a company. The rules will relate to the governance of the company in respect of matters not addressed by the New Companies Act or the Memorandum of Incorporation of the company. Any rules made by the board are void to the extent that they are inconsistent with the New Companies Act or the company s Memorandum of Incorporation. They must be filed with the Commission and they will only be binding on a permanent basis once they have been ratified by the shareholders of the company. As with the Memorandum of Incorporation, the rules of the company will be binding: - between the company and each shareholder; - between or among the shareholders; - between the company and each director of the company; - between the company and each prescribed officer of the company (executive managers who are not directors); and - between the company and any other person serving as a member of a committee of the board of directors. PAR VALUE SHARES AND NON-PAR VALUE SHARES Companies incorporated under the New Companies Act may not have par value shares. It is anticipated that the authorised shares of such companies will not have a stipulated value. When shares are issued from the authorised share capital, the board of directors will issue them for adequate consideration as determined by the board at the time of issue. From the effective date of the New Companies Act, Pre-existing Companies may not authorise any new par value shares. Par value shares already issued as at 1 May 2011 continue to hold their par value. If a Pre-existing Company has an authorised class of par value shares of which none are issued (either because none have ever been issued or because any which have been issued have been re-acquired by the company), from the commencement of the New Companies Act the company may not issue any of those shares until they have been converted to shares having no par value. Conversion in these instances is simple, effected by the passing of a board resolution and the filing of a notice of that resolution with the Commission. If a Pre-existing Company has an authorised class of par value shares of which some are issued, from the commencement of the New Companies Act the company:

12 may not increase the number of authorised shares in that class; - may issue further shares in that class, until it voluntarily converts that class of shares to shares not having a par value. A voluntary conversion of par value shares to non-par value shares is effected by an amendment to the company s Memorandum of Incorporation by special resolution of the shareholders of the affected class of shares and by special resolution of the shareholders generally. A copy of the proposed resolutions and board report relating to the conversion must be filed with the Commission and the South African Revenue Service (SARS), either of which may apply to a court for a declaratory order to the effect that the proposed conversion is designed substantially or predominantly to evade tax. If the application is successful, the company will not be able to put the proposed conversion to the vote of shareholders. The Commission and SARS have a narrow window of opportunity to make such an application it must be brought before the shareholders meet to consider the proposed conversion. ISSUING SHARES Under the Old Companies Act, the power of directors to allot and issue shares is expressly subject to obtaining the prior approval of the shareholders. Approval may be general and subject to renewal at each annual general meeting of the company and may be withdrawn by the shareholders at any point. Approval may also be specific to a particular allotment or issue of shares. Under the Old Companies Act, a director who knowingly takes part in the allotment or issue of shares without shareholder approval is liable to compensate the company for any loss, damages or costs which the company may have sustained or incurred because of the unauthorised allotment or issue. Claims for such loss, damages or costs prescribe two years from the date of allotment or issue. Under the New Companies Act, directors may resolve to issue shares at any time. The only constraint on this power is that directors may only issue shares within the classes and to the extent that the shares have been authorised by or in terms of the company s Memorandum of Incorporation. The only difficulty with this is that, unless that Memorandum of Incorporation provides otherwise, the board of directors may, amongst other things: - increase or decrease the number of authorised shares of any class of shares; or - reclassify any classified shares that have been authorised but not issued, without the approval of shareholders. Depending on the requirements of the company, it will be advisable to constrain the powers of directors in relation to altering authorised share capital, given that whatever shares are authorised, may be issued by directors without prior shareholder approval.

13 A director who is present at a meeting where the board approves the issue of unauthorised shares or otherwise participates in the decision to issue unauthorised shares and fails to vote against the issue despite knowing that the shares have not been authorised, is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of that failure. Claims for such loss, damages or costs prescribe three years from the date of the failure to vote against the issue of unauthorised shares. DISTRIBUTIONS Prior to an amendment to the Old Companies Act in 1999, the only way that a company could make a payment to its shareholders was by way of a dividend declared out of profits. Section 90 of the Old Companies Act was amended in June 1999 to allow a company to make payment to its shareholders, irrespective of its profitability but provided this was authorised in terms of its Articles of Association and that the company was solvent after the payment was made. The New Companies Act allows the board of a company to make distributions to its shareholders provided the company will satisfy the solvency and liquidity test after the distribution. Distributions include the incurrence of a debt or other obligation by a company for the benefit of one or more of the holders of its shares or the forgiveness or a waiver of a debt or other obligation owed to the company by one or more of the holders of its shares. A company will satisfy the solvency and liquidity test at a particular time if, considering all reasonably foreseeable financial circumstances of the company at that time: - the assets of the company, as fairly valued, equal or exceed the liabilities of the company; and - it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months following the distribution, where the distribution is a transfer of money or property by the company, or a period of 12 months after the date on which the test is considered, in all other instances. FINANCIAL ASSISTANCE FOR THE PURCHASE OF SECURITIES Section 38 of the Old Companies Act was amended in 1999 to allow a company to provide financial assistance for the purchase of its shares or that of its holding company if the board was satisfied that subsequent to the transaction, the consolidated assets of the company exceeded its consolidated liabilities, the company was commercially solvent and the transaction was sanctioned by a special resolution. The New Companies Act carries these provisions forward and allows the company to provide financial assistance for the purchase of its own shares if this is authorised by the Memorandum of Incorporation and is

14 pursuant to a special resolution of shareholders adopted within the previous two years. In addition, the board must be satisfied that immediately after the provision of financial assistance, the company will satisfy the solvency and liquidity test (which was set out above). An additional condition has now been imposed to the effect that the board must be satisfied that the terms upon which the financial assistance is proposed to be given are fair and reasonable to the company. LOANS OR OTHER FINANCIAL ASSISTANCE TO DIRECTORS The Old Companies Act prohibited a company from making a loan to a director unless authorised by the company in general meeting. The New Companies Act now stipulates that the loan has to be approved by special resolution of the shareholders adopted within the previous two years and the board must be satisfied that immediately after providing the loan, the company will satisfy the solvency and liquidity test and the terms under which the loan is given are fair and reasonable to the company. FUNDAMENTAL TRANSACTIONS Under the Old Companies Act, mergers and acquisitions were achieved through schemes of arrangement, the sale of a business and through the sale of shares. The New Companies Act has now introduced a significant change by the adoption of a statutory merger procedure which allows companies by agreement (and with the requisite approval from their shareholders) to merge their assets and liabilities into a combined entity. This brings South Africa into line with other major jurisdictions worldwide, including the United States, France, Germany and Canada, all of whom have some form of statutory merger procedure. Chapter 5 to the New Companies Act refers to three fundamental transactions namely: - the disposal of all or the greater part of the assets of a company; - amalgamations or mergers; and - schemes of arrangement. A sale of all or the greater part of the assets of a company may not be implemented unless: - the disposal has been approved by special resolution of the shareholders; - the resolution was not opposed by at least 15% of the shareholders entitled to vote and voting on the resolution; - a notice has been given to shareholders requesting them to consider the special resolution giving details of the precise terms of the transaction; and - the assets of the company to be disposed of are fairly valued.

15 If a special resolution has been approved, then the company may not proceed to implement the resolution without the approval of a court if: - the resolution was opposed by at least 15% of the voting rights that were exercised on that resolution and, within 5 business days after the vote, any person who voted against the resolution requires the company to seek a court order for the approval of the resolution; or - any person who voted against the resolution is granted leave to apply and does apply to a court to have the transaction reviewed on the basis that it is manifestly unfair or tainted by conflict of interest, inadequate disclosure or failure to comply with the provisions of the New Companies Act. The new provisions dealing with amalgamation or merger allow two or more companies to amalgamate or merge, without having to apply to court for special sanction, if each company satisfies the solvency and liquidity test and a written agreement is concluded setting out the full details of the merger. If the board believes that the merger will satisfy the solvency and liquidity test, it then submits the merger agreement for approval by the shareholders of the amalgamating and merging companies who may approve the amalgamation or merger by special resolution. The same blocking procedures set out above apply if shareholders holding 15% or more of the voting rights exercised on the resolution, vote against the merger and a dissenting shareholder requires the company to seek court approval. Again, as in the sale of a business, regardless of whether or not the 15% threshold is reached, any shareholder who has voted against the resolution may apply directly to a court for a review of the transaction, which application the court may allow only if it is satisfied that the applicant is acting in good faith and has alleged facts which, if proved, would constitute grounds for setting aside the resolution. Once the requisite shareholder approval (and if necessary, court approval) is obtained, the parties are required before proceeding with the implementation of the merger, to notify each known creditor of each of the merging companies of the merger. Any creditor who believes that it is materially prejudiced by the merger, is entitled to apply to court within 15 business days of being notified for a review of the transaction, provided that the court is satisfied that it is acting in good faith, that they would be materially prejudiced by the merger and there are no other remedies available to it. If no creditor objects to the transaction within the requisite period, the parties may then proceed with the implementation of the merger. Upon the implementation of the merger, all of the assets and liabilities of the merging companies are transferred, by operation of law, to the merged company or companies. This is one of the key advantages of the merger procedure, meaning that companies can avoid the costs and legal formalities normally required for the transfer of a business from one entity to another, as well as the length of time it takes to transfer assets such as immovable property and intellectual property.

16 Schemes of arrangement follow the same process as sales of business and mergers and amalgamations. They now may be implemented without specific court approval and only require approval of the court if the special resolution is opposed by at least 15% of the voting rights exercised on the resolution and any person who voted against the resolution requires the company to seek court approval, or if a person who voted against the resolution makes application to court for a review of the application. It is important to note that the dissenting voters mentioned above have appraisal rights under the New Companies Act. Provided that the dissenting shareholder has given notice of its objection to the resolution in question before it is put to the vote, has voted against the resolution, has complied with various procedural requirements and the resolution to which it has objected has been adopted, the shareholder may demand that the company buy back all of that shareholder s shares in the company for fair value. In these circumstances, the company will be obliged offer to pay a fair value for the dissenting shareholder s shares (fair value having been determined by the directors of the company or a court, where the dissenting shareholder objects to the value determined by the board and applies to a court for the determination of a fair value). When the offer is accepted, the company will be obliged to pay the value stipulated in the offer for the shares. Payments pursuant to the exercise of the appraisal rights described here are not subject to satisfaction of the solvency and liquidity test. That said, a company may apply to a court varying the company s obligation to pay a dissenting shareholder pursuant to the appraisal rights provisions, if there are reasonable grounds to believe that the company will be unable to pay its debts as they fall due and payable for the ensuing 12 months if the company were to discharge its obligations pursuant to the appraisal rights provisions set out above. PROHIBITION ON TRADING RECKLESSLY The New Companies Act provides that a company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. Until recently, the New Companies Act also included a prohibition on trading in insolvent circumstances, which meant that a company could not continue to trade unless it satisfied the solvency and liquidity test. Trading under insolvent circumstances was to result in the incurrence of criminal liability, as well as liability on the part of directors for loss, damages or costs sustained by the company which continued to trade in insolvent circumstances. As it stands as at the date of preparation of this note, the New Companies Act provides that if the Commission has reasonable grounds to believe that a company is carrying on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose, or is unable to pay its debts as they become due and payable in the normal course of business, the Commission may issue a notice to the company to show cause why the company should be permitted to continue carrying on its business or to trade. In terms of the Regulations, the notice must clearly set out the grounds on which the Commission formed its belief. Should the company fail, within 20 business days, to satisfy the Commission that it is not engaging in prohibited conduct or to satisfy the Commission that it is able to pay its debts as they become due and payable in the normal course of business, the Commission may issue a compliance notice to the company requiring it to

17 cease carrying on its business or trading. It is a criminal offence to fail to satisfy a compliance notice, punishable by imprisonment of up to 12 months or a fine, or both. Alternatively, a failure to comply with a compliance notice may be met with an administrative fine of up to 10% of turnover during the period of noncompliance, or R , whichever is greater. Under the Old Companies Act, any person who is knowingly a party to the carrying on of the business of a company recklessly, may be declared by a court to be personally liable for all or any of the debts or other liabilities of the company, as the court may direct. Essentially, directors and managers of a company may be held liable for reckless trading if they incur a liability on the part of the company knowing that the company will be unable to pay that debt when it falls due. The effect of the New Companies Act, as it stands, is to make a director of a company liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director having acquiesced in the carrying on of the company s business despite knowing that it was being conducted recklessly. Presumably, the test for recklessness used under the Old Companies Act will remain. In addition, directors or managers who contravene the provision in the New Companies Act which prohibits reckless trading will be liable to any other person for any loss or damage suffered by that person as a result of that contravention (by virtue of a general provision in the New Companies Act imposing liability for contraventions of the New Companies Act). This opens the door to broader creditors claims than those catered for under the Old Companies Act. BUSINESS RESCUE PROCEEDINGS Judicial management under the Old Companies Act has given way to business rescue in the New Companies Act. Business rescue proceedings are proceedings intended to facilitate the rehabilitation of financially distressed companies. A company is financially distressed when: - it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months; or - it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months. Once business rescue proceedings have been instituted in relation to a company, amongst other things, there will be a general moratorium (prohibition) on legal proceedings against the company, the directors of the company will be subject to the authority of the business rescue practitioner appointed to supervise the company, certain contractual obligations of the company may be suspended and the rights of creditors and holders of securities of the company will be informed by the contents of a business rescue plan prepared in consultation with affected persons (defined below) and approved by the company s creditors ( creditors may

18 include employees whose wages are outstanding) and holders of securities (where the business rescue plan alters their rights). There are two ways to institute business rescue proceedings: - Firstly, the board of a company may resolve that the company be placed under supervision and commence business rescue proceedings, if the board has reasonable grounds to believe that the company is financially distressed and that there appears to be a reasonable prospect of rescuing the company. To rescue a company is, in terms of the New Companies Act, to restructure its affairs, business, property, debt and other liabilities and equity so as to maximise the likelihood of the company continuing to exist on a solvent basis or, should this not be possible, so as to result in a better return for the company s creditors and shareholders than they would receive if the company were to be liquidated immediately. Any affected person (a concept defined immediately below) may apply to court for an order setting aside a board resolution for the commencement of business rescue proceedings. - Secondly, an affected person may apply to court for an order placing the company under supervision and commencing business rescue proceedings. Such an application will suspend any liquidation proceedings which may have commenced in relation to the company until the application is dismissed or any business rescue proceedings commenced pursuant to the application have ended. Notably, an affected person includes a shareholder and a creditor of the company, as well as any registered trade union representing employees of the company and each employee of the company which is not represented by a registered trade union. Every affected person is entitled to participate in the hearing of an application described here and it follows that any affected person may oppose the application. PRELIMINARY ACTION LIST The New Companies Act is going to commence on 1 May To start getting your company s affairs in order, we recommend the following: - The entity through which you conduct business will need to be re-assessed. For example, decisions will need to be made as to whether to convert a close corporation to a company, whether to convert a public company to a private company and whether rather to trade using a trust or partnership so as to avoid extended obligations to a wider group of stakeholders and the risk of the initiation of business rescue proceedings. - Steps should be taken to obtain shareholder authorisation for directors remuneration payable after 1 May 2011.

19 Each company s Memorandum of Association and Articles of Association will need to be replaced with a Memorandum of Incorporation. This should be done as soon as possible. - Your company s Shareholder Agreement will need to be amended so that it is consistent with the Memorandum of Incorporation. - Steps should be taken to assess your company s Public Interest Score, so that you can determine whether your business is still required to be audited. - Consider whether your business is owner-managed, in other words all directors are also shareholders and eligible for an exemption from the requirement that its annual financial statements be audited or reviewed. - Consider whether your company s Public Interest Score obliges your company to appoint a social and ethics committee. - Consider whether it is feasible to re-structure your business to lower your company s Public Interest Score. - Consider who to designate in your next annual returns as the person responsible for ensuring your company s compliance with the accountability requirements in the New Companies Act. - Consider to what extent the scope of liability of your company s directors has been increased or decreased under the New Companies Act, as well as the need to obtain additional insurance, or revise the wording of any existing policy dealing with director liability. - Consider whether the new merger and amalgamation provisions may be utilised so as to effect a restructuring. - Consider whether any party would be in a position to initiate business rescue proceedings in respect of your business. - Consider whether any of your company s key suppliers may be regarded as financially distressed in terms of the New Companies Act and subject to the commencement of business rescue proceedings, since their obligation to supply may be suspended, leaving your company only with the right to assert a claim for damages against the supplier. It would be advisable to incorporate provisions in contracts with suppliers providing for the automatic termination of the agreements on the commencement of business rescue proceedings.