Company Structure and Insolvency Basics

Company Structure and Finances

• A company with 20,000 shares, valued at £1 each, exists
• The company had a cash amount, likely representing its liquid assets
• The company had issued £10,000 in debentures, secured by a bond against its assets. This means outside investors lent the company money, and the bond gave them a claim against the company's assets in case of default.

Insolvency

• The company became insolvent because it did not have enough assets to cover its liabilities, particularly its secured debt.
• Secured creditors, often those with a bond over assets, were prioritized during insolvency, leaving unsecured creditors without full payment.
• There was a legal dispute regarding a secured creditor's involvement during the insolvency process.
• The court decided that a company has a separate legal identity from its members
• The company's debts are solely the company's, and members are not personally liable for them.

Consequences of Separate Legal Identity

• A company owns its property, not the shareholders
• The company's debts are its own, not the shareholders' debts
• A company's legal identity is distinct from its physical form, it acts through agents and representatives.
• A company is a distinct entity from its members
• A company can sue or be sued in its own name
• A company has its own rights and duties
• Even if members change, the company continues to exist, this is called perpetual succession
• Only specifically appointed representatives can act on behalf of the company

Legal Personhood - Two Types

• Natural persons are human beings
• Juristic persons are legal entities separate from their members (e.g., companies, close corporations), with their own rights and duties to participate in business activities.

Gaining Legal Personhood

• A company can gain legal personality through a specific Act or through a general Act that allows for company formation
• Specific legal personhood is created directly by certain Acts
• Companies can be formed under general enabling Acts, such as the Companies Act

Examples of Separate Legal Identity

• Dadoo Ltd v Krugersdorp Municipal Council 1920 AD 550: The court ruled that a company formed by non-white individuals was a separate legal entity from its members, regardless of their race. This case demonstrated that the company's business dealings were not affected by the ethnic background of its members.
• Salomon v Salomon & Co Ltd: A significant case highlighting the legal identity of a company. Salomon, a sole proprietor, transformed his business into a company and sold it to this company. The court determined that the company was distinct from Salomon even though he owned most of the shares.

Piercing the Corporate Veil

• Courts may disregard the separate legal identity of a company in cases where a company is used to perpetrate fraud or improper conduct or when required by legislation.

Tax Purposes

• Courts may pierce the corporate veil if a company is used to avoid paying taxes.

Partnership Intention

• Erasmus v Pentamed: This case involved partners converting their partnership into a company. They later tried to exclude one partner from the directorship. The court considered if winding up the company due to perceived unfair treatment of the partner was appropriate.
• Ebrahimi v Westbourne Galleries Ltd 1973 AC 360: This case involved partners converting their partnership into a company with a third partner. Subsequently, disputes arose, with two partners intending to remove the third partner from the directorship and shareholder status. They could not agree on fees or dividends because this would make the remaining partner's shares worthless. The court determined that the shareholders initially had the right to remove a director; however, due to a breach of trust, an unfair advantage was taken of the corporate structure. The court decided to wind up the company as they were initially intended to operate as a partnership.

Note

• Courts are reluctant to pierce the corporate veil. However, cases like Cape Pacific Limited and Hulse-Reutter 2001 illustrate that specific legislative violations may lead to the corporate veil being pierced.

Piercing the Veil through Legislation

• Legislatures anticipate instances where people may exploit the separate legal identity of a corporation. These acts can preemptively pierce the corporate veil.
• This is done to penalize noncompliance with statutory obligations.
• Examples of south African legislation cited for this include sections 75, 76, and 20(9).

Types of Companies

• Profit and non-profit companies are the two primary categories of companies.

Profit Companies

• Public Companies (Ltd): These companies are not state-owned, personal liability companies, or private companies. Their shares are sold to the public, making them freely transferable. They can be listed or unlisted.
• State-Owned Companies (SOC): Controlled by the national government, these companies operate businesses without relying on tax revenue. Examples include CSIR, Aventura, SABS, and various water boards.
• Personal Liability Companies (Inc): Mostly utilized by professional associations. These companies, while having separate legal identities, hold the directors personally liable for company debts. This is stipulated in their Memorandum of Incorporation (MOI).
• Private Companies (Pty) Ltd: Public offering of shares and their transferability are restricted by the MOI. They incorporate pre-emptive rights for shareholders. Transferability is crucial. These shares cannot be transferred unless specific requirements in the MOI are met.
• Ring Fenced Companies: These are profit companies with restricted capacities, entrenched in their MOI, requiring specific procedures to make amendments.

Non-Profit Companies (NPC)

• Previously known as s 21 companies.
• A least one of their objectives must involve public benefit or cultural, social, or communal activities.
• All assets must be used to achieve these objectives, and dividend payments are not permitted.
• Members cannot benefit financially except for reasonable remuneration.
• Upon liquidation, any net value must be transferred to another non-profit company.

Disregarding Separate Existence of a Corporate Entity

• Companies lack a physical mind or body and operate through human agents like directors and shareholders.
• The question arises regarding a company's actions: Do they act through their human organs, or do individuals act in the guise of company organs for personal gain?
• Hiding behind the corporate structure is not a justifiable defense for wrongdoing
• Courts may disregard the separate legal existence of a company in specific circumstances.

Reasons for Piercing the Veil

• Public policy
• Improper use of the corporate entity

Public Policy

• Daimler Co Ltd v Continental Tyre & Rubber Co 2 AC 307:
• Two companies had a contract before a war.
• Trade between enemy countries was prohibited during the war.
• Daimler, an English company, had nearly all its shares owned by enemy aliens.
• The English company attempted to cancel the contract due to the war.
• The German company argued a company lacked ethnicity and therefore wasn't an enemy.
• The court disregarded the company's separate legal existence, concluding that the company's controller’s ethnicity should be considered in war.
• Note: This judgment is considered conflicting with other legal opinions.

Improper Use of Corporate Entity

• Robinson v Randfontein Estates GM Co Ltd 1921 AD 168:
• A company chairman (R) bought farmland with mineral rights in his personal name.
• The company struggled to agree on the purchase price.
• R sold the farm to the company for a substantially inflated price.
• R's actions were deemed a breach of trust.
• The court disregarded the subsidiary company's legal identity, focusing solely on the individual involved.
• Cattle Breeders Farm (Pvt) Ltd v Veldman 1974 (1) SA 169 RAD:
• The controlling shareholder utilized the company to evict the owner's wife from her house.
• The court disregarded the company's existence and ordered the controlling shareholder to pay damages.

Related and Inter-related Companies

• The Companies Act also covers relationships between companies and individuals, including related and inter-related persons, and control.

Control & Related Individuals

• Individual to Another Individual: Married or living in a relationship similar to marriage, or connected by two degrees of consanguinity or affinity.
• Individual to Juristic Person: The individual controls the juristic person
• Juristic Person to Another Juristic Person: One directly or indirectly controls the other, or the business of the other, or they are subsidiaries of each other, or they are controlled by a common third party.
• Controlling a Juristic Person (Company): A juristic person is a subsidiary of the company.
• Controlling a Juristic Person (Company): A person, along with related entities, controls the majority of voting rights in the company or has the right to appoint or elect directors who control a majority of the votes at a board meeting.

Legal Consequences for Groups of Companies

• Companies in a group have distinct legal identities but face specific financial reporting requirements and restrictions.
• Group annual financial statements must be prepared.
• Subsidiaries must disclose loans and security provided to the holding company.
• A subsidiary of a company can only acquire up to 10% of the holding company's shares, without voting rights attached while the subsidiary holds those.

Independent Board of Directors (BoD)

• If a subsidiary's BoD operates independently of the holding company, the holding company owes no fiduciary duty to the subsidiary.
• If not independent, the holding company does owe a fiduciary duty.

Subsidiary Director's Duty

• A director of the subsidiary company owes no fiduciary duty to the holding company.

Regulatory Requirements

• Each subsidiary must meet solvency and liquidity requirements independent of the other companies within the group structure.

Consortium of Companies

• Companies can form partnerships with other legal or natural entities known as consortia, joint ventures, or syndicates.
• This is simply a partnership between two or more companies.
• It does not result in a separate legal entity unless a separate joint venture company is established.

Transitional Provisions and CCs (Close Corporations)

• Pre-existing companies that have this type of arrangement can continue to exist.
• New registrations for companies or conversions of existing companies is no longer allowed.

Groups of Companies - Definitions

• "Group of companies": Companies linked through a holding company or subsidiary relationship.
• "Holding company": Controls the subsidiary through specific shareholder agreements.
• "Subsidiary": Defined according to section 3 of applicable legislation.

Subsidiary Relationships

• A company is a subsidiary of another legal entity if:
• The entity (including its subsidiaries or nominees) has control or can exercise a majority of the voting rights in the company due to shareholder agreements.
• The entity has the right to appoint or elect directors or control the appointment/election of directors who control the majority of votes at a board meeting.

Pre-Incorporation Agreements

• A company can ratify or reject pre-incorporation contracts within three months of incorporation.
• If the company neither ratifies nor rejects a pre-incorporation contract within three months, it is considered ratified.
• Once ratified, the company is bound by the agreement as if it existed at the time.
• Any liability of a person relative to that agreement is discharged.
• If a company rejects a pre-incorporation contract, anyone liable for that contract can claim benefits received by the company.

Common Law Methods for Pre-Incorporation Contracts

• A promoter can enter an agreement with a third party, intending it for the benefit of a future company.
• The promoter and third party act as principals.
• When the company is established, it accepts the benefit and is obligated to fulfill the promises, while the promoter is no longer involved.
• All three parties (promoter, 3rd party, and company) act as principals.
• The company doesn't need to exist when the agreement is made, but it should have an intended benefit for the company.

Pre-Incorporation Contracts: Promoters

• Promoters prepare companies for incorporation, ensuring they can function and obtain assets.
• Promoters might not want to wait to secure assets like premises until the company is formed.
• It's advisable to settle contracts before a company is incorporated to avoid complications.
• Common law states that a company gains legal personality only with the certificate of incorporation from the Registrar. This means a company cannot directly enter contracts before official incorporation.
• Promoters face a challenge as an unincorporated company cannot make contracts. In common law, a person cannot act as an agent for a non-existent principal.

Statutory Contracts

• The Companies Act (section 21) addresses this challenge.

• S21 enables promoters to act as agents for an unincorporated company and enter contracts with third parties on the company's behalf. These contracts can be ratified by the company after incorporation.

• "Ratify" means to authorize after the fact. .

• S21:*

• Individuals can enter written agreements in the name of, or purport to act for, a company that is planned to be incorporated even though the company doesn't yet exist.

• The person acting under this section is jointly and severally liable for liabilities resulting from the pre-incorporation agreement, if

• the planned company is not incorporated, or.

• if the company rejects the agreement after incorporation.

Explore the fundamentals of company structure, financing, and the intricacies of insolvency. This quiz covers key concepts such as debentures, secured and unsecured creditors, and the legal implications of a company's separate identity during financial distress. Test your understanding of how these elements interact in the context of company finances.