Corporate Finance PDF

4.1Introduction to corporate finance The term ‘corporate finance’ covers many areas. This chapter focuses predominantly on corporate finance in so far as it is relevant to company law. There is no doubt that the directors of a company have to make strategic, financing and investment decisions. In...

4.1Introduction to corporate finance The term ‘corporate finance’ covers many areas. This chapter focuses predominantly on corporate finance in so far as it is relevant to company law. There is no doubt that the directors of a company have to make strategic, financing and investment decisions. In particular, the directors need to determine: what assets are to be acquired by a company and what assets should be disposed of by a company; how assets under the control of the directors are to be financed; and how assets under the control of the directors are to be invested or utilised. All these decisions are corporate finance decisions. Various provisions of the Companies Act, 2008 have an impact on directors when they make or implement these decisions. For example, the directors may decide that the company should expand its operations, and that the funding required for such expansion will be raised through an issue of shares. The Companies Act sets out certain legal requirements and procedures that can or must be complied with before there is an issue of shares. The nature, amount, and the number of assets that a company needs obviously depend on a number of factors, including the nature and location(s) of the company’s business, the type of assets required (such as cash or plant and equipment), whether or not the business is capital intensive, and the cash-flow needs of the company in conducting its business. Once the asset needs of a company have been determined, a decision has to be made on how those assets will be financed. The Rand value of assets that a company has and needs in the future determines the level and type of financing (that is, funding) required by a company. Generally speaking, there are only two sources of funding available to the directors of a company, namely debt and/or equity. This chapter deals with those two sources of funding and with the provisions of the Companies Act in so far as they are relevant to these two sources of funding of a company’s assets. Table 4.1 below gives examples of sections of the 2008 Act that refer to securities. When the Act refers to ‘securities’, it refers to both (a) shares (including different classes of shares) and (b) debt instruments such as debentures and a company must comply with these provisions both as regards shares and as regards debt instruments. Section 1 of the Companies Act defines ‘securities’ as meaning any shares, debentures or other instruments, irrespective of their form or title, issued or authorised to be issued by a profit company. Page 85 85 Table 4.1 Sections of the 2008 Act dealing with securities Section number Topic concerning securities 42 Options for subscription of securities 43 Securities other than shares 44 Financial assistance for subscription of securities 49 Securities to be evidenced by certificates or uncertificated 50 Securities register and numbering 51 Registration and transfer of certificated securities 52 Registration of uncertificated securities 53 Transfer of uncertificated securities 54 Substitution of certificated or uncertificated securities 55 Liability relating to uncertificated securities 56 Beneficial interest in securities 4.1.1Debt Debt is money or assets obtained by a company when it does any of the following: issues debt instruments, such as (but not limited to) debentures; obtains long-term and/or short-term loans; enters into lease agreements; obtains credit terms from its suppliers, effectively allowing the company to pay in the future for goods or services already received; and obtains overdraft facilities from banks. The Companies Act, 2008 specifically deals with ‘debt instruments’,1 but the Act also indirectly deals with the incurrence of the other types of debt, for example by prohibiting reckless trading, and by imposing certain duties (and personal liability in certain circumstances) on directors.2 Thus, for example, if the assets and operations of a company are largely financed by borrowings, and a company is unable to service the interest or repay any capital relating to those borrowings, the directors may very well fall foul of certain provisions of the Companies Act, such as the prohibition against reckless trading.3 The extent to which assets will be financed by debt and/or equity is therefore a very important part of corporate finance, company law and the provisions of the Companies Act, 2008. Page 86 86 CASE STUDY: When incurring debts is reckless In Ozinsky NO v Lloyd, 4 the court held: If a company continues to carry on business and to incur debts when, in the opinion of reasonable businessmen, standing in the shoes of the directors, there would be no reasonable prospect of the creditors receiving payment when due, it will in general be a proper inference that the business is being carried on recklessly. Similarly, in Bellini v Paulsen5 the court concluded that the conduct of the defendant in this case constituted fraudulent and reckless management of the company’s affairs because the defendant knew that the company would not be able to pay its debts as and when they fell due. [T]he first defendant, with reckless disregard of his duties, allowed this situation to continue … when the plaintiff sought to exact payment from [the company] for the debt due to him … well knowing that [the company] had no assets and no way of servicing the debt. 4.1.2Equity Equity consists of shares and retained income. 4.1.2.1Shares A company can therefore obtain funding for its business operations (that is, for its assets and expenses) by issuing shares. 6 The shares in issue can have the same or different rights. In other words, a company can have shares all of the same class, or it can have different classes of shares.7 The number, nature and classes of shares are an important part of corporate finance (being a financing decision). Shares and share issues are also an important part of company law. The nature and types of shares, and share issues, are therefore dealt with in this chapter with specific reference to the provisions of the Companies Act, 2008.8 The raising of funds by way of a share issue also has a significant impact on existing shareholders: are shares being issued to outsiders (thereby diluting the interests of existing shareholders), or are existing shareholders given the opportunity to invest more funds into a company in exchange for shares (a so-called ‘rights issue’)? If existing shareholders do not take up their rights in a rights issue, their shareholding will also be diluted. Company law, including the Companies Act, has always made it very clear that the rights of shareholders are very different from the rights of creditors.9 For example, creditors10 have significant rights in business rescue proceedings, whereas shareholders have less rights, and the requirement to apply the solvency and liquidity test before certain transactions can take place is largely aimed at the protection of creditors.11 Section 22(2), inter alia, provides that if the Commission has reasonable grounds to believe that a company is unable to pay its debts as they become due and payable in the normal course of business, the Commission Page 87 87 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. It should be kept in mind that when a shareholder invests in a company, that shareholder’s rights are determined (a) in terms of a company’s MOI and (b) in terms of the rights attaching to the class of shares that have been issued to that shareholder. It is also significant that when a shareholder puts funds into a company in return for shares, those funds now become the property of the company and the shareholder then merely has the rights attaching to the shares and does not have rights to the property now held by the company. PRACTICAL ISSUE The court in Itzikowitz v Absa Bank Ltd12 emphasised that when a shareholder acquires shares in a company certain fundamental principles of company law must be kept in mind: 1.The notion of a company as a distinct legal personality is no mere technicality — a company is an entity separate and distinct from its shareholders and property vested in a company is not and cannot be, regarded as vested in all or any of its shareholders. 2.A company’s property belongs to the company and not its shareholders. 3.A shareholder’s general right of participation in the assets of the company is deferred until winding-up, and then only subject to the claims of creditors. The court stressed that the shareholder’s shares are merely the right to participate in the company on the terms of the Memorandum of Incorporation, which right remains unaffected by a wrong done to the company. Accordingly a loss suffered by a company, or a wrong committed against a company, is not a loss or a wrong to a shareholder. The court made it clear that a shareholder cannot recover damages merely because the company in which he or she has invested has suffered damage. A shareholder cannot recover a sum equal to the diminution in the market value of his or her shares, or equal to the likely diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His or her only ‘loss’ is through the company, in the diminution in the value of the net assets of the company, in which he or she has a shareholding. 4.1.2.2Retained income Retained income is also an important part of the funding of a company. This is why the ‘dividend policy’ of a company is an important corporate finance decision: instead of paying profits to shareholders by way of dividends, directors can choose to retain all or some of those profits in the business13 in order to fund operations and expansions. Of course certain shares have rights to dividends, such as preference shares, and the directors of a company would be obliged to pay these dividends in accordance with the rights attaching to those shares. However, directors need to be aware that in deciding upon a dividend policy (a financing decision) and in making investment decisions (determining how retained funds will be invested or utilised), a company needs to apply retained assets in a profitable and Page 88 88 more effective manner than the shareholders themselves would be able to do if those profits were paid to them as dividends. In this regard, directors should be mindful of the common-law and statutory duty14 to be careful, diligent and skilful, as well as the requirement that, after a dividend has been paid, a company has to be both liquid and solvent (see paragraph 4.2 below). The provisions of the Companies Act regarding the declaration and payment of dividends are discussed in this chapter, since retained profits form an important part of the equity funding of the assets of a company.15 Moreover, the Act defines ‘distribution’ as including not only dividends, but also share buybacks (s 48) and the payment of cash in lieu of issuing capitalisation shares (s 47).16 Since share buybacks and cash payments will have a direct bearing on equity and on the assets retained or paid out by a company, ss 47 and 48 are also discussed in this chapter.17 In summary, this chapter deals with debt and equity as sources of financing for a company’s operations and assets, as indicated in Table 4.2 below: Table 4.2 Sources of funding: equity and debt instruments Topic Paragraph where discussedEquity (shares and distributions) Shares as a source of finance: the nature of shares Paragraph 4.5 Authorised shares Useful disclosure? Paragraph 4.6 Content of MOI Paragraph 4.6.1 Unalterable provisions Paragraph 4.6.2 Changing authorised shares Paragraph 4.6.3 Issued shares Introduction Paragraph 4.7 Consideration Paragraph 4.7.1 Future payments Paragraph 4.7.2 Capitalisation shares Paragraph 4.7.3 When shareholder approval is required Paragraph 4.7.4 Pre-emptive rights Paragraph 4.7.5 Financial assistance for the subscription of a company’s own shares Paragraph 4.7.6 Certificated and uncertificated shares Paragraph 4.7.7 Records (securities register) and access thereto Paragraph 4.7.8 Unissued shares Paragraph 4.8 Distributions Introduction Paragraph 4.9 Requirements preceding distributions Paragraph 4.9.1 Acquisition by a company of its own shares (share buybacks) Paragraph 4.9.2 Payment of cash in lieu of the issue of capitalisation shares Paragraph 4.9.3 Topic Paragraph where discussedDebt instruments Securities other than shares (such as debt instruments) Paragraph 4.10 Page 89 89 4.2Sources of finance, nature of assets and the solvency and liquidity test The Companies Act introduces a solvency and liquidity test, 18 which must be applied and passed by a company prior to certain transactions taking place. For example, before the directors can declare a dividend they have to apply the solvency and liquidity test and confirm that the company passes this test. Similarly, the solvency and liquidity test must be applied and passed before a company repurchases any of its own shares. The introduction of the solvency and liquidity test will influence directors when making the corporate finance decisions referred to earlier in this chapter. For example, in deciding how assets and ongoing operations should be financed (that is, whether by debt and/or Page 90 90 equity), directors must be mindful of the fact that if assets and expenses are financed largely by debt, the company may fall foul of the solvency part of the solvency and liquidity test– because the company’s debts may become greater than its assets, or it may fall foul of the liquidity part of the test because it might not be able to pay the interest or capital repayments at some point in time. Problems may particularly occur when debt finance is used to fund expenses rather than assets. As mentioned earlier, if a company fails the solvency and liquidity test, it will not be able to do certain things, such as declare a dividend. This test also has a direct influence on other corporate finance decisions (the strategic, financing and investing decisions referred to above). For example, the composition of the assets of a company is an important strategic decision: how much cash should a company have in order to satisfy the liquidity part of the solvency and liquidity test? A company may very well have an excess of assets over liabilities (that is, it may be solvent), but the assets could be illiquid (not easily turned into cash) resulting in a company being unable to pay its debts in the normal course of business and thereby offending the liquidity part of the test described above.19 The test can be summarised as follows: a company is regarded as passing the solvency and liquidity test if at a particular time, considering all reasonably foreseeable financial circumstances of the company, its assets fairly valued exceed its fairly valued liabilities and it will be able to pay its debts as they become due and payable in the ordinary course of business for a period of 12 months after the date when its solvency and liquidity are tested. 4.3A new approach to capital regulation in the Companies Act One of the more significant changes brought about by the Companies Act, 2008 is a new approach to the regulation of the capital of a company. There are two important developments: 1.the virtual abolition of the capital maintenance concept; and 2.the extensive default20 powers given to directors (rather than shareholders) to determine both the authorised and issued shares of a company, and to declare dividends. 4.3.1Capital maintenance The 1973 Companies Act was originally based on the capital maintenance concept, which ensured that the contributed share capital of a company had to be maintained or preserved for a number of reasons, not least of which was the protection of creditors. The concept was based on the principle that the contributed share capital of a company was the fund, or reservoir, to which the creditors of a company could look for satisfaction of their claims. Accordingly, that fund had to be maintained. Even though the Companies Amendment Act21 relaxed many of the strict capital maintenance rules (such as on the strict prohibition on a company to repurchase its own shares), it was left to the 2008 Act to abolish the capital maintenance concept almost Page 91 91 completely, and replace it with a company law regime based on the principles of ‘liquidity and solvency’. Thus, for example, before a company can buy back its own shares (s 48), or provide financial assistance in connection with the subscription of its securities (s 44), or before the directors can propose a distribution (s 46), the liquidity and solvency test has to be applied and satisfied. Not only does the 2008 Act abolish the capital maintenance rule, but it also does not use the word share ‘capital’ and simply refers to authorised and issued ‘shares’. This may well mean that the traditional description of ‘share capital’ (both authorised and issued) in the financial statements of companies should be replaced by the description ‘authorised and issued shares’. An interesting observation regarding the abolition of the capital maintenance rule and its replacement by a liquidity and solvency test is that the 2008 Act probably protects the interests of creditors to a far greater extent than the capital maintenance rules did. While capital had to be ‘maintained’ in terms of those rules (and could not, for example, be returned to shareholders), there was no minimum level of capital that had to be provided. In the result, many companies’ assets were funded by a small nominal amount of share capital, and by very large shareholders’ loans. All that was required was for that nominal capital to be maintained, which hardly afforded creditors any protection at all. In terms of the 2008 Act, companies that are funded by large shareholders’ loans (which are obviously liabilities of the company) would mostly be insolvent in the sense that the value of their assets would be less than their liabilities, and such companies would not be able (under the 2008 Act) to declare dividends,22 buy back shares,23 or enter into other transactions that require a successful application of the solvency and liquidity test.24 4.3.2Default powers of directors Another significant change brought about by the 2008 Act in the corporate finance arena is the introduction of the so-called ‘default’ provisions of the Act (that is, the provisions that will automatically apply to a company unless altered in a company’s Memorandum of Incorporation (MOI)). These empower the board of directors (and not the shareholders) to determine a company’s authorised and issued shares, and to declare dividends. These default provisions suit ‘owner-managed’ private companies, but they will in most cases need to be altered or abolished in the MOI of a company that has a number of diverse and unrelated shareholders, especially if there are minority shareholders. Such shareholders would need to be protected, for example, from having their interests diluted as a result of the directors unilaterally deciding to increase authorised or issued shares. In terms of the 1973 Companies Act, there had to be both authorisation in the articles, and a special resolution of shareholders, before there could be any change in a company’s authorised shares. The 2008 Act therefore takes a significantly different view of this matter. 4.4The application of the solvency and liquidity test The solvency and liquidity test must be applied in each of the following circumstances: when a company wishes to provide financial assistance for subscription of its securities in terms of s 44; Page 92 92 if a company grants loans or other financial assistance to directors and others as contemplated in s 45; before a company makes any distribution as provided for in s 46; therefore, the test must be applied before dividends are declared to shareholders (s 46), as well as when there are other ‘distributions’ (as defined, see footnote 15 above) to shareholders, for example writing off a debt owing to the company by its shareholders (s 46); if a company wishes to pay cash in lieu of issuing capitalisation shares in terms of s 47; and if a company wishes to acquire its own shares as provided for in s 48; and when there are amalgamations and mergers (s 113). The Act stipulates that the requirements of the solvency and liquidity test must be met immediately after the transaction in question (i.e. the company will still be liquid and solvent after the transaction) as well as for a period of 12 months thereafter. In the case of declaring a dividend, the solvency and liquidity test must be applied twice – right after the dividend has been declared and when the dividend will be paid (and don’t forget the 12 months thereafter). It is clear from the definition of the liquidity and solvency test25 that a company satisfies the test if it is both ‘solvent’ (by reference to its assets and liabilities) and ‘liquid’ (by reference to its future cash flows). Section 4 of the Companies Act, 2008 defines the requirements of the solvency and liquidity test as follows: [A] company satisfies the solvency and liquidity test at a particular time if, considering all reasonably foreseeable financial circumstances of the company at that time— (a)the assets of the company, as fairly valued, equal or exceed the liabilities of the company, as fairly valued; and (b)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— (i)12 months after the date on which the test is considered; or (ii)in the case of a distribution contemplated in paragraph (a) of the definition of ‘distribution’ in section 1, 12 months following that distribution. PRACTICAL ISSUE What does the solvency and liquidity test involve? ‘Solvency’ refers to the situation where a company’s assets must exceed its liabilities (also known as factually solvent). The directors, therefore, have to compile a list of all the company’s assets and liabilities and determine their fair values. Any reasonably foreseeable contingent liabilities and assets must be taken into the consideration. Remember to include the company’s intellectual property or debts that have been incurred but are not yet payable, seeing that you need to consider the liquidity and solvency position for the next 12 months. For the company to be considered solvent, the total value of the assets must be worth more than the total value of the liabilities, thus resulting in a net asset position. Page 93 93 ‘Liquidity’ refers to a company’s possession of or access to cash to be able to pay its debts as and when they fall due. This is also referred to as commercial solvency (as opposed to factual insolvency referred to above). In determining if a company is liquid, a detailed cash flow forecast needs to be prepared for at least the next 12 months. Solvency and liquidity is discussed in more detail below. 4.4.1Solvency From a reading of the definition in s 4,26 it is clear that the expression ‘fairly valued’ is used with reference to both assets and liabilities. The concept of ‘value’ is obviously very different from ‘historic cost’, or ‘book value’. It may well be suggested that directors should have a separate record of all assets and liabilities indicating the respective values of those assets and liabilities. The value of an asset could of course be either higher or lower than its value as determined for financial reporting purposes, and the value of a liability could certainly be below its face value. Taking the latter as an example, if the liabilities of a company are greater than the fair value of its assets, it is submitted that the directors would be perfectly entitled, in applying the solvency and liquidity test to reduce the face value of liabilities to the recoverable amount.27 By reducing the face value of liabilities (for example, a shareholders’ loan) to its recoverable amount (i.e. by ‘impairing’ the value of a loan), the directors could in fact ensure that a company’s liabilities are no longer greater than its assets, thereby satisfying the solvency and liquidity test, thus enabling the company to do certain things, such as declaring a dividend, which it would not otherwise be allowed to do in terms of the solvency and liquidity test.28 Under the 1973 company law regime, shareholders’ loans were often ‘subordinated’ or ‘backranked’. In terms of the 2008 Act, any such subordination would not reduce the liabilities of a company, because a subordination merely back-ranks, but does not extinguish a debt. A subordination of shareholders’ loans would therefore not restore a company’s solvency as described above. There is an additional reason not to subordinate shareholders’ loans. In business rescue proceedings,29 the voting interests of a secured or unsecured creditor are determined by giving a voting interest equal to the value of the amount owed to that creditor by the company. However, a concurrent creditor with a subordinated claim has a voting interest only equal to the amount, if any, that the creditor could reasonably expect to receive in such a liquidation of the company. In other words, any shareholder who subordinates a loan account could dilute any voting interest that is exercisable in considering a business rescue plan. 4.4.2 Page 94 94 Liquidity In applying the solvency and liquidity test, it is clear that the directors will have to prepare a cash flow statement indicating future inflows and outflows. Such a cash flow statement must contain an assessment of the future level of debt and the company’s ability to settle its due debt commitments by cash as required by the section. 4.5Shares as a source of finance and the nature of shares Section 1 of the Companies Act defines ‘share’ as one of the units into which the proprietary interest in a profit company is divided. This does not mean that a share entitles the holder thereof to the assets of the company. The company itself, being a separate legal entity, owns its assets. The number of shares held by a shareholder is therefore simply an indicator of the extent to which a holder has an interest in the company itself. In Cooper v Boyes NO, 30 the court discussed the nature of a share, and held that a share represents an interest in a company, which interest consists of a complex of personal rights: a share is incorporeal movable property that gives rise to a bundle of personal rights. All the shares of the same class must have the same rights.31 It follows then that if the rights attaching to the shares of a company differ, there are different classes of shares. A share is part of the ‘securities’ of a company. The Act defines ‘securities’ as any shares, debentures or other instruments, irrespective of their form or title, issued or authorised to be issued by a profit company. This definition is important because when the Act refers to securities, it refers to both shares and debt instruments such as debentures.32 The question of what shares should be issued33 focuses on the asset requirements of a company and the extent to which such assets will be funded by equity contributors (by way of issued shares and retained income), and the extent to which the assets are to be funded by lenders and creditors. In determining what shares should be issued, and at what price, it is important for the directors to avoid the dangers of over-capitalisation and under-capitalisation, by steering a middle course between the two. Over-capitalisation arises when the amount received, or to be received,34 by a company from the issue of its shares is in excess of its requirements, as measured by the earning capacity of its assets – it is then not possible for a satisfactory return to be earned on the equity invested. Under-capitalisation, on the other hand, occurs when a company finds itself short of funds, so that its expansion is curtailed, and it cannot seize appropriate business opportunities or extend credit to customers. A realistic assessment of the equity requirements of a company for the future is therefore necessary and highly desirable. The factors to be taken into account will include some or all of the following: the nature of the business and the assets required; the risk appetite of the company (the extent to which assets should be funded by equity or by debt and borrowings); Page 95 95 the proposed outlay, if any, on capital infrastructure and expenditure; the amount of working capital required, such as the level and variety of inventories required, and the need for cash; and the availability of borrowings. 4.6Authorised, issued and unissued shares In terms of s 36 of the 2008 Act, a company’s MOI must set out a company’s authorised shares by specifying the classes of shares, and the number of shares in each class. Unlike the 1973 Act, where shares were either ‘par value’ or ‘no par value’ shares, under the 2008 Act, there are simply ‘shares’, which can comprise shares of different classes. The classes and number of authorised shares as stated in a company’s MOI are, however, not very meaningful because the amount (value) for which those shares have been or will be issued is not determined in the MOI. Moreover, the authorised shares, as disclosed in a company’s MOI, can always be increased (or decreased) at a later stage.35 And if a company issues shares that have not been authorised in a company’s MOI, or that are in excess of the number of authorised shares of any particular class, the issue of those shares may be retroactively authorised by the board (s 36),36 or by a special resolution of shareholders37 within 60 business days after the date on which the shares were issued. As opposed to authorised shares, the number of issued shares, 38 and the amount received or receivable39 from their issue is indeed useful information, because these show not only the classes of shares, but also what the company has received, or will receive,40 from such issue. Whether the company is over- or under-capitalised41 can then be assessed and rectifying measures, if any, may be taken. 4.6.1Authorised shares and the Memorandum of Incorporation The MOI must set out,42 with respect to each class of shares: a distinguishing designation for that class; and the preferences, rights, limitations and other terms associated with that class (unless these will be determined later by the board of directors).43 All of the shares of any particular class must have the same rights and limitations.44 Therefore, if there are different preferences, rights, limitations or other terms attaching to the shares of a company, that company has different classes of shares. Those with the same rights and limitations form part of the same class. The authorised shares of a company may consist of one homogeneous type of share, or of several different classes of shares, each with different rights as regards voting, sharing in the profits, and participating in new issues of capital or in the distribution of assets in the Page 96 96 event of the company being wound up. The following are the classes of authorised shares commonly encountered: ordinary shares; preference shares, which may be cumulative, non-cumulative, participating, redeemable, and/or convertible; unclassified shares (a stated number may be authorised in the MOI), which are subject to classification by the board of the company in accordance with s 36(3)(c) – this allows the board to reclassify shares into one or more existing classes of authorised shares or to increase the number of authorised shares of an existing class; and ‘blank’ shares, which are a class of shares that does not specify the associated preferences, rights, limitations or other terms of that class, and for which the board of the company must determine the associated preferences, rights, limitations or other terms, and which must not be issued until the board of the company has determined the associated preferences, rights, limitations or other terms of those shares.45 Section 37(5) provides that a company’s MOI may establish, for any particular class of shares, preferences, rights, limitations or other terms that: confer special, conditional or limited voting rights; provide for shares of that class to be redeemable or convertible; entitle the shareholders to distributions calculated in any manner, including dividends that may be cumulative, non-cumulative, or partially cumulative; or provide for shares of that class to have preference over any other class of shares with respect to distributions, or rights upon the final liquidation of the company. Moreover, s 37(6) provides that a company’s MOI may provide for preferences, rights, limitations or other terms of any class of shares of that company to vary in response to any objectively ascertainable external fact or facts. 4.6.2Entrenched rights attaching to authorised shares The Act allows for different classes of shares, which means that different rights can attach to different shares. However, the Act provides for a few ‘unalterable’ rights that attach to shares despite any terms to the contrary in the MOI. These are described below. 4.6.2.1Right to vote on proposals to amend the rights attaching to shares Section 37(3)(a) provides that despite anything to the contrary in a company’s MOI, every share issued by that company has associated with it an irrevocable right of the shareholder to vote on any proposal to amend the preferences, rights, limitations and other terms associated with that share. 4.6.2.2Right to seek relief if the rights of a shareholder are materially and adversely altered Section 37(8) provides that if a company’s MOI has been amended to materially and adversely alter the preferences, rights, limitations or other terms of a class of shares, any holder of those shares is entitled to seek relief in terms of s 164 if that shareholder: notified the company in advance of the intention to oppose the resolution to amend the [MOI]; and Page 97 97 was present at the meeting, and voted against that resolution. Section 164 gives dissenting minority shareholders a so-called ‘appraisal right’ in terms of which a shareholder may demand that the company pay the shareholder the fair value for all of the shares of the company held by that person. 4.6.2.3Rights when there is only one class of shares Section 37(3)(b) provides that if a company has established only one class of shares: those shares have a right to be voted on every matter that may be decided by shareholders of the company; and the holders of that class of shares are entitled to receive the net assets of the company upon its liquidation. 4.6.3Changes to authorised shares Unless the MOI of a company provides differently, the directors of a company can increase (or decrease) a company’s authorised shares, and make certain other changes.46 If the MOI does not allow the directors to make changes, then the shareholders’ approval will be necessary. The alteration of a company’s MOI is discussed in detail in Chapter 2 of this book.47 As far as changing the authorised shares of a company is concerned, s 36(3) provides that, except to the extent that a company’s MOI provides otherwise, the board of directors itself may do any of the following: increase or decrease the number of authorised shares of any class of shares; reclassify any classified shares that have been authorised but not issued; classify any unclassified shares that have been authorised but not issued; or determine the preferences, rights, limitations or other terms of shares in a class contemplated in s 36(1)(d). 4.7Issued shares Issued shares are those that are actually issued – that is, they are allocated to a particular shareholder or shareholders and they cease to be merely potential shares in that sense. In terms of s 221 of the 1973 Act, before directors could make a further issue of shares, over and above the shares originally allotted, they had to secure the prior consent of the company in general meeting. This consent could have been specifically related to the new issue or could have been a general approval permitting the directors to issue further shares at their discretion. Unlike the 1973 Act, the 2008 Act provides that the board itself may resolve to issue shares of the company at any time, but only within the classes, and to the extent, that the shares have been authorised by or in terms of the company’s MOI. In other words, the prior approval of shareholders is no longer required for the issue of shares (unless the company’s MOI alters this power that is automatically given to directors in terms of the Act). The issued shares may constitute a portion or the whole of the authorised shares but cannot exceed it, and, together with undistributed profits (or retained income), and other reserves, it constitutes the equity of the company for the operation of its undertaking. Page 98 98 However, if a company issues shares that have not been authorised, or shares that are in excess of the number of authorised shares of any particular class, the issue of those shares may be retroactively authorised in accordance with a company’s MOI (s 36) or by shareholders’ special resolution (s 16) within 60 business days after the date on which the shares were issued. If they are not retroactively authorised, then the share issue is a nullity to the extent that it exceeds any authorisation, and the company must return to any person the fair value of the consideration received by the company in respect of that share issue to the extent that it is nullified, together with interest in accordance with the Prescribed Rate of Interest Act.48 4.7.1Consideration for issued shares Section 40(2) of the Companies Act, 2008 provides that before a company issues any particular shares, the board must determine the consideration for which, and the terms on which, those shares will be issued. In other words, the board must decide what value the company will receive in exchange for issuing shares to the holder of those shares. In terms of s 40(1), the board of a company may issue authorised shares only: for adequate consideration to the company, as determined by the board; in terms of conversion rights associated with previously issued securities of the company; or as a capitalisation share (as contemplated in s 47). In principle, there is no reason why shares cannot be issued for cash or for assets other than cash. The consideration for the shares can also be received in the future or in terms of an agreement for future services or benefits.49 Where future benefits are not concerned, s 40(4) provides that ‘when a company has received the consideration approved by its board for the issue of any shares …, the company must issue those shares and cause the name of the holder to be entered on the company’s securities register’.50 4.7.2Issue of shares for future payments or services As has already been mentioned in this chapter, many of the sections of the 1973 Act were based on the capital maintenance principle. For example, s 92 of that Act provided that only fully paid shares could be allotted or issued.51 In terms of s 92, whatever was paid for the shares, in cash or in kind, had to be received by the company before or when it issued the shares. In Etkind v Hicor Trading Ltd, 52 the court held that an agreement that provides for a company to acquire assets by the issue of shares without or before receiving delivery of the assets was void and unenforceable because it was in breach of s 92. Section 40(5) of the 2008 Act takes a very different view, and provides that shares can be issued for future payments, future benefits or future services. Such shares are held in trust until that future event occurs. While the shares are held in trust, voting or appraisal rights are not exercisable (unless the trust deed provides differently). Page 99 99 An interesting question that arises when shares are issued for future benefits is whether or not any accounting entries could or should be passed at the time of the issue of the shares, and, if so, which accounting entries should be passed? It is submitted that since there has to be a consideration before shares can be issued,53 that consideration must be capable of being given a monetary value (even if it is present-valued), and that value must be recorded. Failure to do this could result in donations tax (except in the case of public companies, which are exempt from donations tax) because the company would then be issuing shares for no consideration. There is no doubt that a company that issues shares for future benefits acquires a right (in the form of a claim against the subscribing party), and the value of that right must be capable of determination. The other interesting point is that if the shares are issued in exchange for labour, the person who has performed (or will perform) the labour may have to include the value of the shares in his or her gross income for tax purposes.54 4.7.3Issue of capitalisation shares Section 47 of the Companies Act, 2008 provides that the board of directors may approve the issuing of any authorised shares of the company as capitalisation shares, 55 on a pro rata basis to the shareholders of one or more classes of shares. Capitalisation shares are ‘bonus shares’ issued in lieu of dividends and arise as a result of the capitalisation of the profits of the company rather than their distribution. The issue of shares by a company, even the issue of capitalisation shares, is not regarded as a distribution and is therefore not subject to the solvency and liquidity test or to the other provisions of s 46.56 It is logical that a capitalisation issue is not regarded as a distribution because the company has not distributed or paid out any asset: there is merely a reclassification of equity (that is, a transfer of retained income to issued shares). Subject to a company’s MOI, the directors, when resolving to award a capitalisation share, may resolve to permit any shareholder who is entitled to receive such an award to elect instead to receive a cash payment at a value determined by the board. The payment of cash in lieu of a dividend is regarded as a distribution and must comply with the provisions of s 46,57 which regulates the payment of distributions. This makes sense because if a shareholder chooses to receive cash instead of shares, the assets of the company are reduced by the payment made. It is also important to note that s 47 allows the shares of one class to be issued as a capitalisation share in respect of shares of another class. 4.7.4When shareholder approval is required to issue shares Section 41 of the Companies Act, 2008 requires shareholder approval (by way of special resolution) for issuing shares in certain circumstances. 4.7.4.1Issue of shares to directors and related parties Shareholder approval is required if the shares, securities, options or rights are issued to a director, future director, prescribed officer, or future prescribed officer of the company (or Page 100 100 to a person related or inter-related to the company, or to a director or prescribed officer of the company; or to any nominee of such person).58 However, shareholder approval will not be required if the issue of shares is:59 under an agreement underwriting the shares, securities or rights; in the exercise of a pre-emptive right to be offered and to subscribe shares as contemplated in s 39; in proportion to existing holdings, and on the same terms and conditions as have been offered to all the shareholders of the company or to all the shareholders of the class or classes of shares being issued; pursuant to an employee share scheme that satisfies the requirements of s 97; or pursuant to an offer to the public, as defined in s 95(1)(h), read with s 96. 4.7.4.2Issue of shares when voting power of issue will be 30 per cent or more Section 41(3) requires approval of the shareholders by special resolution if there is an issue of shares, securities convertible into shares, or rights exercisable for shares in a transaction (or a series of integrated transactions), and the voting power of the class of shares so issued will be equal to or exceed 30 per cent of the voting power of all the shares of that class held by shareholders immediately before the transaction or series of transactions. 4.7.5Pre-emptive rights Any company’s MOI can provide that, if the company proposes to issue any shares, each shareholder has the right, before any other person who is not a shareholder of that company, to be offered and, within a reasonable time to subscribe for, a percentage of the shares to be issued equal to the voting power of that shareholder’s general voting rights immediately before the offer was made. This is known as a pre-emptive right. However, the Companies Act, 2008 makes a distinction between a public (including stateowned) company and a private company with regard to pre-emptive rights. In the case of a private company, s 39 makes the right of pre-emption a default position. In other words, shareholders in a private company automatically have this pre-emptive right unless it is changed or abolished by the company’s MOI. The default position for public and state-owned companies is that the shareholders do not have this automatic right. In the case of private companies, this right does not apply to shares issued: in terms of options or conversion rights; shares issued for future services or benefits;60 or when there is a capitalisation issue. In exercising the pre-emptive right, the default position is that a shareholder of a private company may subscribe for fewer shares than the shareholder would be entitled to subscribe for under that subsection. Shares that are not subscribed for by a shareholder may be offered to other persons to the extent permitted by the company’s MOI. Page 101 101 4.7.6Financial assistance Section 44 of the Companies Act, 2008 sets out the requirements if a company provides financial assistance in connection with the issue of any of its securities.61 Compliance with these requirements is not necessary if the company is a moneylender (as part of its ordinary and primary business). The default position62 is that the board of directors may authorise the company to provide financial assistance63 subject to the following three requirements: 1.the particular provision of financial assistance is ◆pursuant to an employee share scheme that satisfies the requirements of s 97; or ◆pursuant to a special resolution of the shareholders, adopted within the previous two years, that approved such assistance either for the specific recipient, or generally for a category of potential recipients, and the specific recipient falls within that category; and 2.the board is satisfied that ◆immediately after providing the financial assistance, the company would satisfy the solvency and liquidity test; and ◆the terms under which the financial assistance is proposed to be given are fair and reasonable to the company; and 3.any conditions or restrictions respecting the granting of financial assistance set out in the company’s MOI have been satisfied. 4.7.7Certificated and uncertificated securities Any securities issued by a company must be either certificated or uncertificated.64 A certificated security is one that is evidenced by a certificate, whereas uncertificated securities are defined as ‘securities that are not evidenced by a certificate or written instrument and are transferable by entry without a certificate or a written instrument’,65 and are therefore securities that are held and transferred electronically. Securities can only be traded on the JSE if they are uncertificated.66 Section 49(3)(a) of the Companies Act, 2008 makes it clear that except to the extent that the Act expressly provides otherwise, the rights and obligations of security holders are not different according to whether they are certificated or uncertificated. Certificated securities can be converted into uncertificated securities and vice versa. If the company issues uncertificated securities, or where certificated shares are converted into uncertificated securities, a record of these securities must be kept in the prescribed form as the company’s uncertificated securities register by a participant or central securities depository.67 This register must contain the same information required in the case of certificated securities. This register forms part of the company’s securities register. Page 102 102 A central securities depository is licensed68 to operate the electronic system for the holding and transfer of uncertificated securities. The current licensee is Strate Ltd (the acronym ‘Strate’ is derived from Share TRAnsactions Totally Electronic). Only ‘participants’ can liaise with Strate directly. Persons trading in uncertificated securities and their brokers must therefore work through a participant.69 A participant is a person who administers securities and who has been accepted as a participant by a central securities depository.70 Currently, six CSD participants have been accepted by Strate. Five of them of them are banks and the other is Computershare. Of these, only Computershare currently offers investors the option of holding the securities in their own name. The others make all registrations in the name of their nominee companies. 4.7.8Records of issued shares Section 24 of the Companies Act, 2008 requires every company to maintain certain specific records. All of a company’s accounting records must be kept at, or be accessible from, the registered office.71 A company must notify the Commission of the location of, or any change in the location of, any company records that are not located at its registered office. As far as issued shares are concerned, s 24(4) provides that every company must maintain a securities register or its equivalent, as required by s 50, in the case of a profit company, or a member’s register in the case of a non-profit company that has members. The register reflects the names of the current holders of shares and other securities. In practice, there is also extensive use of nominees, and this means that the registered holder is often not the beneficial holder of the rights pertaining to the securities. Therefore, where there is a nominee holding shares in a public company, details of the beneficial owner must also be disclosed by the nominee and given to the company. The total number of securities held in uncertificated form must also be entered in the securities register.72 The securities register is proof of the facts recorded in it, in the absence of evidence to the contrary. In terms of s 26, both shareholders and non-shareholders have the right to inspect the securities register in the manner provided for in that section. CASE STUDY: Entitlement to access securities registers In Basson and Another v On-point Engineers (Pty) Ltd, 73 the applicants were members of the media who had sought access to the respondents’ registers to establish the shareholding of each of the respondents so that they could establish who benefitted from the state tenders that were awarded to the respondents. The court held that if there was any doubt as to whether the applicants were in terms of s 26(6) entitled to access the securities registers of the applicants then the court had to adopt an interpretation of s 26(6) which best promoted the spirit, purport and objects of the Bill of Rights as set out in s 39(2) of the Constitution. The court referred to previous cases where it has been held that s 113 of the 1973 Act did not oblige a person requesting information to provide motivation for doing so, and a person who seeks to inspect the register need not give Page 103 103 reasons for doing so. The court referred to the case of La Lucia Sands Share Block Ltd v Barkhan74 where the court states: In a constitutional state in which freedom of association and access to information are valued, courts should be slow to make orders that have a limiting effect. It bears repeating that in terms of s 113(3) of the Act a failure to comply with a legitimate request for access to the register of members renders a company, and every director or officer who knowingly is a party to the refusal, guilty of a criminal offence. Similarly, the court held that in this case s 26(9) makes it an offence not to accommodate any reasonable request for access to any record in terms of s 26 or s 31. The court therefore concluded that all three respondents had to provide copies of the securities register or allow the inspection thereof. Section 37(9) provides that a person acquires the rights associated with any particular securities of a company: when that person’s name is entered in the company’s certificated securities register; or as determined in accordance with the rules of the central securities depository, in the case of uncertificated securities. A person ceases to have the rights associated with any particular securities of a company: when the transfer to another person, re-acquisition by the company, or surrender to the company has been entered in the company’s certificated securities register; or as determined in accordance with the rules of the central securities depository, in the case of uncertificated securities. 4.8Unissued shares As the name implies, unissued shares are those shares that have been authorised but not yet issued. The default position (unless altered in a company’s MOI) is that directors have the power to reclassify authorised yet unissued shares from shares of one class to shares of another, and to increase or to decrease such authorised shares.75 4.9Distributions The word ‘distribution’ is very broadly defined and means the transfer of both cash and other assets by a company to its own shareholders or to the shareholders of any company within the same group. Such transfer can be in any of the following ways: by way of a dividend; as a payment in lieu of a capitalisation share; as payment for any share buyback (such shares can be the company’s own shares, or those of a company within that group of companies); by the company incurring a debt or other obligation for the benefit of one or more of its shareholders, or shareholders of another company within the same group of companies; or Page 104 104 by the forgiveness or waiver by a company of a debt or other obligation owed to the company by its own shareholders or shareholders of another company within the same group of companies. Specifically excluded from the definition is any action taken upon the final liquidation of a company. The definition of ‘distribution’ is also broadened by s 37(5)(b), in terms of which a company’s MOI can provide for redeemable shares of any class. However, any redeemable shares are also subject to the requirements of s 46 (on distributions), even though a share redemption is not regarded as a share buyback.76 In summary, a share redemption is regarded as a distribution that must comply with the provisions of s 46. This means that, even though a redemption is pursuant to an obligation of the company, before the redemption can take place, the solvency and liquidity test must be applied and passed in the same way that must happen for any other distribution. The difference between a redemption and a share buyback is that a company is not compelled to buy back its own shares, whereas in the case of a redemption there is an obligation on the company to buy back the shares in terms of the rights of shareholders attaching to the shares at the time of issue. 4.9.1Requirements preceding any distribution Section 46 of the Companies Act, 2008 is titled ‘Distributions must be authorised by board’. It states that a company must not make any proposed distribution unless the following requirements have been complied with: the distribution is either pursuant to an existing legal obligation of the company, or a court order; or the board of the company, by resolution, has authorised the distribution; and it reasonably appears that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution; and the board has by resolution acknowledged that it has applied the solvency and liquidity test, and reasonably concluded that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution. If a distribution takes the form of the incurrence of a debt or other obligation by the company, the requirements set out above: apply at the time that the board resolves that the company may incur that debt or obligation; and do not apply to any subsequent action of the company in satisfaction of that debt or obligation, except to the extent that the resolution, or the terms and conditions of the debt or obligation, provide otherwise. It is clear that the solvency and liquidity test must be applied even if the distribution is pursuant to a court order. The section therefore provides that if the company fails to satisfy the solvency and liquidity test and accordingly cannot comply with a court order: the company may apply to a court for an order varying the original order; and the court may make an order that it must be just and equitable, having regard to the financial circumstances of the company; and Page 105 105 ensure that the person to whom the company is required to make a payment in terms of the original order is paid at the earliest possible date compatible with the company satisfying its other financial obligations as they fall due and payable. 4.9.2Share buybacks The definition of ‘distribution’ in s 1 makes it clear that a share buyback is regarded as a distribution to shareholders in the same way that a dividend is regarded as such.77 A share buyback is the acquisition by a company of its own shares. Section 48 of the Companies Act, 2008 provides that the board of a company may determine that the company will acquire a number of its own shares provided that certain requirements are complied with. The section also acknowledges that a share buyback can also be pursuant to an existing legal obligation of the company, or a court order. The board must, however, acknowledge by resolution that it has applied the solvency and liquidity test,78 and that it has reasonably concluded that the company will satisfy the solvency and liquidity test immediately after completing the proposed buyback. When a company’s own shares are acquired by a company in terms of a dissenting shareholder’s appraisal rights,79 this is not regarded as a share buyback, and therefore the application of the solvency and liquidity test as provided for in s 48 does not apply to such acquisitions. An unalterable provision of the Act is that a company may not acquire its own shares, and a subsidiary of a company may not acquire shares of that company, if, as a result of that acquisition, there would no longer be any shares of the company in issue other than: shares held by one or more subsidiaries of the company; or convertible or redeemable shares. In terms of s 48(8), if any shares are to be acquired by a company from a director or prescribed officer of the company, or a person related to a director or prescribed officer of the company, a decision by the board to buy back such shares must be approved by a special resolution. Section 48(8) also provides that if the share buyback, either alone or together with other transactions in an integrated series of transactions, involves the acquisition by the company of more than 5 per cent of the issued shares of any particular class of the company’s shares, the requirements of ss 114 and 115 must be complied with. These sections deal, inter alia, with schemes of arrangement, and, generally speaking, require a special resolution of shareholders as defined in those sections. 4.9.3Cash in lieu of capitalisation shares The board of directors can decide to offer to award a cash payment in lieu of a capitalisation share, 80 but may only do so if: the board has considered the solvency and liquidity test, as required by s 46, on the assumption that every such shareholder would elect to receive cash; and the board is satisfied that the company would satisfy the solvency and liquidity test immediately upon the completion of the distribution. Page 106 106 The taking of cash instead of shares does properly constitute a distribution, because if a shareholder chooses to receive cash instead of shares, the assets of the company are reduced by the payment made by the company to the shareholder. It is also important to note that s 47 allows the shares of one class to be issued as a capitalisation share in respect of shares of another class. 4.10Debt instruments The 1973 Act81 makes extensive reference to and provision for debentures, whereas the 2008 Act adopts a more modern approach when it comes to debt arrangements. The 2008 Act uses the term ‘debentures’ but does not define it. Instead it uses the expression ‘debt instrument’, which allows the company and a creditor to be flexible in contractually entering into a specific debt arrangement that suits each other’s needs. A debenture is thus merely one form of debt instrument. As already discussed,82 a share is part of the securities of a company. The Act defines ‘securities’ as any shares, debentures or other instruments, irrespective of their form or title, issued or authorised to be issued by a profit company. This definition is important because when the Act refers to securities, it refers to both shares and debt instruments such as debentures.83 A company must include its debt instruments in its register of issued securities.84 A debt instrument is defined85 as ‘including any securities other than the shares of a company …, but does not include promissory notes and loans’. Every security document must clearly indicate, on its first page, whether the relevant debt instrument is secured or unsecured. Section 43(2) is an alterable provision and provides that the board of a company may (without consulting shareholders) authorise the company to issue a secured or unsecured debt instrument at any time. But the contents of a company’s MOI might abolish or curtail this power or provide for other requirements. Another default position, capable of being altered by the provisions of a company’s MOI, is that any debt instrument issued by the company may grant special privileges regarding the following: attending and voting at general meetings; the appointment of directors; or the allotment of securities, redemption by the company, or substitution of the debt instrument for shares of the company, provided that the securities to be allotted or substituted in terms of any such privilege, are authorised by or in terms of the company’s MOI. A debt instrument may therefore have a number of rights attached to it. Although not a share, it may have any number of the rights that usually attach to shares, such as voting rights. While the 2008 Act does not specifically deal with debentures, it has been pointed out86 that the nature of a debenture, the various rights that might attach to a debenture, and the methods by which a debenture may be secured (for example, over property) are still governed by the common law and certain statutes such as the Deeds Registries Act.87 Page 107 107 THIS CHAPTER IN ESSENCE 1.The Companies Act, 2008 has an impact on a company’s corporate finance decisions – that is, what assets to acquire and retain, and how to finance and invest such assets. 2.The financing of a company’s assets is generally sourced from debt and/or equity. 3.Debt may take the form of: debt instruments (such as debentures); loans; lease agreements; credit terms; and overdraft facilities. 4.Equity consists of shares and retained income. 5.A company may issue shares in return for assets with which to fund the company’s operations. The shares of a company may have the same or different rights – that is, they may be of the same or different classes of share – but all entitle the holder to a defined interest in the company, as set out in the company’s Memorandum of Incorporation (MOI). 6.Retained income, which implies a decision by the company to retain profits for future operations rather than to pay out a dividend, is a further form of funding for the company. 7.The 2008 Act gives the directors of a company certain default powers previously enjoyed by the shareholders – namely, the power to determine a company’s authorised and issued shares and to declare dividends. Such powers may be altered in the company’s MOI. 8.The 2008 Act abandons the priority given to the principle of capital maintenance in the 1973 Act and embraces the solvency and liquidity test in its place as a more flexible and better protection for creditors. A company is solvent if its assets equal or exceed its liabilities, and it is liquid if it is able to pay its debts. 9.The introduction of the solvency and liquidity test affects corporate finance decisions: too much debt finance could result in a failure to meet the solvency requirements of the test; too little cash in the asset make-up could negatively affect liquidity. 10.The solvency and liquidity test must be applied: when a company wishes to provide financial assistance for subscription of its securities in terms of s 44; if a company grants loans or other financial assistance to directors and others as contemplated in s 45; before a company makes any distribution as provided for in s 46; if a company wishes to pay cash in lieu of issuing capitalisation shares in terms of s 47; and if a company wishes to acquire its own shares as provided for in s 48. 11.The securities of a company are made up of its shares and debt instruments. 12.A company’s MOI must set out its authorised shares by specifying the classes and numbers of authorised shares. Unless the MOI provides otherwise, the directors may make changes to the company’s authorised shares. However, it is more meaningful to note the number of issued shares and the value received or receivable from their issue in order to assess whether a company is under- or over-capitalised. 13.Classes of authorised shares include: ordinary shares; preference shares; unclassified shares; and blank shares. Page 108 108 14.A company’s MOI may provide for any particular class of share to have particular preferences, rights or limitations. However, the 2008 Act provides that certain rights attaching to shares are unalterable by the MOI. These include rights: to vote on proposals to amend the rights attaching to shares; to seek relief if the shareholder’s rights are materially and adversely altered; and in the case when there is only one class of shares. 15.Before issuing shares, directors must determine the consideration to be received by the company in return for the issue of shares. Shares may be issued in return for future payments, benefits or services in terms of the 2008 Act. 16.Authorised shares may be issued as capitalisation shares – that is, in lieu of a payment of dividends. 17.The issue of shares generally requires shareholder approval in the following circumstances: if issued to directors and prescribed officers of the company, or to persons related to or nominees of such persons; and when the voting power of the issue will be 30 per cent or more of the total voting power of all the shares of that class. 18.A company’s MOI may provide for shareholders to enjoy pre-emptive rights – that is, upon the issue of any new shares of the company, existing shareholders may have the right before any other person to subscribe for a percentage of the shares to be issued equal to the existing voting power of the shareholder’s general voting rights. In the case of private companies, shareholders enjoy pre-emptive rights by default, whereas this is not the case for public companies. 19.A company may offer financial assistance to persons wishing to subscribe for its securities, provided: the assistance is pursuant to an approved employee share scheme, or an approved special resolution of the shareholders; and  the board is satisfied that the requirements of the solvency and liquidity test are met, and that the terms of the assistance are fair and reasonable; and any relevant conditions in the company’s MOI are met. 20.Securities of a company may be certificated or uncertificated and may be converted from the one form to the other. Only uncertificated securities can be traded on the JSE. 21.Every company must keep a securities register reflecting the names of the current holders of shares and other securities and the number of shares held in uncertificated form. Shareholder and non-shareholders alike have the right to inspect the securities register. 22.Unissued shares are those that have been authorised but not yet issued. 23.A distribution is a transfer of cash or assets to shareholders and may take the form of: a dividend; a payment in lieu of a capitalisation share; a payment for a share buyback; a debt incurred for the benefit of one or more shareholders; a waiver of a debt owed to a shareholder; or a share redemption. 24.Debt instruments are securities other than shares of the company and include debentures. A debt instrument may have a number of rights attached to it, such as voting rights. 5.1Introduction and definitions A company is an artificial person and therefore has no physical existence. It acts through: (a) its shareholders in a general meeting; and (b) its directors, its managers, and/or its employees. Exactly who acts in respect of a particular matter is determined by a number of factors, not least of which are the provisions of the Companies Act, 2008 and a company’s own Memorandum of Incorporation (MOI). There are many sections of the Companies Act that refer to the ‘shareholders’ of a company, including the following: section 35: Legal nature of company shares and requirement to have shareholders; section 36: Authorisation for shares; section 38: Issuing shares; and  section 50: Securities register and numbering. Section 36 provides that a company’s Memorandum of Incorporation must set out the classes of shares, and the number of shares of each class, that the company is authorised to issue, and s 50(2) of the Companies Act provides that as soon as practicable after issuing any securities a company must enter or cause to be entered in its securities register certain information. In terms of s 26(1) of the Companies Act, a person who holds or has a beneficial interest in any securities issued by a profit company has a right to inspect and copy the information contained in certain records of the company, including the securities register of a profit company, or the members register of a non-profit company that has members. In terms of s 26(2), outsiders also have a right to inspect the securities register of a profit company, or the members register of a non-profit company that has members. CASE STUDY: Right of access to the securities register of a company In Nova Property Group Holdings Ltd v Cobbett, 1 the respondents had attempted to exercise their statutory right in terms of s 26 to access the securities registers of the appellants. The one respondent had sent requests to the appellants for access to their securities registers and to make copies thereof, in terms of s 26(2). He delivered a request for access to information in the form required by the Companies Regulations, 2011 for this purpose. When the respondent’s requests were met with refusals, an application was launched to compel the appellants to provide access to it for inspection and making copies of the securities registers within five days. This issue in this case concerned the proper interpretation of s 26(2) and whether it confers an unqualified right of access to the securities register of a company contemplated in the section. The appellants argued that s 26(2) only confers a qualified right of access because access may be refused: (a) on the grounds set out in the Promotion of Access to Information Act (‘PAIA’); and (b) on the grounds of the ‘motive’ of the requester. On the other hand, it was argued that that s 26(2) gives an unqualified right to any person who meets the procedural requirements of s 26(2). The court stated that the role that companies play in society, and their obligations of disclosure that arise from the right of access to information in s 32 of the Constitution, is central to the interpretation of s 26(2) of the Companies Act. The court stated that both the Supreme Court of Appeal and the Constitutional Court have recognised that the manner in which companies operate and conduct their affairs is not a private matter. Page 111 111 The court in this case stated that this approach has been repeatedly endorsed. This passage in Bernstein was cited in La Lucia Sands Share Block Ltd v Barkhan2 in dealing with s 113 of the 1973 Companies Act, the predecessor to s 26 of the 2008 Companies Act. The court referred to the judgement in Company Secretary of Arcelormittal South Africa v Vaal Environmental Justice Alliance3 where the Appeal Court emphasised that ‘citizens in democracies around the world are growing alert to the dangers of a culture of secrecy and unresponsiveness, both in respect of government and in relation to corporations’ and that Parliament, driven by constitutional imperatives, had rightly seen fit to cater for this in its legislation. The court held that the 2008 Companies Act gives specific recognition to a culture of openness and transparency in s 7, which lists the core objectives of the Act. Section 7(b)(iii), in particular, provides that a purpose of the Act is to: … [encourage] transparency and high standards of corporate governance as appropriate, given the significant role of enterprises within the social and economic life of the nation. The court held that s 26 is enacted with precisely these objectives in mind. It recognises that the establishment of a company is not purely a private matter and may impact the public in several ways. It therefore seeks to impose strong rights of access in respect of very specific but ultimately limited types of information held by companies. Section 26 must, therefore, be interpreted in accordance with this purpose. Section 26(1) confers a right of access to information in respect of various kinds of information on a person who holds a beneficial interest in any securities issued by a profit company, or who is a member of a non-profit company. Section 26(2) then confers a narrower and more specific right of access on all others persons. The SCA stated that, notwithstanding the above, and the clear wording of s 26(4) and s 26(7) of the Companies Act, the appellants placed considerable reliance on PAIA contending that they were entitled to argue that the refusal of access to the appellants ‘is justified on the basis of the provisions of s 68(1) of PAIA’. In terms of s 68(1) of PAIA, access to a record of a company may be refused if the record: (a)contains trade secrets of the [company]; (b)contains financial, commercial, scientific or technical information, other than trade secrets, of the [company], the disclosure of which would be likely to cause harm to the commercial or financial interests of the [company]; (c)contains information, the disclosure of which could reasonably be expected; will put the [company] at a disadvantage in contractual or other negotiations; or will prejudice the [company] in commercial competition. The court held that securities registers quite clearly do not contain information of the nature contemplated in s 68(1) of PAIA, and access cannot possibly be refused by the appellants on that basis. Furthermore, the appellants had contended that the right of access in s 26(2) must be qualified by, and subject to, the provisions of PAIA, and that the person requesting the information must demonstrate that the information is required for the purpose of exercising or protecting a right. The court held that it is not clear how this requirement can be imported into s 26(2) without doing violence to a right which is expressly intended by the legislature to be unqualified. Moreover, the appellants failed to explain how this reliance on PAIA can be sustained in light of the clear Page 112 112 language of sub-ss 26(4) and 26(7). Accordingly, the court concluded that the appellants’ reliance on PAIA was unsustainable. In this regard, the court said that legislative history: … demonstrates a clear intention on the part of the Legislature to provide that the right under s 26(2) can be exercised independently of PAIA, and that a company cannot require disclosure of the reason for the request to access the securities register of a company – as the right is unqualified.4 The appellants had also contended that an unqualified right of access to a company’s securities register would constitute a violation of a shareholder’s right to privacy in terms of s 14 of the Constitution, and that the rights of access to information and freedom of expression must be weighed against this right as no right is absolute. The appellants contended that information contained in a private company’s securities register is information of a personal nature as it will contain names and identities of individuals, and their home and work addresses. In addition, they contended that, depending on the nature of the company, it may also expose their business affiliations, how wealthy they are, and what their political, moral and religious leanings are. The contention thus advanced was that a company’s securities register contains information of a sensitive nature that may reveal deeply private matters about shareholders in a particular company which, in the hands of the wrong people, may be open to abuse. The court disagreed with this argument for various reasons, including because the privacy and dignity rights of shareholders are minimally implicated in the right of access conferred by s 26(2). It is a narrow right of access, which is limited to securities registers and directors’ registers of companies, that is contemplated in the section. A shareholder in a company is only required to provide his or her name, business, residential or postal address, an email address if he or she elects to do so, and an identifying number that is unique to him or her. 5.1.1Can shareholders act in respect of company matters? Certain provisions of the Companies Act are ‘unalterable’ in the sense that a company’s MOI cannot abolish or modify those provisions. These unalterable provisions include sections that impact on who may act on behalf of a company. The Act confers powers exclusively on shareholders in respect of certain decisions and transactions: for example, s 71(1) is unalterable and enables shareholders to remove a director at any time by ordinary resolution. This section therefore entrenches the rights of shareholders in this matter5. It is essential to know which provisions of the Act are ‘alterable’ and which are not, because certain provisions of the Act will automatically apply unless they are abolished or altered by a company’s MOI. An in-depth awareness of the provisions of both the Act and of a company’s MOI is therefore essential in determining who can act in respect of a particular matter, and the requirements that must be met before certain transactions can be carried out. The Companies Act, 2008 specifically provides that before certain transactions can take place, they must be approved by shareholders, either by way of special or ordinary resolution. Thus, for example, s 41 of the Act provides that an issue of shares to certain persons in certain circumstances can only take place if approved by special resolution of the shareholders of Page 113 113 a company.6 Another example is s 66(9), which provides that remuneration (directors’ fees) can only be paid to directors in accordance with a special resolution of shareholders.7 However, the Act gives great flexibility when it comes to what is meant by an ‘ordinary’ and a ‘special’ resolution because it allows a company’s MOI to change the default position. The MOI may provide that a ‘greater’ percentage than the default 50,1 per cent of the vote is required for an ‘ordinary’ resolution, and the MOI may allow for a ‘different’ percentage from the default 75 per cent required for a ‘special’ resolution.8 Moreover, the Act allows an ordinary or special resolution to be defined differently for different transactions. A company’s own MOI can also restrict the powers of directorsto act in respect of a particular matter, and an MOI can, for example, provide that certain transactions have to be pre-approved by shareholders, either by way of ordinary or special resolution. For example, s 46 requires a distribution (for example, a dividend) to be authorised by the board of directors (not by shareholders) but a company’s MOI can provide that before a dividend can be paid, it must also be approved by shareholders. Moreover, note that s 15(2)(a)(iii) provides that the MOI of a company may include any provision imposing on the company a higher standard, greater restriction, longer period of time or any similarly more onerous requirement, than would otherwise apply to the company in terms of an unalterable provision of the Act.9 5.1.2Definitions of ‘shareholder’, ‘share’, ‘securities’ and ‘shareholders’ meeting’ A shareholder is defined in s 1 of the Act as the holder of a share issued by a company and who is entered as such in the certificated or uncertificated securities register of the company.10 For the purposes of Part F of Chapter 2 of the Act,11 (for example, for the purposes of a shareholders’ meeting) ‘shareholder’ means a person who is entitled to exercise any voting rights in relation to a company, irrespective of the form, title or nature of the securities to which those voting rights are attached. CONTEXUAL ISSUES Structure of Part F of Chapter 2 of the Companies Act, 2008 As far as shareholders are concerned, Part F of the Companies Act deals with the governance of companies as follows: section 58: Shareholder right to be represented by proxy; section 59: Record date for determining shareholder rights; section 60: Shareholders acting other than at a meeting; Page 114 114 sections 61 to 64: Shareholders’ meetings, notice of meeting, conduct of meetings, quorum; and section 65: Shareholder resolutions. A ‘share’ is part of ‘the securities’ of a company. The Act defines ‘securities’ as any shares, debentures or other instruments, irrespective of their form or title, issued or authorised to be issued by a profit company. This definition is important because when the Act refers to ‘securities’, it refers to both shares and debt instruments (such as debentures). In terms of s 1 of the Act, share means one of the units into which the proprietary interest in a profit company is divided. The phrase ‘shareholders meeting’, in relation to a particular matter concerning the company, is defined as a meeting of those holders of a company’s issued securities12 who are entitled to exercise voting rights in relation to that matter. This means, for example, that for the purposes of a ‘shareholders’ meeting’, a ‘shareholder’ could include the holder of a debt instrument who has been granted special privileges in the form of voting rights in terms of the rights attaching to that debt instrument.13 Shareholders, as shareholders, do not generally have any duties towards the company, but they may have duties or obligations towards one another in terms of a shareholders’ agreement 14. Perhaps the one significant duty on a shareholder in terms of the 2008 Act is the duty to abide by the terms and provisions of a company’s MOI. CASE STUDY: Relationship between shareholders In Hulett v Hulett, 15 three people created a small domestic company for a business purpose in which they were co-directors, with equal loan accounts, and in which they personally or in a representative capacity had equal shareholdings. The court stated: It is true that in some small domestic companies the association between the shareholders and directors may be purely commercial. However, in the case under consideration this was manifestly not the situation … The evidence adduced on behalf of the appellants shows that the pre-existing personal bonds of mutual trust and confidence between the members … were imported into and sustained within the company. Apposite here is the reminder by Lord Wilberforce in Ebrahim v Westbourne Galleries Ltd AC H 360 (HL) at 379 b–c ( 2 All ER 492 (HL) at 500 a–b) that a limited company is not merely a legal entity, and ‘… that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure.’ The court thus concluded that the relationship existing internally between the shareholders was one that could be loosely described as a ‘quasi-partnership’ and that ‘in the present case nobody appreciated better than the defendant himself that during the continuance of a partnership one partner may not overreach his fellow-partners’. Page 115 115 5.1.3Shareholders and the issuing of shares In terms of s 221 of the 1973 Companies Act, before directors could make a further issue of shares, over and above the shares that were already issued, they had to secure the approval of the shareholders of the company in general meeting. This consent could have been specifically related to the new issue or could have been a general approval permitting the directors to issue further shares at their discretion. In terms of s 36 of the 2008 Act, however, the board itself may resolve to issue shares of the company at any time, but only within the classes, and to the extent that the shares have been authorised by or in terms of the company’s MOI. In other words, the prior approval of shareholders is no longer required for the issuing of shares. Section 36(3) specifically provides that except to the extent that a company’s MOI provides otherwise, the board of directors may do any of the following: (a)increase or decrease the number of authorised shares of any class of shares; (b)reclassify any classified shares that have been authorised but not issued; (c)classify any unclassified shares that have been authorised as contemplated in subsection (1)(c), but are not issued; or (d)determine the preferences, rights, limitations or other terms of shares in a class contemplated in subsection (1)(d). Section 36 is therefore an alterable provision that, if not altered, basically permits directors to both authorise and issue shares without reference to the body of shareholders. PRACTICAL ISSUE When shareholder approval is required for an issue of shares Section 41 requires shareholder approval (by way of special resolution) for issuing shares in certain circumstances. Shareholder approval is required if the shares, securities, options or rights are issued to any of the following: a director;  future director; prescribed officer; future prescribed officer of the company; and to a person related or inter-related to the company, or to a director or prescribed officer of the company or to any nominee of such person. In terms of s 41(2), however, shareholder approval will not be required if such issue is: (a)under an agreement underwriting the shares, securities or rights; (b)in the exercise of a pre-emptive right to be offered and to subscribe shares, as contemplated in section 39; (c)in proportion to existing holdings, and on the same terms and conditions as have been offered to all the shareholders of the company or to all the shareholders of the class or classes of shares being issued; (d)pursuant to an employee share scheme that satisfies the requirements of section 97; or (e)pursuant to an offer to the public, as defined in section 95(1)(h), read with section 96. Page 116 116 5.2General comments regarding meetings The following important principles apply to shareholders’ meetings: Before a meeting of shareholders16 can be held, it has to be properly called and convened. A meeting is properly convened if the prescribed notice for convening the meeting was given by persons who have the relevant authority to convene the meeting. Notice convening a meeting must be given to all persons who are entitled to receive notice of the meeting. A meeting must be convened for a time, date and place that are accessible to the shareholders of the company. A meeting may commence only if a quorum is present. A quorum is the minimum number of members who have to be present at the meeting before the meeting can commence. 5.3Record date Section 1 of the Act defines the term ‘record date’ as ‘the date … on which a company determines the identity of its shareholders and their shareholdings for the purposes of this Act’.17 The record date is therefore important because it is the date that determines shareholder rights – for example, the right to receive a notice of a meeting and the right to vote at a meeting. 5.3.1Record date may be set by board of directors As far as shareholders’ meetings are concerned, the Act provides that the board of directors may set a record date for determining which shareholders are entitled to the following:18 to receive notice of a shareholders’ meeting; to participate in and vote at a shareholders’ meeting; and to decide any matter by written consent or electronic communication. Such a record date may not be earlier than the date on which the record date is determined or more than 10 business days before the date on which the event or action, for which the record date is being set, is scheduled to occur and must be published to the shareholders in a manner that satisfies any prescribed requirements. 5.3.2Where no record date is set by board of directors19 Where the board does not determine a record date for any action or event, unless the MOI or rules of the company provide otherwise, the record date is: in the case of a meeting, the latest date by which the company is required to give shareholders notice of that meeting; or the date of the action or event. Page 117 117 5.4Calling of shareholders’ meetings20 The board of directors, or any other person specified in the company’s MOI or rules, may call a shareholders’ meeting at any time. A shareholders’ meeting must be called in the following circumstances: at any time that the board is required to convene a meeting and to refer a matter to decision by shareholders as provided for in the Companies Act or by the MOI – for example, to elect a director or to fill a vacancy; and when a meeting is demanded by shareholders, provided that the demand is signed by the holders of at least 10 per cent of the voting rights entitled to be exercised in relation to the matter proposed to be considered at the meeting. (A company’s MOI may specify a lower percentage than 10 per cent.) The following points are relevant when a demand is made: A demand to convene a meeting must specify the specific purpose for which the meeting is proposed. A company, or any shareholder of the company, may apply to a court for an order setting aside a demand for a meeting on the grounds that the demand is frivolous, or because it calls for a meeting for no other purpose than to reconsider a matter that has already been decided upon by the shareholders, or is vexatious. A shareholder who submitted a demand for a meeting may withdraw the demand before the start of the meeting. Where a demand for a meeting is withdrawn, the company must cancel the meeting if, as a result of one or more demands being withdrawn, the voting rights of any remaining shareholders continuing to demand the meeting, in aggregate, fall below the minimum percentage of voting rights required to call a meeting. CASE STUDY: Removal of a director by shareholders The case of Butler v Van Zyl 21 concerned the right of shareholders of a company to requisition a shareholders’ meeting to effect the removal of a director. The majority shareholders of Company N, holding 78% of the shares, sought to remove its managing director (MD) from his position. The reason for the removal was an accusation that the MD had placed the company at risk of losing its only asset, namely, its right to prospect for chromite deposits on certain farms. To achieve their aim of removing the MD as a director, the majority shareholders had to secure a meeting of Company N’s shareholders. Therefore, they chose to requisition a shareholders’ meeting in terms of s 61(3) of the Act. According to the majority shareholders, the decision to proceed in terms of s 61(3) was based on advice that its provisions were peremptory, that it places an obligation on the board of a company to convene a shareholders’ meeting, and that it is not open to it to choose not to do so. The demand for a shareholders’ meeting was accompanied by a detailed list of the grounds on which the proposed resolutions were founded. The company secretary advised the directors in writing that a demand in terms of s 61(3) of the Act had been received from the majority shareholders. The board meeting was attended by the MD and one other director. The MD voted against the holding of a shareholders’ meeting. The other director was of the view that, despite the MD being against it, the board had no choice other than to convene a meeting of shareholders. Page 118 118 That director, therefore, proceeded to notify the shareholders – including the MD – that a meeting was to be held of all the shareholders as requested in terms of s 61(3) of the Act. In response, the MD launched an urgent application to court in which he sought an order, inter alia, that the notices requesting and calling the meeting be declared invalid, and that they be set aside, and for the parties to be interdicted from holding a shareholders’ meeting for the purpose of dealing with any of the proposed resolutions. The court held that the shareholders were entitled to demand that the board of directors convene a shareholders’ meeting for the proposed purpose, and the director was authorised to respond to that demand by convening a meeting of the board. 5.5Notice of meetings22 The first step in convening a meeting is to send out a notice convening the meeting. The following issues relate to the giving of proper notice: A notice convening a shareholders’ meeting must be in writing. The notice must include the date, time and place for the meeting. Where the company sets a record date for the meeting, the notice convening the meeting must include the record date. The notice should explain the general purpose of the meeting and any other specific purposes. With regard to a public company or a non-profit company that has voting members, notice of a shareholders’ meeting should be given 15 business days before the date of the meeting. In the case of any other company, the notice convening the meeting must be sent 10 business days before the date of the meeting. The provisions of the MOI may prescribe longer minimum notice. A copy of any proposed resolution received by the company, and which is to be considered at the meeting, must accompany the notice convening the meeting. The notice should indicate the percentage of voting rights required for the resolution to be adopted. A notice convening the annual general meeting of a company must contain a summary of the financial statements that will be tabled at the meeting. The notice should also explain the procedure that a shareholder can follow to obtain a complete copy of the annual financial statements for the preceding financial year. A notice convening a meeting must contain a prominent statement that a shareholder is entitled to appoint a proxy23 to attend, participate in, and vote at the meeting in the place of the shareholder. The notice should indicate that meeting participants will be required to provide satisfactory proof of identity at the meeting. Where the company has failed to give notice of a meeting or where there has been a defect in the giving of the notice, the meeting may proceed if the persons who are entitled to vote in respect of each item on the agenda are present at the meeting, and acknowledge actual receipt of the notice, and agree to waive notice of the meeting, or, in the case of a material defect, ratify the defective notice. If a material defect in the notice relates only to one or more particular matters on the agenda for the meeting, any such matter may be taken off the Page 119 119 agenda and the notice will remain valid with respect to any remaining matters on the agenda. Where the meeting ratifies a defective notice in respect to a matter taken off the agenda, the meeting may proceed to consider the matter. An immaterial defect or an accidental or inadvertent failure in the delivery of the notice to any particular shareholder does not invalidate any action taken at the meeting. A shareholder who is present at a meeting is deemed to have received or waived notice of the meeting. CASE STUDY: Effects of an improperly constituted meeting In Thompson v ILIPS (Pty) Ltd, 24 the court found that there was no doubt that the appointment of the fourth respondent as CEO as well as certain other decisions resulted from an improperly constituted meeting of the shareholders. In calling the meeting, no notice had been given to one of the shareholders. The court found that even though there had been a quorum, it was not a properly constituted m