Monday, March 10, 2008

Typically, the scheme would operate as follows: the company would establish a trust for the benefit of the company’s employees.  The trust will acquire shares in the company either from one of the shareholders of the company or by the fresh issue of shares to the trust.  The company will grant the trust a loan in order to purchase the shares.  The trust will hold the shares and the company will instruct the trustees in relation to which employees of the company should benefit from the trust.  Before any distributions are made to the beneficiaries, the trust would be required to settle the company’s loan and until such time, the trust will pledge the shares to the company as security.
In terms of the BEE Codes, black participants in an employee share ownership scheme holding rights of ownership in the company being measured (Measured Entity) may contribute:

A maximum of 40% of the total points allocated for the ownership component of the scorecard, if the scheme meets the following qualification criteria:

The scheme’s constitution must define the participants and the proportion of their claim to receive distributions.  A written record of the name of the participants or the use of a defined class of natural person satisfies the requirement for identification.  A written record of fixed percentages of claim or the use of a formula for calculating claims satisfies the need for defining proportion of benefit.

The fiduciaries of the scheme must have no discretion in this regard.

The participants must take part in:

 appointing at least 50% of the fiduciaries of the scheme;

 managing the scheme at a level similar to the management role of shareholders in a company having a shareholding.

The constitution, or other relevant statutory documents, of the scheme must be made available, or on request, to any participant in an official language in which that person is familiar.

All accumulated economic interest of the scheme is payable to the participants at the earlier of a date or event specified in the scheme constitution or on the termination or winding-up of the scheme.

The scheme fiduciaries must present the financial reports of the scheme to participants yearly at an annual general meeting of the scheme.

100% of the points allocated for the ownership component of the scorecard, if the scheme has a track-record of operating as an employee ownership scheme or in the absence of such track record demonstrable evidence of full operational capacity to operate as an employee ownership scheme. Operational capacity must be evidenced by suitably qualified and experienced staff in sufficient number, experienced professional advisors, operating premises and all other necessary requirements for operating a business.

The majority of schemes, even if they hold at least 25.1% of the shares in the Measured Entity, will not comply with the BEE Codes in that it does not define the proportion of the beneficiaries claim to receive distributions, the beneficiaries are not involved in the appointment of the trustees, there is no obligation on the trustees to present the financial reports to the beneficiaries, etc. 
But the scheme requirements in the BEE Codes are problematical:

It is not clear from the BEE Codes what effect any white beneficiaries will have in calculating the points allocation, that is, if 10% of the beneficiaries are white employees will the Measured Entity only be awarded 90% of the points or 100% of the points given that the majority of the beneficiaries are black.  The requirements for broad-based ownership schemes suggests that the Measured Entity will not be prejudiced if at least 85% of the beneficiaries are black.

It is unrealistic and impractical to expect the scheme’s constitution to define the participants and to restrict the trustees’ discretion given that the company would probably want to vary the beneficiaries from time to time.

It is unclear what is the relevance of requiring the scheme’s constitution to define the proportion of their claim to receive distributions if the scheme is set up for the benefit of black employees only and the trustees do not have a discretion to change this.

Inherent in schemes of this nature is the staggering of dividend and capital income to the beneficiaries which is used as a means of retaining key employees; however, it is not clear to what extent this would undermine the scheme from a BEE perspective considering that such provisions would not ordinarily apply to a shareholder.

 It is not clear how far back one must go in order to prove that the scheme has a track-record of operating as an employee ownership scheme.

It is unclear how the points allocation must be applied to these schemes: the one approach is to assume that if the scheme satisfies the minimum qualification criteria including the additional qualification criteria, then the Measured Entity will be awarded the full 20 points for ownership on the Ownership Scorecard.  The flaw with this approach is that it does not take into account that the scheme and consequently the beneficiaries will not be entitled to the full economic rights of the shares held in the company until such time as the loan has been repaid.  Ordinarily, the Measured Entity in these circumstances would not be entitled to the full points on the Ownership Scorecard. The second approach would be to calculate the total ownership points after applying each item of the Ownership Scorecard to the scheme and thereafter to award only 40% of the points scored to the Measured Entity if the minimum qualification criteria are met and 100% of the points scored if the additional qualification criteria are met by the scheme.  The criticism of the second approach is that there is no clear rationale why the total ownership points scored by the Measured Entity should be subject to further criteria and possible dilution.

On a closer reading, the qualification criteria for employee ownership schemes suggest that the goal should be to align the beneficiaries’ rights in the trust in such a manner that it is akin to rights of ownership and to limit the trustees discretion as far as possible.  Until such time as these issues have been clarified, companies would be well advised to procure a rating agency to review any proposed amendments to the scheme’s constitution and to suggest any further amendments required.