Monday, March 03, 2008

In terms of section 38 of the Companies Act, 1973, a company is not permitted to give, whether directly or indirectly, and whether by means of a loan, guarantee, the provision of security or otherwise, any financial assistance for the purpose of or in connection with a purchase of or subscription for any shares of the company, or where the company is a subsidiary company, of its holding company.
The Corporate Laws Amendment Act, 2006, which came into force on 14 December 2007, and which amends the current Companies Act, has been enacted to deal with certain pressing company law issues, one of which is financial assistance.  The changes to the financial assistance provisions by the Amendment Act appear to be driven by the need to facilitate the funding of BEE transactions.  Following these amendments Act coming into force, a company may now provide financial assistance if such assistance is sanctioned by a special resolution of the company’s shareholders and if certain solvency and liquidity tests are met.
These amendments should be compared with the treatment of financial assistance in terms of the major review of the company law by way of the Companies Bill, 2007, which will replace the current Act, and which is expected to come into force in about 2010.
Section 40 of the current public draft of the Companies Bill deals with financial assistance and although the fundamental principles contained in s38 of the current Companies Act are retained in the Companies Bill, there are a number of differences worth noting, bearing in mind that s40 may be amended further prior to its enactment.
Firstly, the current Act specifically prohibits the provision by a company of financial assistance for both the purchase and subscription of shares of that company.  The Bill, however, makes no reference to the word “subscription” and instead uses the phrase “purchase of a share issued or to be issued”.  While the phrase used in the Bill does include both the purchase of shares already issued and subscription for shares to be issued, the terminology is uncommon to South African company law which differentiates between a “sale” and a “subscription” of shares (and may be a consequence of drafting of the Bill by foreign lawyers). The omission of the word “subscription” in the Bill should therefore be clarified.
Secondly, s38 of the current Act prohibits the giving of financial assistance for the purchase or subscription by a person of shares in that company or where the company is a subsidiary, the purchase of or subscription for shares in its holding company. S40 goes further and prohibits the provision of financial assistance for the purchase of a share or option issued or to be issued by the company or a related or inter-related company (as opposed to a holding company). In terms of the Bill, a company is related to another company if either of the companies directly or indirectly controls the whole or part of the business of the other; either is a subsidiary of the other; or a person directly or indirectly controls the whole or part of the business of both of them.
Thirdly, while s40 retains the “solvency and liquidity tests” and the requirement that the shareholders approve the financial assistance by way of a special resolution, the Bill does clarify both the time at which these tests are to be satisfied as well as the requirements for the test. For example, the Bill provides that all reasonably foreseeable financial circumstances of the company at the time when the financial assistance is sought must be taken into account, while the current Act is less clear what factors need to be taken into account.  Unlike s38 of the Act, which refers to the consolidation of assets and liabilities, s40 of the current draft of the Bill refers to the company’s total assets equalling or exceeding its total liabilities.   Another difference is that s38 of the Act requires that the solvency test must be met subsequent to the transaction and the liquidity test must be met subsequent to providing the assistance and for the duration of the transaction, whereas the Bill requires that the liquidity requirements be met for a period of twelve months after the date on which the test is considered.
Fourthly, in addition to the solvency and liquidity tests and approval by special resolution of shareholders, s40 requires that the board must be satisfied that the terms under which the assistance is proposed to be given are fair and reasonable to the company.  This and the other requirements of s40 are particularly onerous on directors as each director who voted in favour of a resolution, or approved an agreement, in contravention of the section will be liable to compensate the company or any shareholder for any loss, damages or costs that the company or shareholder may have sustained or incurred in relation to the transaction.
Fifthly, the Bill requires that the special resolution required to be passed by shareholders must be for either a “specific recipient” or “generally for a category of potential recipients” and the special resolution remains valid for a period of five years after the resolution is passed.  The word “category” seems rather broad and should be considered in more detail.  Further, whether there should be a five year threshold, and the ramifications of such a threshold, merits further consideration.
Sixthly, under s38, any contravention of the section renders the transaction void and will result in civil and, potentially, criminal sanction.  Section 40 of the Bill removes the possibility of criminal sanction and instead holds that the directors are liable to the company and the shareholders in the manner described above.
The aim of the Bill is to address and update outdated laws and to simplify South African company law and make it more flexible.  In doing so, the Bill aims to preserve the underlying principle behind s38 of the Act which is the protection of creditors by requiring that financial assistance be given only if the company is in a position to do so. 
Charles Douglas is a director at Bowman Gilfillan.