Wednesday, April 02, 2008

South Africa’s upcoming corporate law amendments effect sweeping changes to the legislation governing corporate finance in general, including the nature of debentures in particular.
Importantly, the debenture provisions in the current draft of the Companies Bill bring clarity to the definition of “debenture” and also add a new dimension to the relevant provisions of the Companies Act, 1973 (as amended).
The Bill’s explanatory memorandum describes how the Act’s “archaic” debenture provisions will be replaced by a “general scheme designed to protect the interests of debenture holders without making unnecessary distinctions based on the artificial categorisations of the debt instruments they hold”.
The concepts the Bill introduces include:
·         A broadened definition of “debenture”;
·         The exclusion of the obligatory distinction between “secured” and “unsecured” debentures;
·         The inclusion of provisions relating to voting rights and meetings of debenture holders;
·         The stipulation of conversion dates; and
·         The addition of special privileges captured in the Memorandum of Incorporation (the equivalent of Memorandum and Articles of Association of a company under the Companies Act).
In terms of the Bill, a “debenture” includes debenture stock, debenture bonds, common notes and any other debt security of a company but does not include promissory notes and loans, whether constituting a charge on the assets of the company or not. This definition gives more certainty to what is presently an imprecise definition of “debenture” under the Companies Act.
A company may create and issue debentures except in instances where its Memorandum of Incorporation provides otherwise. This is a new concept, in contrast to that contained in the Companies Act, which requires a company to create and issue debentures only if it is allowed under its Articles of Association.
The Bill further introduces a new concept via a “debenture document”, which includes “any document by which a debenture is offered or enabled, embodying the terms and conditions of the debenture, including but not limited to a trust deed or certificate”. It will no longer be necessary to issue debenture certificates or to issue debentures in terms of a trust deed. In order to validly issue debentures, any document may be used, provided that the terms and conditions of the debentures are contained in it.
Under the Bill, a debenture document need no longer state whether a debenture is “secured” or “unsecured”, as is currently required under the Companies Act. The Bill does, however, prohibit the expression of debenture as “secured” in a debenture document unless such a debenture meets the set requirements for a “secured” debenture.
The Bill specifically provides that “secured” debentures must be secured to a “substantial extent” by a direct specific mortgage on freehold or long leasehold property or other immovable property or any other fixed assets that meet any requirements contained in the debenture document. Debentures secured by movable property do not constitute “secured” debentures under the specifications set out in the Bill.
The Bill does not preclude the issue of debentures secured by movable property; it only precludes such debentures from being referred to as “secured” debentures – a principle that contrasts with the Companies Act, which provides for the manner in which movable property may be bound as security for a debenture (for example, a deed of pledge, notarial bond, surety bond, etc).
Nor have the requirements for registration of any bond of security for debentures and for annexing the debenture trust deed to the bond or (if applicable) deed of pledge been included in the Bill’s debenture provisions.
A debenture document may provide that debentures be issued at different times, as determined by the company. However, each debenture, whenever issued, ranks in preference concurrently with all other debentures at the date on which the debenture document was registered or constituted. The Companies Act has a similar provision, except that the provisions in the Companies Act relate only to bonds or pledges that have been executed in favour of the trustee for debenture holders.
The Bill allows for the board of directors of a company to determine the terms and consideration or other benefit for which the debentures will be issued. The determination of the board of directors as to the “adequacy” of the consideration or other “benefit” for the debentures may only be challenged on the grounds of a breach of directors’ fiduciary duties.
Although “benefit” is not defined in the Bill, it may be interpreted as a type of security or payment made in return for the issue of a debenture.
Once a company has received the benefit approved by the board of directors, the debentures are seen to be fully paid up. Hence, the company is obliged to issue the debentures and enter the name of the debenture holder on the company’s securities register. The Companies Act requires a separate register for debenture holders.
Like the Companies Act, the Bill recognises that debenture holders may place their debentures in trust. The trustees for debenture holders may not be a director or officer of the company and must not have any interest in or relationship with the company which may conflict with their position as trustee.
The Bill prescribes that a trustee must be a “corporation” or individual of “standing and repute”.
Another fresh concept contained in the Bill is that the appointment of a new trustee must be approved by 75% of debenture holders at a general meeting; a provision designed to protect “minority” debenture holders.
Note that any provision in a trust deed for the securing of an issue of debentures is void to the extent that it exempts or indemnifies a trustee against liability for breach of trust or “failure to exercise the degree of care and skill required of a prudent and careful person”.
Be that as it may, the Bill states that any provision enabling a release with the consent of 75% in value of debenture holders present and voting at a meeting called for this purpose and with respect to a specific act or omission is valid. This provision is similar provision to that contained in the Companies Act.
Provisions relating to the protection of creditors, the issue of debentures with special privileges, and conversion rights are new concepts in the regulation of debentures. In order to protect creditors against the voluntary liquidation of a company, the Bill prohibits the provision for payment of an amount less than the face value and the premium due at the time (a specified date or on notice) in instances where a debenture is repayable at a premium determined at a fixed or variable rate.
The Bill allows for debentures to be issued with special privileges relating to the allotment of securities, attending and voting at general meetings and the appointment of directors. These special privileges are allowed provided they are in a manner and form stipulated in the Memorandum of Incorporation and are approved by way of special resolution of all shareholders’ present at a general meeting convened to approve such resolution.
Unlike in the Companies Act, the Bill provides for where a debenture is subject to periodic redemption, that any redemption be partial or in full.
Additionally, the Bill provides that a debenture document makes provision for a fixed initial period of at least one year from the date of issue during which redemptions may not take place.
The provisions relating to redemption rights and conditions attached to them may not be altered unless specifically approved by way of a meeting of debenture holders by special resolution (not less than 75% of persons voting at the meeting on a show of hands or by proxy). This is the only instance in the Bill where voting on a poll is permitted.
To the extent that any power is reserved for the company or trustee to purchase redeemable debentures, the Bill prohibits the purchase of such debentures at any price higher than the nominal value, unless this has specifically been provided for in the debenture document. Once a debenture is purchased or redeemed, the Bill requires that it be cancelled and the company’s obligation to redeem be reduced to the face value of the cancelled debenture.
The Bill does not provide for the ability of a company to re-issue redeemed debentures if certain requirements are met, as is the case with the Companies Act. Accordingly, all redeemed debentures under the Bill must be cancelled.
Unlike in the Companies Act, the Bill provides for a final conversion date of debentures and indicates that a company may not issue capitalisation shares or options on securities before that date, unless the convertible debenture holders so approve in a general meeting by way of a debenture holders’ ordinary resolution.
The conversion period is regulated by the debenture document and is subject to the provisions of the Memorandum of Incorporation. Conversion rights and conditions may only be amended by way of a debenture holders’ special resolution.
Most notably, and in contrast to the Companies Act, general meetings of debenture holders, unless otherwise provided for in the Memorandum of Incorporation, must be called by written notice signed by at least 10% of the nominal amount of the debentures for the time being that are outstanding.
The written notice must be sent at least six weeks before each conversion date or the redemption date. As for shareholders, debenture holders may also be represented by proxy.
In conclusion, although the Bill brings some clarity to the provisions regulating debentures, certain provisions are unclear and ought to be more comprehensive.
The registration and transfer of certificated and uncertificated shares, and regulations covering the disclosure of beneficial interests in shares, will be discussed in the next Bowman Gilfillan column on corporate finance.
Kelebogile Modise is a director in the Corporate Department of Bowman Gilfillan