BETTER BE CERTAIN THAN HOLDING YOUR BREATH HOPING THAT YOU ARE NOT WIDELY HELD BY LUVO MNDUZULWANA
The Corporate Laws Amendment Act of 24 of 2006 (“Amendment Act”), which came into effect on 14 December 2007 introduced a new concept into our company law, namely, the distinction between ‘widely held’ and ‘limited interest’ companies. This distinction is however not clear and has caused confusion and headaches for company law practitioners. The confusion is exacerbated by the definition of a limited interest company, which is defined as a company that is not a widely held company.
This has led to a number of interpretations of the definition of widely held, with some practitioners going for a pragmatic approach, others choosing a more restrictive one while some may have been guided by convenience.
The Amendment Act adds section 1(6) to the Companies Act 61 of 1973, which provides, inter alia, that a company is a widely held company if:
Its articles provide for an unrestricted transfer of its shares;
It is permitted by its articles to offer shares to the public;
It decides by special resolution to be a widely held company; or
It is a subsidiary of a company falling within the ambit of any of the above criteria.
The last two characteristics are less problematic and need no further deliberation. It seems that ‘provide’ in bullet point one does not require an express statement in a company’s articles that its shares shall be freely transferable - if the articles are silent on that issue there is nothing to restrict the transferability of such shares.
Likewise ‘permit’ in bullet point two ought to be read as including silence on the offering of shares to the public. Private companies however by their very nature cannot issue shares to the public so this cannot apply to them.
Thus, any company that:
Provides for an unrestricted transfer of its shares;
Permits an offer of its shares to the public;
Is a combination of the above;
Decides by special resolution to be a widely held company; or
Is a subsidiary of any of the above companies...
would be a widely held company.
Regrettably, however, the meaning of “unrestricted” remains a mystery. The Amendment Act provides that a transfer of shares is unrestricted if it is not subject to an “effective right of pre-emption”, which, in turn, is defined as a right of pre-emption which operates in favour of all shareholders of the company and upon every proposed sale of shares to a person who is not a shareholder of the company.
The pragmatic interpretation of “unrestricted” insists on the ordinary meaning of the word unless it gives rise to an absurdity – the golden rule of statutory interpretation.
An ordinary meaning of “unrestricted” suggests that any form of restriction or limitation on the transfer of a company’s shares would suffice for their transfer not to be “unrestricted” under the Amendment Act – for example, the commonly used director’s discretion to refuse to register a transfer of shares, with or without reason.
Thus, as the argument goes, any form of restriction on the transfer of a company’s shares contained in its articles is sufficient for that company to be a limited interest company.
This interpretation is supported by the use of means more restrictive than rights of pre-emption – for instance, where the articles contain an absolute prohibition on transfer to a non-shareholder. Such restriction would be more effective than a right of pre-emption, which may result in the shares falling into the hands of a non-shareholder provided the pre-emptive provisions of the articles have been complied with.
Persuasive as this argument is, it is unsatisfactory, as it would mean that every private company would, of necessity, be a limited interest company, since in terms of section 20 of the Companies Act private companies are required to restrict the transfer of their shares and prohibit them from being offered to the public.
What of the dilemma of a private company with a right of pre-emption as the only form of restriction, which pre-emption right does not satisfy the requirements of subsection 6(c)(ii)?
The pragmatic interpretation suggests that such companies would be limited interest companies as they perfectly meet the requirements for private companies.
Could it have been the legislature’s intention to impose, in addition to the section 20 requirements, a further requirement for a company seeking to be a limited interest company? If not, then the provisions of subsection 6(c) would be superfluous.
It is a trite rule of statutory interpretation that the legislature avoids superfluity. Furthermore, subsection 6(e)(ii) provides that an effective right of pre-emption contained in the articles shall be deemed to apply also to an offer by a company of its shares to a non-shareholder.
Acceptance of the above interpretation would mean private companies (qua limited interest companies) that do not have an “effective right of pre-emption” in their articles would be at liberty to allot and issue their shares to a non-shareholder, while identical companies with an effective right of pre-emption in their articles may not.
To mitigate against this superfluity the proponents of this interpretation argue that the legislature intended the use of the phrase “a transfer of shares is unrestricted if it is not subject to an effective right of pre-emption” to refer to one of the ways a transfer of a company’s shares could be restricted.
Had the legislature intended this to be the case it should have done so in clear and unambiguous terms, thereby, on one hand, including other forms of restriction on the transfer of shares. On the other, the legislature could have added that where a right of pre-emption is used as a form of restriction on the transfer of shares it should be an “effective right of pre-emption” – followed by the definition of a “right of pre-emption”.
Some choose a restrictive approach and argue that a transfer of shares in a company would be unrestricted only if it is subject to an “effective right of pre-emption”. Put differently, for a restriction on the transfer of shares contained in the articles to suffice for the purpose of the Amendment Act, it must be “an effective right of pre-emption” per subsection 6(c)(i).
This would mean that any form of restriction on the transfer of shares contained in the articles falling short of an effective right of pre-emption would not be regarded as a restriction on the transfer of shares for the purposes of the Amendment Act, while it is for the purposes of section 20 and other provisions of the Companies Act that predate the Amendment Act.
This argument is premised on the wide use of rights of pre-emption as a form of restriction on the transfer of shares. Company articles with some other form of restriction but no rights of pre-emption, invariably provided for it elsewhere, usually in shareholders’ agreements.
However, rights of pre-emption are of little restrictive impact when they apply to some, not all, shareholders or apply with exceptions – for example, where a right of pre-emption does not apply to the majority shareholder or the majority shareholder is permitted to transfer to its associates but the minority shareholder is not.
The legislature sought to close this gap by introducing the concept of an effective right of pre-emption.
Yet this restrictive interpretation cannot be entirely correct. To interpret an effective right of pre-emption as the only recognised way of restricting transfer under the Amendment Act would contradict relevant jurisprudence. Over the years, the courts have upheld the other forms of restricting transfer to be valid restrictions on transfer.
Logic, too, dictates that this should not be the case. An absolute prohibition on transfer to non-shareholders is more restrictive than an effective right of pre-emption which merely puts preconditions on that transfer. Open to debate is whether pre-emptive rights, properly construed, are a restriction on transfer. Quite clearly, this interpretation cannot be accepted without some form of adaptation.
Severe consequences may ensue for contravening or failing to comply with the widely held companies provision. The most severe arises when a company issues a financial report that does not comply with the requirements of financial reporting standards applicable to widely held companies. In this event, the company and every director who signed or was party to the preparation of that financial report shall be guilty of an offence and liable to a fine of up to R1 000 000.
Company executives should be mindful of the dire consequences of an incorrect interpretation.
Hopefully, the courts will soon get an opportunity to pronounce on the issue. Until then, adding an effective right of pre-emption to the articles, in addition to other forms of restriction, although inconvenient and arguably impractical, is surely the best defence against being classified as widely held.
Luvo Mnduzulwana is an associate in the Corporate Department of Bowman Gilfillan