Monday, June 07, 2004

One of the main challenges relating to the transfer of ownership and control to black investors is the low level of access to capital resources by black investors. 
In the first wave of empowerment deals after 1994, black investors generally relied heavily on external, highly geared funding mainly from institutional investors. The repayment of borrowings depended on the need for inordinate growth in the equity value of the underlying investments.  Many of these ventures failed, with the equity ending up in the hands of the financial institutions. 
The current wave of BEE transactions have attempted to address the lack of access to finance and to reduce transaction and finance costs through vendor financing mechanisms. This usually involves employing elaborate transaction structures which generally involve a combination of debt, equity and hybrid instruments (such as deferred shares, options and preference shares).  These are complex schemes involving various legs and multiple parties (subsidiaries, special purpose vehicles, empowerment trusts etc).
The advisors to these transactions have to be continually alert to possible contraventions of section 38 of the Companies Act, which prohibits a company from giving any type of financial assistance, directly or indirectly, in connection with the purchase of or subscription for its shares or shares in its holding company.  The consequences of contravening the section are severe – the transaction will be void and the contravention cannot be cured by any shareholder, creditor or court approval.  In addition, the company giving the financial assistance and each of its directors will be guilty of a criminal offence.
In an article published in the Company Lawyer in 2000, Richard Sykes SC estimated that the annual costs in the UK (primarily legal costs) to industry and to the City related to the observance of the equivalent section of the English Companies Act, were approximately £20 million.  Similarly in South Africa, the costs and time associated with ensuring compliance with section 38 in the context of BEE transactions must also be great.  These costs must surely undermine the supposed savings on transaction costs which are punted in support of the current BEE transaction structures.
The main purpose behind section 38 is to protect shareholders and creditors and to prevent abuses where persons with insufficient funds seek to acquire control of a company by using the company’s funds and assets.  A classic example of financial assistance prohibited by this section would be where a company mortgages its assets as security for a loan given by a third party to a party which then uses the funds to buy shares in the company.  Another example is where company A subscribes for preference shares in company B, which then uses the proceeds to acquire ordinary shares in company A.  There are of course other transactions where the financial assistance is more indirect and part of a broader scheme (for example where subsidiaries or third parties are interposed between the company and the purchaser), but which would nevertheless be in contravention of the section.  This is where many current BEE transaction structures may fall foul.
The prohibition against a company giving financial assistance for the purchase or subscription of its shares is also generally seen as part of the share capital maintenance regime, which seeks to place limitations on the ability of a company to purchase its own shares and thereby reduce its capital.  The share capital maintenance provisions of our Companies Act have, since 1999, been substantially relaxed.  A company can now purchase its own shares, subject to it passing liquidity and solvency tests and its shareholders approving the buy-back by special resolution. Section 38 has not been amended in line with the other capital maintenance sections of the Companies Act and as a result, there is no provision for the giving of financial assistance (other than in certain limited circumstances), even with the unanimous approval of shareholders and creditors, or if it is in the best interests of the company.
The English and Australian Companies Act have been amended to allow a company in certain circumstances to give financial assistance in relation to the acquisition of its shares.  For example, the English Companies Act distinguishes between public and private companies giving financial assistance.  The prohibition on giving financial assistance by private companies or their subsidiaries has been relaxed to allow private companies to give financial assistance provided that the directors make a statutory declaration as to the solvency of the company, that the financial assistance is approved by special resolution and the assistance is only provided out of distributable profits or the company’s net assets are not thereby reduced.  The Australian Companies Act has relaxed the prohibition on giving financial assistance even further. The giving of financial assistance is not prohibited if firstly, the assistance does not materially prejudice the interests of the company or its shareholders or the company’s ability to pay its creditors and secondly, the assistance is approved by special resolution of the shareholders.
In order to facilitate the funding of the transfer of ownership and control in the economy to BEE investors and to ensure that the recently enacted broad-based empowerment legislation can properly be implemented, it has become increasingly necessary to review section 38.  In many instances the giving of financial assistance by a company to enable a BEE investor to acquire shares in it can only be in the interests of the company and its shareholders. 
Any changes to section 38 would of course need to incorporate adequate safeguards for the shareholders and creditors of the company.  A specific exclusion from the ambit of section 38 of BEE-related transactions would, on its own, probably not be sufficient and may increase uncertainty in interpreting and implementing the section.  The changes would therefore need to incorporate a hybrid of the provisions included in the English and Australian Companies Acts.  These principles (for example, the special approval of shareholders and solvency and liquidity requirements) are already to some extent included in sections 85 to 90 of our Companies Act.