LOOKING OUT FOR THE LITTLE GUY – PROTECTION AGAINST THE DILUTION OF MINORITY SHAREHOLDINGS IN SOUTH AFRICA AND THE UNITED KINGDOM
Looking out for the little guy – Protection against the dilution of minority shareholdings in South Africa and the United Kingdom
By Matthew Bonner and Shoba Chiba
When investing in a company by purchasing a small percentage of its overall issued share capital it is essential that one understands, and takes measures to protect oneself against, the risks that come with being a minority shareholder in a company. Some minority protections will be contained in the governing law of the country the particular company was formed in but if at all possible it is wise to enter into a shareholders agreement with the fellow shareholders of the company in order to regulate your dealings with one another and protect your interests as a minority shareholder. One of the pitfalls of being a minority shareholder is the danger of having your shareholding diluted by a further issue of shares by the company. While South African company law does have measures to guard against this (particularly in relation to listed companies in South Africa) the current South African law falls short of the protection afforded to minorities in the United Kingdom when a company decides to issue further shares (and consequently dilute the shareholdings of existing holders).
The position in the United Kingdom
Both private and public companies in the UK may issue shares for cash on the basis of an authority given in their articles of association or by means of shareholder approval in terms of an ordinary resolution (a simple majority of shareholders present at the meeting). Such authorities must expire within five years. However, section 89 of the Companies Act, 1985 ("the UK Companies Act") provides for existing shareholders in a company to have a right of first refusal over issues of new shares for cash in the company in proportion to the nominal value of their existing shares, thus allowing them to preserve their existing percentage shareholding in the company.
Although this applies to both private and public companies, private companies may indefinitely exclude this pre-emptive right by inserting a provision to that effect in their memorandum or articles of association (either when forming the company or by amending their articles by special resolution, which is a resolution passed by 75% of the shareholders present at the meeting in question). It is therefore essential that before investing in shares in any private company in the United Kingdom one has thoroughly checked the provisions of the company’s memorandum and articles in this regard. Furthermore, both public and private companies may dispense with this right by special resolution, although such disapplication would be limited to a maximum of five years.
Similar rules regulating pre-emptive rights for listed companies in the United Kingdom are contained in the Listing Rules of the UK Listing Authority. Listed companies in the United Kingdom will therefore need to comply with both these rules and the laws regulating public companies as set out in the UK Companies Act.
The position in South Africa:
Issues of shares for cash in both private and public companies in South Africa are dealt with in section 221 of the Companies Act No 61 of 1973 ("the South African Companies Act") and, for listed companies on the JSE Limited, section 5.51 of the Listings Requirements of the JSE Limited ("the Listings Requirements").
Section 221 provides that directors may not allot and issue shares without the prior approval of the company in general meeting. This approval may take the form of a general authority (which will remain valid for 15 months or until the next annual general meeting, whichever is the earlier) to allot or issue shares at their discretion (usually subject to certain restrictions) or a specific authority to allot in a particular situation. It is important to note that both of these approvals may be obtained by ordinary resolution rather than special resolution.
What is significant is that nowhere does the South African Companies Act contain a provision granting pre-emptive rights to existing shareholders on a new allotment of shares.
The Listings Requirements require a higher threshold of 75% approval by the shareholders of the company present at the meeting voting in favour of a general or specific authority to issue shares for cash. While this higher threshold offers more protection to minority shareholders than that offered to unlisted companies in terms of the South African Companies Act, what is more important is that the Listings Requirements, like the UK Companies Act, provide for pre-emptive rights. The Listings Requirements provide that when a listed company issues further shares for cash it must first offer those shares to its existing shareholders in proportion to their existing shareholdings before other persons may take up the offer (although this requirement may be waived with the prior approval of the JSE if the directors of the company consider it necessary or expedient because of legal impediments or because of compliance with the requirements of any regulatory body of any territory recognised as having import on the offer). The Listings Requirements specifically provide that a general or specific authority to issue shares for cash made otherwise than to existing shareholders in proportion to their existing holdings in terms of the Listings Requirements (and consequently requiring 75% approval from the company’s shareholders) will constitute a waiver of pre-emptive rights.
In both the UK and South Africa a company may issue shares for cash based on an authority obtained by a simple majority of its shareholders (although listed companies in South Africa require a higher threshold of 75% shareholder approval). However, in the UK such an issue will be subject to pre-emptive rights and will not dilute an existing shareholders shareholding in the company (unless this pre-emptive right is waived by obtaining 75% shareholder approval). In South Africa it is only shareholders in listed companies who are protected by pre-emptive rights, although as is the case in the UK, this may be waived by obtaining a 75% majority vote from the listed company’s shareholders. As a result of this, in order to avoid having one’s shareholding diluted, it is recommended that when making a minority investment in an unlisted company in South Africa one should endeavour to obtain similar pre-emptive rights to those in listed companies by means of a provision in the company’s articles of association or by way of a binding shareholders agreement.