Tuesday, September 04, 2007

Ann Pratt case - new precedent on exchange control compliance
By Wally Horak

The application of exchange control restrictions to the transfer of intellectual property "(IP") and shares to a non-resident was considered in the decision in Couve and Another v Reddot International (Pty) Ltd and others 2004 (6) SA 425 (W). It was held that the transfer of such assets to a non-resident without the approval by the Exchange Control Department ("Exchange Control") of the Reserve Bank was void.
This decision seems to be in conflict with the judgment in Barclays National Bank v Brownlee 1981 (3) SA 579 (D) where the court concluded that a contravention of the prohibition under Regulation 3(1)(e) did not imply that the particular transaction was null and void.
The latest decision on exchange control compliance, Pratt v First National Bank Limited & others (not yet reported: heard 31 January 2007 in the High Court, TPD) dismissed the decision in the Brownlee case, implying that there is no scope for Exchange Control to retrospectively "ratify" such a transaction.
Since all these decisions are local or provincial court decisions in different provinces, there is no clear precedent. It is thus still not clear whether a transaction concluded without Exchange Control approval is always void.
An important consequence of the Pratt decision (on merits) is that the decision has effectively "blessed" so-called "loop structures" which calls into question the validity of Exchange Control Circular D.405 and D.417, which ruled that such transactions were contraventions of Exchange Control Regulation 10(1)(c).
Remaining restrictions on the export of certain assets
Regulation 10(1)(c) provides as follows:

"10(1) No person shall, except with permission granted by the Treasury….
(c) enter into, any transaction whereby capital or any right to capital is directly or indirectly exported from the Republic".
In the Couve case, the Court held that the assignment of rights in and to foreign patent applications to a non-resident constituted the transfer of the right to receive future royalties, which constituted an export of capital.
Furthermore, it held that an agreement, in terms of which shares are sold or transferred to a person outside the Republic, constitutes an export of capital. It is not clear how the Court came to this conclusion since our law recognises that, in the case of a share, the location of the share is the place where the share register of the company is kept (ie in South Africa). The Court appears to have relied on the judgment in S v De Castro 1979 (2) SA 1 (A) where it was found that "transaction whereby" may mean "an arrangement or agreement in consequence whereof". Therefore, a transaction which created a "channel" for the future export of capital (ie dividends, sale proceeds or capital reductions) would already constitute an "export" as contemplated. It is doubtful whether the De Castro case is good authority for such a wide application.
Consequence of a contravention
The Couve case held that the effect of such a contravention of Exchange Control Regulations is that the transfer of the assets was null and void.
The Court distinguished the case from the decision in Brownlee’s case where it was held that the granting of credit to a resident, relying on security provided by a non-resident in contravention of Regulation 3(1)(e), did not imply, under the particular circumstances, that the transaction was null and void. The Court in the Brownlee case relied on a citation in Standard Bank v Estate van Rhyn 1925 AD 266 for its decision: "As Voet 1.3.16 puts it – ‘but that which is done contrary to law is not ipso jure null and void, where the law is content with a penalty laid down against those who contravene it’. Then after giving some instances in illustration of this principle, he proceeds: ’The reason for all this I take to be that in these and the like cases greater inconveniences and impropriety would result from the rescission of what was done, than would follow the act itself done contrary to the law’."
It is submitted that this basic rule of our common law should be applied by a Court to determine whether, in the particular circumstances, a transaction may be regarded as void if it contravened Exchange Control Regulations. The decision of the Appellate Division in Barclays National Bank Ltd v Thompson, 1985 (3) SA 778 (A) may lend support to this interpretation, albeit that the decision is not in point.

In Pratt v FirstRand Bank and another, [2004] 4 All SA 306 (T), (dealing only with the exception of the defendant) the Court expressed support for the decision in the Couve case and dismissed the decision in the Brownlee case. In the subsequent case on the merits (unreported), the Court agreed that transactions in contravention of Regulation 3(1)(e) and Regulation 10(1)(c) were null and void. However, it found that Exchange Control approval had been granted for the respective transactions since the shares in question had been "endorsed" by the Authorised Dealer Bank.

Impact on "loop" structures

The critical consequence of the Pratt decision on the merits is the finding that the "endorsement" of a share as "non-resident" by an Authorised Dealer Bank can be regarded as evidence that the transaction was endorsed pursuant to the provisions of Regulation 14, which implies that the transferability was approved by Exchange Control and a transfer would thus not contravene the prohibition under Regulation 10(1)(c).

The structure described in the judgments is a "loop structure" as described in Exchange Control Circular D.405, ie Ann Pratt controlled the offshore trust (The Fast Track Trust) which acquired 70% of the shares in her South African company (Ann Pratt & Associates). On 8 May 2000, the Fast Track Trust purchased 700 ordinary shares in Ann Pratt & Associates. In December 2001, Ann Pratt borrowed R25 million from FirstRand Bank to capitalise a close corporation (Classy Living cc) which purchased the shares from the Fast Track Trust. The question arose whether the arrangements contravened Regulation 10(1)(c).

The Court did a detailed analysis of the applicable Exchange Control Regulations and Rulings relating to the transfer of shares to a non-resident. It concluded that the endorsement of a share certificate by an Authorised Dealer Bank, following the required procedures (inter alia, ensuring that the market value has been confirmed by an independent valuation), is evidence of compliance with the Exchange Control Regulations and the transaction transferring the purchase price to the non-resident was thus an authorised export of capital.

Therefore, the decision could be regarded as authority for the establishment of a valid loop structure. This would surely be contested by Exchange Control, since it may face a barrage of damages claims of residents who were forced to unwind their loop structures.