YOU MAY BE A WIDELY HELD COMPANY AND YOU DON’T EVEN KNOW IT – RUDOLPH DU PLESSIS
THE NEW DEFINITIONS OF WIDELY HELD COMPANY AND LIMITED INTEREST COMPANY, AND OTHER OBSCURE PROVISIONS OF THE CORPORATE LAWS AMENDMENT ACT
The new definitions of widely held company and limited interest company
The Corporate Laws Amendment Act, 2006 (“the Amendment Act”) amends the Companies Act, 1973 (“the Companies Act”), and came into effect on 14 December 2007. The Amendment Act introduces a number of onerous corporate governance and accounting measures which apply to widely held companies, but not to limited interest companies. According to the memorandum on the objects of the Amendment Act the new measures are imposed for the benefit of investors in the entity (the shareholders) and, therefore, a distinction is drawn in the Amendment Act between widely held companies and limited interest companies. One example of the onerous provisions is the compulsory appointment of an audit committee which must have at least two independent, non-executive directors as members
It is therefore important to understand the new definitions of widely held company and limited interest company. Unfortunately, the new section 6 of the Companies Act (as amended by the Amendment Act) is confusing. The first point of criticism is that the section contains too many negative statements. Difficulty in comprehension is increased where sentences contain more than one negative (Aitken and Butt Piesse, The Elements of Drafting 94). If one reads the definition of limited interest company (section 6(d) read together with section 6(a)(i)), it contains three negative statements. The second point of criticism is that the section is structured badly and is not clear whether section 6(c) is an exhaustive description of when the transfer of shares is unrestricted.
What then is a widely held company?
Section 6(a) states that “a company is a widely held company if:
(i) its articles provide for an unrestricted transfer of its shares;
(ii) it is permitted by its articles to offer shares to the public;
(iii) it decides by special resolution to be a widely held company; or
(iv) it is a subsidiary of a company described in subsections (i), (ii) or (iii).”
In terms of section 6(d) a company is a limited interest company if it is not a widely held company.
The meaning of subsections (iii) and (iv) is fairly clear. If any company, whether or not it falls within the ambit of the definition of a widely held company, decides by special resolution to be a widely held company, or is a subsidiary of any company that falls within the scope of subsections (i), (ii) or (iii), then such company would be a widely held company. The enquiry stops there and there is no need to analyse the nature of the company any further. It seems clear that private companies can also fall into these two subsections.
Subsection (ii) provides that if a company is “permitted” by its articles to offer shares to the public, it is a widely held company. It is submitted that the word “permit” does not require an express permission and that the absence of a prohibition would be sufficient to allow or permit the offer of the company’s shares to the public. Section 20(1)(c) of the Companies Act provides that the articles of a private company must prohibit any offer of its shares to the public – accordingly all private companies would not be permitted to offer their shares to the public and would not fall within the ambit of section 6(a)(ii).
Subsection (i) is not so clear and is analyzed in more detail. The plain language of subsection (i) seems to be clear and is consistent with the requirements for a private company, as set out in section 20(1)(a) of the Companies Act. If the articles provide for an unrestricted transfer of the company’s shares, the company would be a widely held company. Although subsection (i) states that the articles must “provide” for an unrestricted transfer of the company’s shares, it is submitted that the word “provide” is wide enough to include the situation where the articles contain no express provision restricting the transfer of the shares in the company, and accordingly the transfer of the shares are unrestricted. Conversely, any restriction on the transfer of shares contained in the articles would mean that the articles do not provide for an unrestricted transfer. This interpretation is nothing new and is simply a negative statement of the first part of the definition of a private company in section 20(1)(a) of the Companies Act.
Although the plain meaning of section 6(a)(i) seems clear that any restriction on the transferability of the shares in the company would be sufficient for a company to fall outside of the scope of section 6(a)(i), section 6(c) creates confusion by stating that, “For the purposes of this subsection a transfer of shares is unrestricted if it is not subject to an effective right of pre-emption”. Section 6(c) goes further to provide that an effective right of pre-emption is a right of pre-emption which operates in favour of all shareholders and upon every proposed sale of shares to a person who is not a shareholder. As I see it, section 6(a)(i) read with section 6(c) can mean one of two things:
- first interpretation: the only instance where the articles could be said to provide for an unrestricted transfer is where the articles do not contain an effective right of pre-emption – i.e. if the articles contain a pre-emptive right that falls short of what is defined as an effective right of pre-emption, there would be no effective right of pre-emption and the transfer of the shares would be unrestricted. The only restriction on transfer of the shares that are to be recognised for this purpose is where there is an effective right of pre-emption, to the exclusion of any other restriction on transfer, no matter how much it restricts the transferability of the shares; or
- second interpretation: any restriction on the transferability of the shares in a company would mean that the articles do not provide for an unrestricted transfer of the shares, and section 6(c) merely clarifies that a transfer of shares is unrestricted if it is not subject to an effective right of pre-emption, without it being the only instance of an unrestricted transfer.
In my view, the first interpretation, can lead to absurd results. A company with an absolute restriction on the transferability of its shares (and a smaller chance that any outside investor could ever acquire shares in the company), but without an effective right of pre-emption, would fall within the definition of a widely held company merely because it does not have an effective right of pre-emption in its articles. Surely, if the intention of the legislature (as stated in the memorandum on the objects of the Amendment Act) is to protect investors, this intention would be better achieved by defining limited interest companies with reference to restrictions on the transferability of shares rather than pre-emptive rights. As an example of the effect of the first interpretation: private companies with rights of pre-emption in their articles that exclude anyone from the operation of the right of pre-emption, for example, where sales of shares in a company between group companies are excluded from the operation of the right of pre-emption, would be widely held companies.
I prefer the second interpretation. The second interpretation gives effect to the ordinary meaning of the words “unrestricted transfer” while the first interpretation ignores the words and interprets them narrowly with reference to effective rights of pre-emption only. The second interpretation also seems to fit into the stated intention of the legislature with the Amendment Act. The memorandum on the objects of the Amendment Act states that to “qualify as a limited interest company, a company’s articles will have to restrict the transferability of its shares …”. This means that all private companies (which by definition restricts the transferability of shares in the company), and any public company with a restriction on the transferability of its shares, would be classified as limited interest companies (assuming it meets the other requirements of section 6). Companies (such as JSE listed companies) with no restriction on transfer of their shares would be widely held companies (assuming it meets the other requirements of section 6).
Once a widely held company, always a widely held company?
Subsection 7 says that an existing widely held company which prior to its annual general meeting ceases to fall within the definition of a widely held company, may by special resolution passed at that annual general meeting, become a limited interest company, if the directors certify that the company will not in the following financial year seek to become a widely held company. The implication of this is that a company will not stop being a widely held company automatically upon it ceasing to fall within the definition of a widely held company. Only upon passing a special resolution to become a limited interest company, will the company cease to be a widely held company. In addition, this special resolution can only be passed at the next annual general meeting. The implication of the section seems to be that if such special resolution is not passed the next annual general meeting, the company remains a widely held company. It is not clear whether this subsection merely gives a company the right to choose when it will become a limited interest company (in other words to fix the date by which it will become one) or whether it stipulates the only way in which a widely held company can become a limited interest company. In light of the definitions in subsection 6, the former interpretation seems the more palatable.
All issues of new shares in limited interest companies have to be by way of rights issue?
The new section 6(e) provides that an effective right of pre-emption contained in the articles of a limited interest company shall be deemed also to operate, with the necessary changes, upon “an offer by the company of shares created in terms of section 75(1) of the Companies Act to any person who is not a shareholder of the company”. Any limited interest company that wishes to issue new shares created in terms of section 75(1) (the section dealing with the increase of the company’s share capital) must first offer to issue those shares to existing shareholder pro rata to their existing shareholding. This provision is odd for a number of reasons. Firstly, it seems that this section constitutes a substantive provision of the Companies Act although it is contained in the definition section of the Companies Act (section 1). Secondly, no mention is made of this new substantive provision of company law in the memorandum on the objects of the Amendment Act. This seems to be a fairly fundamental change to “slip into” the definition section of the Companies Act without any explanation. Thirdly, the new subsection only applies in respect of new shares created in terms of section 75(1), and not in respect of “old” shares which the company was incorporated with. Lastly, it only applies to limited interest companies with an effective right of pre-emption in their articles (this can be seen as an indication that all limited interest companies must have effective rights of pre-emption, and may be some support for the first interpretation referred to above).
Conclusion
The Amendment Act contains far-reaching amendments to the Companies Act. The amendments are not all that easy to understand and companies should consider the provisions of the Amendment Act very carefully before implementing the changes.
Rudolph du Plessis is a director at Bowman Gilfillan.