New Company Law Regime for South Africa: Some Implications For Financing Transactions
Kevin Cron -
The current South African Companies Act was introduced in 1973 and, despite being amended several times since then, is out of date in many respects and has not reflected many of the developments in market practice over the years. A complete revision of the Companies Act was therefore begun four years ago which resulted in the enactment of a new Companies Act in 2008.
Although the new Act has been enacted, it is not yet in force and is expected to be brought into force in mid-2010.
Furthermore, although the Act has been promulgated, the numerous regulations contemplated in the Act are still in the course of drafting and will need to be finalised and published before the Act can be brought into force.
While the 2008 Act retains many of the existing features of South African company law, albeit in some instances in modified form (for example, the duties of directors have been partially codified in an attempt to spell out many of the common law obligations relating to directors), the new Act also introduces a number of new concepts hitherto unknown in South African law. Thus, the concept of a statutory mechanism of merger and amalgamation similar to that found in Canada and certain US jurisdictions has been introduced and an entirely new concept in the form of “business rescue” has been introduced, inspired by the Chapter 11 provisions in USA insolvency law.
The new legislation provides for two broad categories of companies, namely “non-profit companies” and “for profit companies”. The “non-profit companies” are companies which are designed primarily for charitable and similar purposes, whilst “for profit companies” are companies to be utilised for general commercial purposes. The “for profit companies” will in turn be split into four base types, namely private companies, personal liability companies, public companies and state-owned companies. Foreign companies that conduct business in South Africa will be required to register as external companies in South Africa, as is currently the case. These provisions essentially reflect the types of companies available under current legislation.
Viewed from the perspective of those involved in banking and finance transactions, the new legislation introduces a number of changes and new concepts which will require careful consideration and will have an impact on the structuring and documentation of finance transactions. There are three areas which stand out as being immediately relevant in this regard, namely the changes to the share capital structure of companies, the changes made to the doctrine of constructive notice, the establishment of the capacity of a company and, finally, the introduction of the concept of business rescue.
Under the current Companies Act, companies may have shares with a par (or nominal) value, shares of no par value or may be limited by guarantee. In the new legislation, the concept of companies limited by guarantee has disappeared entirely and it is provided that, in future, all companies must have shares of no par value. The concept of par value is therefore to be phased out. The rationale for this is that the par value of a share seldom bears any realistic relationship to the actual or market value of that share and, given the relaxation in the historical rules relating to the maintenance of capital, the concept of par value is therefore now irrelevant. The primary impact of this change from a banking and finance point of view is the effect that this will have on the highly popular method in South Africa of funding through the use of preference shares. For many years, South African corporate entities have found the use of preference shares to be an efficient and cheaper form of funding in many instances than simply raising debt. The types of preference shares issued in this regard are invariably par value shares. The par value of the preference shares is relevant in determining the voting rights of the shares (which, in the instance of public companies, are dependent upon the amount of the par value of the shares). In addition, the distinction between share capital and share premium is often relevant in calculating the redemption value of the preference share.
Not only will the new Companies Act effectively abolish par value as a concept in share capital, it does not even contain any reference to preference shares. The new legislation provides that a company may in its Memorandum of Incorporation (MOI) (which will be the constitutional document of a company in the future), create different classes of shares, being classes of shares having different rights and interests. A transitional period is provided for to enable companies to convert their existing constitutional documents to the new MOI and presumably at the same time to convert their par value shares to no par value shares. While preference shares have been largely regulated by the rights attaching to such preference shares which would be embodied in the constitutional documents of the company, they have also relied, to a large extent, upon the accepted legal provisions applicable to preference shares found in current company law; and the conversion of existing preference shares from their current form to a form which will accord with the requirements of the new legislation is therefore a task which requires careful consideration and is not entirely free from difficulty. Given that South African banks and other financial institutions hold many billions of rands of investments in the form of preference shares, the potential for disruption to the economic system in South Africa if the process is not handled properly is significant. The task of converting all the preference shares currently in issue is an enormous one and, given the risk of disputes if the necessary changes are not made timeously, of importance to both issuers and holders.
The legal profession has recommended to the responsible minister that a transitional period of at least two years be allowed to complete the process, during which period the existing provisions relating to par value and preference share would remain in place, to enable companies and investors adequate time to undertake the exercise of converting the existing preference share structures into equivalent structures under the new legislation.
Interestingly, the transitional arrangements contained in the new legislation exempt banks from the conversion of par value to no par value shares until the minister has consulted with the responsible financial authorities in South Africa. Although the wording of this provision is not entirely clear, it can only be interpreted on the basis that it is the bank’s own capital structure that has been temporarily exempted from the requirements to convert from par value to no par value shares and it cannot relate to the numerous preference share investments held by banks but issued by ordinary corporates. The exemption is therefore targeted at preventing disruption to the capital structure of banks themselves but does not apply to investments held by banks.
A further complicating factor is that currently in South Africa an agreement between all the shareholders overrides the company’s constitutional documents as between the shareholders. The new Act specifically provides that a shareholders agreement cannot override the MOI and, to the extent that there is any conflict between the MOI and the provisions of a shareholders agreement, the MOI will prevail. In the conversion process therefore, it will be necessary to ensure that all of the relevant provisions relating to the relationship between shareholders, which currently may be encapsulated in a shareholders agreement, will need to be analysed and, if necessary, included in the MOI.
The doctrine of constructive notice is a doctrine that has existed for many years in South African law. In terms of this doctrine, persons dealing with a company are regarded as having knowledge of a company’s constitutional documents as they are registered and open for inspection at a public registry. The new legislation abolishes this doctrine and provides that the mere fact that the MOI and Notice of Incorporation of a company are registered in a public registry will not result in third parties being deemed to have knowledge of those documents or their contents.
The doctrine of constructive notice has been of great value in structuring financing transactions in facilitating the creation of insolvency remote special purpose vehicles as an integral part of financing transactions. By limiting the authority and capacity of a company, the risk of insolvency is reduced and the use of such insolvency remote special purpose vehicles is a common feature of South African financing transactions. The loss of the doctrine of constructive notice is therefore of concern. It must be conceded that special provision is made in the new legislation for companies with limited powers or capacity, such companies to be designated “RF” (being an acronym for “ring-fenced”). If particular reference is made to these limitations in the company’s Notice of Incorporation, then the doctrine of constructive notice does apply. However, the new Act further provides that no person may rely on a limitation, restriction or qualification in any legal proceedings to claim that a company’s action is void, save between the company and its shareholders, directors or prescribed officers, or between the shareholders and directors and/or prescribed officers. Accordingly, if a third party contracts in good faith with a company without actual knowledge of its restrictions, even if it is a company designated “RF”, then it may not be possible to rely upon the restriction. The position is unfortunately not clear, but it may be that the deeming provision in relation to RF companies will be sufficient to ensure that third parties are deemed to have knowledge of the restrictions.
Finally, the introduction of the concept of business rescue is an innovation in South African law. Currently, companies in financial distress may be placed under judicial management, which is a process designed to permit a company an opportunity to reorganise its affairs and avoid being wound up. In practice, judicial management has been a failure and has been found to be an ineffective mechanism of corporate rescue. It is seldom used in practice. The 2008 Companies Act introduces the concept of a business rescue practitioner. Once a company is placed under business rescue proceedings, the business rescue practitioner will have full management control over the company and the board will be subservient to the business rescue practitioner. The business rescue practitioner will be required to devise, within prescribed time limits, a business rescue plan designed to restore the company to financial health. Such a business rescue plan must be submitted to creditors for approval and, if the plan is approved, the business rescue practitioner has been granted sweeping powers to implement the plan. Business rescue proceedings are not necessarily court driven processes although the ability for interested parties to request the court to intervene is clearly established. Business rescue proceedings will be an important new tool in workout proceedings and it remains to be seen whether this process will be more successful in preserving companies than judicial management has been. Of particular concern to the finance industry, however, are the powers given to the business rescue practitioner to suspend or cancel, in whole or in part, the provisions of contracts entered into by the company (except employment contracts). The exact ambit of this power and its possible implementation is currently the subject of much heated debate in South Africa and it has even been suggested that it may be unconstitutional if it is applied in such a way as to give rise to an expropriation of contractual rights. The application of these powers on security documents is also unclear and the ambit of this section is of great concern to banks and other financial institutions.
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The introduction of a new company law regime in South Africa therefore clearly holds a number of opportunities and challenges for the banking and finance industry and it will be fascinating to see how the issues arising out of the new legislation are dealt with and resolved in practice.