Rules of the game: The laws governing the establishment and activities of a company

The South African legal system is built upon the foundation of the common law. In this light, legislation in South Africa should be seen as a body of law that has been superimposed and embedded upon the common law. The common law consists of that entire body of law that is not found in legislation. As such, in instances where legislation is silent, the common law will still apply. It is to be remembered, however, that all laws in South Africa must be consistent with and remain subject to the Constitution of the Republic of South Africa.

The term “corporate law” could be understood to include financial and banking regulation, stock exchange rules and regulations, taxation, exchange control regulation, company law and many other legal areas. However, we have limited our remarks to developments in South African company law.

NEW ACT: A significant development in South African company law was the introduction of the Companies Act No. 71 of 2008 (the New Act). The New Act replaced the Companies Act No. 61 of 1973 (the Old Act). Accordingly, the New Act, which came into effect on May 1, 2010, is now the predominant law regulating companies in South Africa. Historically, developments in South African company law have been influenced largely by English company law due to, inter alia, the Old Act having been based primarily on English company law. In contrast, the New Act embodies principles adopted from multiple jurisdictions, including the UK Companies Act, the Model Business Corporation Act (US), the Maryland General Corporation Law (US), the Delaware General Corporation Law (US), the New Zealand Companies Act and Canadian company legislation.

FLEXIBILITY: This latest company law reform has been informed by a desire to encourage business activity and entrepreneurship by providing a flexible regulatory environment that serves, where possible, to ease the regulatory burden on those who would like to incorporate, while at the same time maintaining and improving corporate governance. In this context, the New Act introduces several principles that are intended to ensure that company law remains simple, comprehensive and accessible. Some of these principles are discussed below.

FORMING A COMPANY: The constitutional documents of the company under the Old Act were the memorandum of association and the articles of association. Under the New Act, these have been replaced by a single legal document, the memorandum of incorporation (MOI) to enhance simplicity in the formation of companies. In addition, the board of directors of a company can now make rules in limited instances that are binding on the company until such time as they are changed or approved at the company’s next annual general meeting.

The New Act contains both alterable and unalterable provisions. Alterable provisions can be varied in the MOI and are intended to facilitate flexibility in the legislation so that, for example, a small, privately held company with one shareholder does not require the same levels of regulation as a large, publicly listed company. Unlike the Old Act, the New Act permits the board of directors of a company to issue shares (from existing authorised share capital) without prior shareholder approval.

Private companies are, as a general rule, not required to audit their financial statements, unless they have elected to do so in their MOI. A foreign company not wishing to incorporate a subsidiary in South Africa may instead register and operate as an external company. The requirements of an external company are less stringent than those of resident companies. The definition of “external company” is clearer in the New Act than in the Old Act, and the New Act clarifies with which provisions of the New Act an entity, which satisfies the external company definition, is required to comply.

The capital maintenance doctrine, which previously sought to protect shareholders and creditors from the occurrence of certain transactions, has been abolished and, in certain instances, replaced with the dual protection of requiring that such transactions receive shareholder approval and that the company meet the solvency and liquidity test.

The previous regulation and prohibition for the provision of loans (and other financial assistance) by a company to its directors and entities associated with such directors have now been significantly extended. Under the New Act financial assistance to all persons related to the company are captured. As such, for example, a loan by a holding company to its subsidiary falls within the ambit of the relevant provision. In these circumstances, a shareholders' special resolution and compliance with the solvency and liquidity test will be required from the holding company before the loan is advanced.

CORPORATE GOVERNANCE: To improve corporate governance, directors’ duties are codified so as to enhance the accessibility of the standards to which directors are held. These duties are categorised into fiduciary duties and the duty of care, skill and diligence. The New Act introduces a business judgment test, in terms of which a director will be deemed to have complied with the duty of care, skill and diligence and his fiduciary duty to act in the best interests of the company if: (a) he took reasonably diligent steps to become informed about the matter; (b) he has no undisclosed material personal financial interest in the decision in question; and (c) he reasonably believed and did in fact believe that the decision was in the best interests of the company.

In addition, the New Act makes provision for “prescribed officers”. A prescribed officer is defined broadly to include persons other than directors who exercise general executive control. The important features of this definition include that prescribed officers are subject to the duties of directors, and that any company that is required to have its annual financial statements audited must also disclose the emoluments received by its prescribed officers.

The New Act highlights employee activism. For example, employees are entitled to bring an interdict against the directors of a company if such directors propose to do something inconsistent with the New Act and, in certain instances, may bring an action on behalf of a company against delinquent directors for the recovery of loss or compensation of damages to the company. Employees are also entitled to receive certain notices, such as the commencement of business rescue proceedings.

The New Act introduces, for the first time in South Africa, a business rescue regime. In terms of the new regime, the management of an insolvent company or a company that may imminently become insolvent may institute certain proceedings to facilitate the rehabilitation of the company. This brings South African company law in line with international trends, whereby an attempt is made where possible to rehabilitate rather than liquidate businesses that are undergoing financial distress.

TRANSACTION RULES: Finally, the New Act introduces new principles in relation to fundamental corporate transactions, such as disposals of business and acquisition of shares. These principles include: (a) the introduction of a mechanism to implement a genuine statutory merger (similar to mergers contemplated under US company law); (b) that schemes of arrangement no longer automatically require a sanction of the court, as was the position under the Old Act; (c) that the New Act introduces an appraisal remedy protection for minority shareholders to force the company to buy back their shares at fair value where the company undertakes fundamental transactions; and (d) that the Takeover Regulations Panel, which is the statutory body under the New Act that replaces the Securities Regulations Panel under the Old Act, has wider jurisdiction in that it regulates all private companies in which more than 10% of its share capital has traded during the prior 24 months, in addition to publicly traded companies.