A recent amendment to the South African Companies Act has set structured financiers atwitter. The Corporate Laws Amendment Act 24 of 2006, which came in to effect on December 14 2007, has changed the South African corporate landscape. The amendment to section 38 in particular has opened the door to new structuring possibilities.
Section 38 prohibits a company giving financial assistance (by means of a loan, guarantee, the provision of security or otherwise) for the purpose of, or in connection with, a purchase of or subscription for its shares or shares in its holding company. This prohibition against the giving of financial assistance has long been cursed as an obstacle to overcome when structuring the many Black Economic Empowerment (BEE) deals that continue to bourgeon in the South African market. There is typically a need in these deals for the company selling or issuing shares to a new empowerment partner to assist that partner either by providing a loan or by providing security for bank funding. This assistance has been frustrated by the section 38 prohibition.
Section 38 was originally intended to have a twofold function: as an expression of the capital maintenance rule for the protection of creditors; and as a way of preventing abuse of the company's resources, thereby protecting shareholders. Previous exceptions to the prohibition allowed for financial assistance only in the following circumstances: where the lending of money was in the ordinary course of a company whose business was money lending; where the assistance was in accordance with the purchase of shares by an employee share scheme; where loans were made to employees, other than directors, to enable them to purchase shares in the company they are employed by; and where assistance was given to allow a company to repurchase its own shares.
Deals were structured in myriad ingenious ways to ensure that section 38, which some legal commentators argued was a remnant of an old corporate law regime, did not stifle commercial reality. The Corporate Law's Amendment Act has now provided a new exception to the prohibition, which is intended to relax the rigidity of the previous regime (by allowing BEE deals in particular to be more easily put together), while still enabling the prohibition to protect both creditors and shareholders of the company providing the assistance.
The new exception in sub-section 2A is as follows:
Subsection 1 does not prohibit a company from giving financial assistance for the purchase of or subscription of shares of that company or its holding company if
- the company's board is satisfied that
1. subsequent to the transaction, the consolidated assets of the company fairly valued will be more than its consolidated liability; and
2. subsequent to providing the assistance, and for the duration of the transaction, the company will be able to pay its debts as they become due in the ordinary course of business; and
- the terms upon which the assistance is to be given are sanctioned by special resolution of its members.
Under this new exception, a company may give financial assistance for the purchase or subscription of its shares if two conditions are fulfilled. Firstly, the board of the company must be satisfied that after the transaction the company will be solvent, and after the provision of the assistance and for the duration of the transaction, the company will be liquid (known respectively as the solvency and liquidity tests). Secondly, the shareholders of the company must sanction the terms upon which the assistance is given in a general meeting.
The new exception opens the door for structured transactions. But the drafting of this section is equivocal and commentators are becoming embroiled in debates about the intention of the legislature, which will probably not be finalised before test cases are brought to court. We face a number of interpretational problems. For example, what does it mean for the board to be satisfied? What if the board is negligently satisfied or a financier knows that the board should not be satisfied? Could this render the condition unfulfilled and the assistance prohibited? Since a contravention of section 38 is an offence, directors must be advised to carefully consider their company's position before signing a board resolution on their satisfaction. Perhaps more importantly, financiers should carefully consider whether they are convinced that the board is satisfied before accepting security from the company, because if it transpires that the board was not satisfied then that security will be invalidated.
The moment at which the board must be satisfied is also controversial. The wording of the solvency test suggests that the board should be satisfied regarding the solvency of the company immediately after the transaction, which would ordinarily be understood as the giving of financial assistance. This interpretation is complicated, though, by the wording of the liquidity test, which requires that the board be satisfied that the company be able to pay its debts "subsequent to providing the assistance" and for the duration of the transaction. This implies that the "transaction" and the "provision of assistance" are not the same thing.
This uncertainty about the interpretation of the wording of the new exception will bedevil the practical usefulness of the exception. Boards of companies seeking to use the exception to provide financial assistance will have to consider whether they can be satisfied about the liquidity and solvency of the company. However, with time, the exception will deliver what it was enacted to do: a less restrictive environment that is conducive to empowerment.