Topic 9 – Corporate finance and capital control

Introduction:
Corporate finance concerns itself with the return of funds to a company’s shareholders. This can be
problematic to creditors and minority shareholders. This calls for the law only permitting that
transaction if it will not lead to insolvency or liquidity of the company. This topic deals with the situations
where a company parts with their funds in situations other than in the ordinary carrying on of business.

Company law:
A key function of company law is to protect its shareholders, employees and creditor s through fair
regulations and effective remedies. This ensures the protection of legitimate interests and aims to
prevent improper or oppressive conduct.
Section 7 of the Companies Act 71 of 2008 assists us in regulating this. A balance must be found
between promoting the business and ensuring accountability towards the interest bearers.
The enlightened shareholder value approach aims to act to benefit the company’s shareholders, and
explains that stakeholders (employees, creditors, consumers) should also be taken into consideration as
‘interest bearers’ that are worthy of protection.
The Act is in favour of the ESV objectives, which can be seen in;
• Section 20(4) of the Act: a trade union representing employees of a company can interdict the
company from violating the Act.
• Creditors are permitted to apply for the liquidation of a company/placing a company under
business rescue
• Creditors are protected during mergers and acquisitions
Limited liability is good for shareholders and investment, but creates a risk for a company’s
stakeholders, particularly its creditors.
• limited liability may cause the controllers of companies to take excessive risks that may
consequently prejudice creditors.
• Creditor protection philosophy is evident in the Act:
• Section 4 of the Act (Van der Linde article)
• Section 22 of the Act

The control of corporate capital:

‘The protection of a company’s capital is historical and fundamental. Company capital occupies a key
position within the operations of a company, so scrutiny of the role that shareholders play vis-à-vis
company directors in the protection of that capital is essential. The importance of a company’s capital
has always been seen through the lens that it is meant for the satisfaction of creditors’ claims. In Re
Exchange Banking Co, the court said:
“The creditor has no debtor but that impalpable thing, the corporation, which has no property except
the assets of the business. The creditor gives credit to that capital and he has therefore a right to say the
corporation shall keep its capital and not return it to the shareholders.”’
(Extract from Bidie S “Examining the interpretation of section 115(2)(a) of the Companies Act of 2008”
(2022) 2 6 Law, Democracy & Development)

From capital maintenance to solvency and liquidity:

Share Capital Maintenance doctrine
Control of corporate capital was based on a collection of common law rules interpreted by South
African courts and codified in the Companies Act 61 of 1973
The purpose of these rules was the protection of a company’s creditors against limited liability and the
risk of asset stripping
Share capital was seen as a guarantee fund = the only source creditors could look to for payment of
their debts
Therefore, companies were forced by general rules to maintain their share capital
Strict prohibitions of capital maintenance doctrine:
Companies could only pay dividends out of profits
Companies were not allowed to issue shares at a discount
Companies were not allowed to buy back their own shares, either from issue or back from
shareholders
Regarded as commercially undesirable

1999 Amendment removed share capital maintenance rules

Absolute prohibitions were discarded
Replaced with a solvency and liquidity standard (from USA law)

The solvency and liquidity requirement:

To protect and safeguard creditors and minority shareholders, the company’s board of directors cannot
make any proposed distribution unless; they have applied the solvency and liquidity test and that they
acknowledge that they will satisfy the test immediately after they complete the distribution.
In the case of120 business days passing since the initial acknowledgement and the distribution has not
been completed, they are required to redo the test in respect of the remaining amount.

Solvency and liquidi ty test:

This test is focused on the ability of the company to repay its creditors – which is a more subtle test and
manner of control compared to the capital maintenance doctrine. This test has two aspects to it, the
solvency aspect (which recognises the priority that creditors enjoy over the shareholders upon the
dissolution of the company, which in turn prevents the company from favouring its shareholders
through a partial liquidation) and the liquidity aspect (which recognises the fundamental expectation of
the creditors to be paid on time).

This test is set out in section 4 of the act and for a company to satisfy this test, they must at any time,
considering all reasonably foreseeable financial circumstances of the company at the time, have assets
that are fairly valued at an amount that equals or exceeds the liabilities of said company, and it must
appear that they will be able to pay their debts as they become due for a period of 12 months.

Significant points to this test are; a fair valuation of assets and liabilities, unless the MOI states
otherwise, the preference shareholders are not to be treated as creditors of the company, the test must
be objective, uncompleted distributions must be taken into account as liabilities, and, the assets and
liabilities of any other company in the group or group as a whole cannot be considered.

This test will apply to several transactions, such as; distributions, share buy-backs, financial assistance
for purchase or acquisition of shares, financial assistance to directors and related persons, statutory
mergers.

Liability of directors:
A director is liable for any loss, damages or costs sustained by the company as a direct or indirect
consequence of an unlawful distribution. This arises only if the director participates in the relevant
resolution with the knowledge that it was unlawful. Section 1 of the act provides that knowing means
that the person has knowledge of the matter or were in the position to reasonably have ought to have
knowledge, investigated the matter or could have been expected to have knowledge. The director may
still apply to the court for an order setting aside the liability. This does not rule out the existence of
section 20(6) which provides for shareholders to be able to claim for damages.
A director can be relieved from their liability if there was no willful misconduct or breach of trust. The
director must have acted reasonable and honestly.
The prescription for the recovery of these damages run out after three years after the act or omission.
The amount a director can be liable for also has a limit. This limit is between the amount the
distribution exceeded the amount that could have been distributed without causing the company to fail
the solvency and liquidity test, and the amount recovered by the company from the person to whom the
distribution was made.

Distributions:
Section 1 of the act provides that a distribution is the transfer of money or property, excluding own
shares, to holders of shares in the company or another company in the group, directly or indirectly.
This includes dividends, payments in lieu of capitalization shares, payments of the consideration for the
acquisition by a company of its own shares, and, shares of another company in the group.
However, this does NOT include appraisal rights or distributions upon liquidation.

Why do we need to regulate distributions? It is because assets are leaving the company and this can
threaten the creditors interests.

Authorization of a distribution needs to take place and must generally be done by the company’s board
of directors. Shareholder approval is not needed for this. A court order/legal obligation can also
authorize a distribution according to section 46(1)(a).

The requirement for the authorization is that it must be a court order or a resolution from the board of
directors. It must reasonably appear that the solvency and liquidity test will be passed after the
distribution has been completed, and that there is acknowledgement of the test and the board
reasonably concludes that the solvency and liquidity test is passed.

Directors can also be personally liable for the company’s loss if they were present at the meeting where
the distributions were authorized (s46(6)(a)), did not vote against this (s46(6)(b)), the company does not
pass the solvency and liquidity test immediately after the distribution (s77(4)(a)(i)) and it was
unreasonable to conclude that they would pass the test (s77(4)(a)(ii)).

Once the requirements are met, the distribution MUST proceed.

Share buy - backs:

A share buy-back is the process of a company issuing shares to shareholders and then purchasing
them back. For years this was prohibited to avoid misuse of this practice, but it has since been
changed.
Trevor v Whitworth established that it could not be done even if it was permitted by its constitution. It
posed problems such as trafficking with shares, insider trading, prejudice towards existing shareholders
and directors abusing it to expand their own control.

The justifications for this practice is that the repurchases can be usefully utilized to buy out dissident
shareholders, they enable the company to return surplus funds to shareholders, they can be used to
maintain or achieve what is perceived to be a desirable debt-equity ratio, to reduce the administrative
overheads, assisting companies in takeovers and mergers, to avoid a hostile takeover, and, to assist
management in a buy-out of control of their company.

The benefits that come with this practice is that it supports share value against speculators, it offers an
opportunity to employees who leave employment, it is a defense against hostile takeover and it
increases the earnings per shares.

When shares are repurchased, they become authorized unissued shares and can be issued again.

Share repurchases under the Companies Act of 2008 (section 48) - Repurchases in terms of appraisal
rights and the redemption of redeemable shares are NOT buybacks in terms of section 48(1)
Payments for share repurchases are treated as distributions by a company and must comply with the
requirements of a valid distribution (Section 46(2))

The requirements for a buy-back are; the section 46 requirements have been met, a subsidiary may not
hold more than 10% of the holding company’s issued shares, after the acquisition the company’s
issued shares cannot be held by only a subsidiary and cannot only be convertible or redeemable, and,
section 114 and 115 requirements.

Financial assistance for the acquisition of securities:

This is regulated by the act to ensure that the corporate funds are used for the proper corporate
purposes. This was seen ass a highly improper practice that is open to the gravest abuse and close to a
company trafficking in its own shares. It aimed to protest against the misuse of the company’s capital to
dilute the share value, diminish capital to support incoming buyers and avoid there not being any
control against takeovers.

This is not the case anymore. Section 44 of the act now regulates this practice. It provides that;
44.
(1) In this section, ‘‘financial assistance’’ does not include lending money in the ordinary course of
business by a company whose primary business is the lending of money.
(2) To the extent that the Memorandum of Incorporation of a company provides otherwise, the board
may authorise the company to provide financial assistance by way of a loan, guarantee, the
provision of security or otherwise to any person for the purpose of, or in connection with, the
subscription of any option, or any securities, issued or to be issued by the company or a related or
inter-related company, or for the purchase of any securities of the company or a related or inter-
related company, subject to
subsections (3) and (4).
(3) Despite any provision of a company’s Memorandum of Incorporation to the contrary, the board may
not authorise any financial assistance contemplated in subsection (2), unless—
(a) the particular provision of financial assistance is—
(i) pursuant to an employee share scheme that satisfies the requirements of section 97; or
(ii) pursuant to a special resolution of the shareholders, adopted within the previous two years,
which approved such assistance either for the specific recipient, or generally for a category
of potential recipients, and the specific recipient falls within that category; and
(b) the board is satisfied that—
(i) immediately after providing the financial assistance, the company would satisfy the solvency
and liquidity test; and
(ii) the terms under which the financial assistance is proposed to be given are fair and
reasonable to the company.
(4) In addition to satisfying the requirements of subsection (3), the board must ensure that any
conditions or restrictions respecting the granting of financial assistance set out in the company’s
Memorandum of Incorporation have been satisfied.
(5) A decision by the board of a company to provide financial assistance contemplated in subsection (2),
or an agreement with respect to the provision of any such assistance, is void to the extent that the
provision of that assistance would be inconsistent with—
(a) this section; or
(b) a prohibition, condition or requirement contemplated in subsection (4).
(6) If a resolution or an agreement has been declared void in terms of subsection (5) read with section
218(1), a director of a company is liable to the extent set out in section 77(3)(e)(iv) if the director
(a) was present at the meeting when the board approved the resolution or agreement, or
participated in the making of such a decision in terms of section 74; and
(b) failed to vote against the resolution or agreement, despite knowing that the provision of
financial assistance was inconsistent with this section or a prohibition, condition or
requirement contemplated in subsection (4).
When will section 44 apply? You must ask two questions; was there financial assistance? was it for the
purpose of or in connection with the purchase of securities or subscription to securities?

What is the meaning of financial assistance? The act says this does not include lending money when
that is what takes place in the normal course of business for the company. This means t is a loan, a
guarantee, the provision of security or otherwise. Note that payment of a debt is not financial
assistance. There is a test to help determine this. This is called the impoverishment test.

The impoverishment test asks whether the transaction has made the company poorer. If yes, then
financial assistance has occurred. Lipschitz v UDC Bank 1979 1 SA 789 (A) the AD was not convinced
at the generality of the acceptance of this test. They stated that this assistance does not always involve
impoverishing the company. An example of this is when the company has purchased an asset at an
inflated price which is not required for the business.

The meaning of ‘for the purpose of or in connection with’ excludes the normal commercial transactions
in the interest of the company. in Lipschitz NO v UDC Bank Ltd. The court said the meaning of the
words was profoundly affected by the concept ‘for the purpose of’ to which it was an alternative. The
words appeared to have been inserted to cover a situation where, although the actual purpose of the
company in giving financial assistance might not have been established, the conduct of the company
nevertheless stood in such close relationship to the purchase of its shares that substantially, if not
precisely, its conduct was similar to that of a company that was giving the forbidden assistance with the
purpose described in the section.

Scope of Application of s 44(2)

Section 44(2): Also includes related and inter-related companies
Company A is “related” to Company B if:
(i) Company B is a subsidiary of Company A;
(ii) if Company A is able to exercise control over the majority of voting rights associated with
Company B’s securities; oe
(iii) if Company A is entitled to appoint or elect, or control the appointment or election of directors
holding the majority of voting rights on Company B’s board of directors.
In essence, the “related” relationship is about control.

Requirements
REQUIREMENTS: S 44(3) (Act) and 44(4) are;
It must be pursuant to an employee share scheme that satisfies the requirements of s97, or pursuant to
a special resolution of the shareholders, the board must be satisfied that immediately after providing
the financial assistance, the company would satisfy the solvency and liquidity test, and, the board must
be satisfied that the terms are fair and reasonable to the company. It must also satisfy the MOI
requirements.
SUBJECTIVE STANDARD, not objective like with distributions

Consequences of non- compliance

Financial assistance and resolutions are void (s 44(5)) if contrary to Act or MOI
A punitive sanction such as a fine.
Directors personally liable towards: Company (ss 44(6) & 77(3)(e)(iv)), Shareholders (s 20(6)), Third
party (s 218(2))
Applications can be made to court – decision to set aside (s 77(5))
Financial assistance to directors and related perso ns
A company that wishes to provide ‘financial assistance’ to one of its directors, a related juristic person,
or to a person related to a director or related juristic person, must comply with the requirements
contained in section 45 of the Companies Act 71 of 2008 (the Act) to validly execute such a
transaction. The Act contains no precise definition of the term ‘financial assistance’.
Commentators have speculated that the reach of section 45 may be extremely wide. In Constantia
Insurance v The Master of the High Court, Johannesburg (512/2021) [2022] ZASCA 179 the Supreme
Court of Appeal (SCA) laid down a narrow interpretation of ‘financial assistance’ that explains that the
list is an exhaustive list.

Consequences of contravening s45:

There are no criminal consequences. The resolution will be void to the extent that the provision of that
assistance would be inconsistent with the act or MOI. The act does impose liability on the director who
was present when it was approved, or who participated in the making of the decision, who did not vote
against the resolution while knowing of the inconsistency, and those who had knowledge of this
inconsistency. This is a liability for any loss, damage or cost that the company sustains as a direct or
indirect consequence of the voidness of the resolution or agreement.

Scope of application of section 45

Scope of section 45 is potentially extremely wide:
1) T he r ecipient:
“a director or prescribed officer of the company of a related or inter -related company or corporation,
or to a member of a related or inter-related corporation, or to a person related to any such company,
corporation, director, prescribed officer or member”
What is a related person?
Section 2 of the Act: A natural person is related to another natural person if they are married, live
together in a relationship similar to a marriage, or are separated by no more than two degrees of
consanguinity or affinity.
A natural person is related to a juristic person if the natural person directly or indirectly controls the
juristic person.
A juristic person is related to another juristic person if either of them directly or indirectly controls the
business and activities of the other, if either of them is a subsidiary of the other, or if a person directly
or indirectly controls each of them.
2 ) T he F inancial Assistance:
Section 45(1)(a) of the Act: “financial assistance” for the purpose of section 45 “includes lending
money, guaranteeing a loan or other obligation, and securing any debt or obligation”.
1) Loans
2) Guarantees
3) Securing a debt

REQUIREMENTS
S 45(3) (Act) and 45(4)
1) Employee share scheme (S97); or Special Resolution within previous 2 years wrt general or specific
recipient
2) Solvent and liquid after fin assistance
3) Terms are fair and reasonable to Co; and
4) MOI requirements are fulfilled
• SUBJECTIVE STANDARD, not objective like with distributions
Case law on section 45 of the Companies Act 71 of 2008
T r evo Capital Ltd v Steinhoff International Holdings (Pty) Ltd (2833/2021) [2021] ZAWCHC 1 23 (2 July
2021)
(information from articles)
The recent High Court decision in Trevo Capital Ltd and Others v Steinhoff International Holdings (Pty)
Ltd and Others (2833/2021) [2021] ZAWCHC 123 (2 July 2021) considers Section 45 of the Act and
adopts a broad purposive approach to the wording contained therein. The Steinhoff case is of
particular relevance to South African companies seeking to authorize the provision of financial
assistance to, or for, the benefit of related or inter-related foreign corporations. Further, the Steinhoff
case examines the circumstances in which financial assistance, previously approved by the board in
terms of the Act, is considered "new" financial assistance requiring fresh board approval.

The key takeaways from the Steinhoff case, which are relevant in respect of Section 45 financial
assistance, can be summarised as follows:
• A foreign company falls within the meaning of a "corporation" as set out in Section 45(2) of the
Act.
• The solvency and liquidity test, set out in Section four of the Act, must be applied with reference to
the documentation and information available to the board at the time that such financial
assistance was approved, and not with the benefit of hindsight.
• The restatement of a debt on different terms and conditions, and involving at least one different
party, is the creation of a fresh debt and will need to be specifically approved by the board in
terms of Section 45 of the Act, even where the previous financial assistance was approved by the
board.
• Failure to comply with the provisions of Section 45 of the Act will render the financial assistance
void and may result in personal liability for the individual members of the board who authorized
such financial assistance, in certain circumstances.

Constantia Insurance v The Master of the High Court, Johannesburg (512/202 1 ) [2 0 2 2 ] ZAS CA 1 7 9
(summary of important information found in an article)
In summary therefore, "financial assistance" under section 45 of the Companies Act can only apply to
direct or indirect "financial assistance" which is:
• lending money to a related person;
• guaranteeing a loan or other obligation of a related person; and
• securing any debt or obligation of a related person.
The exhaustive list of instances of financial assistance in section 45(1)(a) must be read with section
45(2), which provides that the prohibition against "financial assistance" to related persons applies to
direct and indirect "financial assistance".

In the Constantia case, the SCA found that the indemnity by Protech Investments indirectly secured the
obligations of Protech Khuthele and was therefore financial assistance within the meaning of
paragraph (a) of the definition of "financial assistance". Put another way, the SCA found that the
indemnity by Protech Investment in favour of Constantia secured the obligations owed by the Protech
Khuthele to third parties and therefore constituted "financial assistance" indirectly for those obligations –
the direct obligations under the indemnity being owed to Constantia.