By Madelein Burger and Sinomtha Mbuqe
Madelein Burger and Sinomtha Mbuqe seek to shed more light on the creation and issue of shares, as well as the transitional status of par value shares under the new Companies Act.
With the reform of the company law regime in South Africa through the enactment of the new Companies Act 71 of 2008 (the Companies Act), as well as the regulations to the Companies Act, there has been uncertainty in practice with regard to the transitional status and treatment of shares under the Companies Act, with a number of questions being raised in this regard. To issue any shares, a company must first ensure that its memorandum of incorporation (MOI) sets out the classes of shares and the number of shares of each class that a company is authorised to issue. In addition, in respect of each class of shares, the MOI of a company must set out the preferences, rights, limitations and other terms associated with a class of shares. The number of authorised shares of each class and the preferences, rights, limitations and other terms associated with a class of shares may only be changed by an amendment of the MOI by a resolution of the board of the company, who may increase or decrease the number of authorised shares of any class or reclassify any classified shares (that is, amend the terms attached to such shares) that have been authorised but not issued, unless the MOI provides for a different approval process and may only be changed by special resolution if any of the shares in a specific class have already been issued.
It is important to note that whereas the general practice under the Companies Act 61 of 1973 (the Old Act) was to reflect the terms of certain classes of shares in subscription agreements or other documents, separate from the old articles of association (especially when issuing preference shares for funding purposes), the Companies Act now requires that all preferences, rights, limitations and other terms associated with a class of shares must be contained in the MOI, failing which they may not be enforceable.
It is also critical to ensure that the terms of the same class of shares are indeed the same. For example, if a company issues shares to its shareholders of the same class, say ordinary shares, but provides in the MOI or shareholders’ agreement that one shareholder will have more voting rights than another shareholder or greater rights as regards dividends, notwithstanding equal shareholding, the shareholders in fact hold different classes of shares and the company is required under the Companies Act to name the classes of shares differently.
Except to the extent that a company’s MOI provides otherwise, directors are authorised to issue the shares of a company, provided that the shares issued have been authorised by or in terms of a company’s MOI and such shares are within the classes authorised and adequate consideration is received by the company for such shares. Generally speaking, issuing shares in a company is a simple process in that all that is required is for the directors to pass a resolution authorising the company to issue the shares to a particular individual or juristic person, subject of course to specific requirements in the MOI or shareholders’ agreement. This is different from the Old Act, as the Old Act always required a shareholders’ resolution for the issue of additional shares to protect shareholders against dilution. The Companies Act now only requires the approval of shareholders by special resolution in exceptional circumstances, namely where a company intends on issuing shares to a director or prescribed officer of that company or a person related or inter-related to that company or a director or prescribed officer or if the shares to be issued will constitute 30 per cent or more of the voting rights in that specific class, a special resolution will also be required. Minority shareholders may therefore wish to negotiate better protection with regard to issue of shares, in the MOI, to prevent the board from diluting the minority, without having to seek the minority’s approval.
Whereas the Old Act required that the subscription price had to be paid in full before the shares could be issued, the Companies Act now provides for a mechanism for a shareholder to subscribe for shares without having paid for such shares in full at the time. Section 40 provides that, if the consideration for any shares that are issued or to be issued is in the form of an instrument such that the value of the consideration cannot be realised by the company until a date after the time the shares are to be issued, or is in the form of an agreement for future services, future benefits or future payment by the subscribing party, the company may issue the shares notwithstanding, subject to a trust agreement being entered into between the company, the subscriber and a third party, for the third party to hold the shares in trust until full consideration has been received. The Companies Act provides for the rights of the subscriber, in the absence of a contrary provision in the aforesaid trust agreement, and facilitates the subscription for shares if a subscriber is not in a position to fund the subscription price on the date of subscription and has proven useful in private equity transactions where a private equity shareholder wishes to advance the subscription price in tranches subject to the performance and financial requirements of the company in question, as well as in empowerment transactions to facilitate vendor financing. Utilisation of this mechanism will also require compliance with the financial assistance requirements of section 44 of the Companies Act.
The Companies Act provides that shares do not have a par or nominal value under the Companies Act, subject to the transitional arrangements contained in schedule 5 of the Companies Act. Despite the abolishment of the concept of par value, all shares issued with a par value by a company which was in existence before 1 May 2011, and held by a shareholder continue to have the same rights associated with the shares, including that the shares will remain to have a par value, subject to any regulations promulgated in this regard.
The regulations provide that par value shares that were authorised by a company incorporated before 1 May 2011 are dealt with in the Companies Act in two ways. If, before 1 May 2011, a pre-existing company had any authorised class of par value shares which had not been issued (that is, no shares in that class have been issued), the pre-existing company would be prohibited from issuing any of the shares until such shares have been converted from par value shares to no par value shares in terms of regulation 31 of the Companies Act. On the other hand, if before 1 May 2011 a company had authorised par value shares from which any shares were issued (for example it had 1 000 authorised ordinary shares with a par value of R1,00 each, of which 100 have been issued), the company may continue to issue further shares of the class (up to the 1 000 authorised ordinary shares) at the par value of R1,00 at any time after 1 May 2011 and may do so until it has utilised the full number of authorised shares (1 000 in our example) or has published a proposal to the company to convert that class of par value shares into no par value shares. However, pre-existing companies are prohibited from authorising any new par value shares or shares having a nominal value (that is, in our example, they may not authorise ordinary shares in excess of 1 000 without first having converted all the shares of that class from par value shares to no par value shares).
Interesting to note is that the prohibition as regards creating new shares applies to the increase of the number of authorised shares, without having first converted the shares from par value to no par value shares, has much broader application than first meets the eye. Any increase in numbers of authorised shares by creating additional shares is hit by this prohibition, including an increase by subdividing existing shares. No new shares may be created of that class without the conversion having taken place but also, in our example, the 1 000 shares may not be subdivided into a higher number of shares without first converting the shares to no par value shares. Some companies have, in an endeavour to avoid a conversion, simply subdivided their number of authorised shares to allow for additional shares to be capable of being issued (that is, in our example subdivided the 1 000 shares into 1 million shares). Such subdivision is however also not allowed until a conversion has taken place.
When a company intends to convert its par value shares to shares of no par value, it should consider the share certificates issued to shareholders, bearing the par or nominal value of the shares. The Companies Act requires that each share certificate bears the name of the issuing company, the name of the person/entity to whom the shares are issued, the number and class of shares and any restriction on the transfer of the shares. It should also be noted that the transitional provisions provide that where a share certificate issued by a pre-existing company fails to satisfy the above requirements, as set out in section 51 of the Companies Act, it will neither constitute a contravention of section 51 nor invalidate the share certificate. Accordingly, a company is not obliged to cancel the existing share certificates bearing a par value on the shares and to issue new share certificates after the conversion, however to err on the side of caution and from a corporate governance perspective, the existing share certificates should preferably be cancelled and new certificates issued which comply with the new requirements.
The conversion of shares from par value to no par value aside, companies and shareholders should be reminded of the new requirements for share certificates, namely that each share certificate should now also record the restrictions on transferability of the shares in question, on the share certificate itself. Failure to do so would be a contravention of the Companies Act.
Madelein Burger is a partner in Webber Wentzel’s Mergers and Acquisition Practice and Sinomtha Mbuqe, is an Associate in Webber Wentzel’s Mergers and Acquisition Practice.
This article was originally published in ASA.