The 2006 Corporate Laws Amendment Bill

The Corporate Laws Amendment Bill proposes to introduce certain changes to the Companies Act which will impact on companies in a number of important ways.

The 2006 Corporate Laws Amendment Bill

Source: Carl Stein - Partner, Bowman Gilfillan

3 August 2006

The Corporate Laws Amendment Bill (The "Bill") proposes to introduce certain changes to the Companies Act which will impact on companies in a number of important ways. It is for this reason that we wish to alert our readers to these proposed changes even though they have yet to become law. The Bill is expected to become law later this year.

The most significant proposals are: Firstly, the Bill substantially increases the circumstances in which a company may provide financial assistance for the purchase of its own shares. Secondly, it confers greater protection on minority shareholders in the face of takeovers. Thirdly, it imposes new obligations on companies and auditors in order to promote the independence of auditors. Fourthly, it gives legal backing to the accounting standards currently used for financial reporting.

Section 38 - Financial assistance

At present, section 38 of the Companies Act severely restricts a company from providing financial assistance for the purchase of its own shares or the shares in its holding company. Proposed amendments to section 38 all but remove these restrictions by permitting a company to give financial assistance for the purchase of its own shares where –

  • the board of directors (the "board") is satisfied that the company will remain solvent after the transaction concerned; and
  • the terms upon which the assistance is to be given has been sanctioned by a special resolution of its shareholders.

Assessing the solvency of the company (the so called "solvency test") requires the board to be satisfied that –

  • on a fair valuation, the consolidated assets of the company will exceed its consolidated liabilities after the transaction, for which purpose the board must take account of any contingent liabilities; and
  • the company will be able to pay its debts as they become due in the ordinary course of business.

This test is almost the same as that adopted in 1999 when section 85 of the Companies Act was amended to permit a company to buy back its own shares.

Although the explanatory memorandum to the Bill states that the amendment to section 38 is intended to facilitate Black Economic Empowerment ("BEE") transactions, the amendments themselves do not mention BEE at all. The amendments are therefore not restricted to BEE transactions alone, and should thus facilitate most financial assistance transactions which meet the solvency test.

Section 228 - Greater protection of minority shareholders in the face of takeovers

Currently, the Companies Act contains a number of mechanisms which may be used to expropriate the shares of minority shareholders in the event of, for example, a takeover bid or acquisition of a public listed company. It also contains provisions which protect the interests of minority shareholders in such instances. In order to avoid the more stringent of these provisions, section 228 of the Companies Act has been frequently utilised as a takeover mechanism. The reason for this is that section 228 allows a company to dispose of the whole or the greater part of the assets, or the whole or substantially the whole of its undertaking, if the disposal is sanctioned by an ordinary resolution of its shareholders. In order to be passed, an ordinary resolution requires that a simple majority of shareholders vote in favour of it. A simple majority is achieved if a quorum is present at the shareholders' meeting convened to consider the ordinary resolution and 50,1% of the shareholders who are present or represented and who vote at the meeting, vote in favour of the resolution.

The Bill amends section 228 so as to require shareholders to approve the disposal of the whole or the greater part of the assets of the company by way of a special resolution. In order to be passed, a special resolution requires that 75% of shareholders who are present or represented and voting at the meeting, vote in favour of such resolution. The minimum quorum requirement for a meeting convened to consider a special resolution is shareholders who hold not less than 25% of the total votes of all shareholders entitled to attend the meeting and to vote thereat.

The disposal of wholly owned subsidiaries by holding companies does not presently fall within the jurisdiction of the Securities Regulation Panel because wholly-owned subsidiaries, by definition, only have one beneficial shareholder and therefore fall outside the ambit of the Securities Regulation Code. This means that minority shareholders in holding companies are presently unable to prevent the disposal of a wholly-owned subsidiary by its holding company. Another change to section 228 proposes that a special resolution will also be required where a disposal by a subsidiary would amount to a disposal by its holding company based on the consolidated financial statements of that holding company. This amendment will bring both disposals of subsidiaries and disposals by subsidiaries within the ambit of section 228, thus also increasing the protection of minority shareholders.

Audit Committees and Auditors

The Department of Trade and Industry has been concerned to address what it perceives to be recent failures by the auditing profession to perform independent assessments of their clients. In part, these failures have been addressed by the enactment of the Auditors Profession Act (the "APA") which came into force on 1 April 2006 and which regulates the auditing profession.

Companies which are able to offer their shares for sale to the public (including, but not limited to, public listed companies) (hereinafter referred to as "public companies") will now be obliged to appoint audit committees. An audit committee must consist of at least two members, both of whom must be independent non-executive directors. A "non-executive" director is defined as a director who is not involved in the day to day management of the company and has not been a full-time salaried employee of the company within its past three financial years. The Bill also provides that a director will act "independently" if he/she exercises his/her judgment impartially and he/she is not related to the company or its shareholders, customers, suppliers or other directors in a way that would lead a third party to conclude that his/her integrity, impartiality or objectivity is compromised by that relationship.

The functions of the audit committee include the duty to nominate an auditor for appointment by the board, to fix the terms of his/her engagement and to determine which non audit services the auditor may provide to the company. The audit committee is also required to report on the company's internal accounting and audit procedures and deal with complaints in respect of its auditing procedures.

Where a firm of auditors is appointed as a public company's auditor, the appointment must specify the name of the individual who will actually undertake the audit. The auditor must be "independent of the company". Furthermore, the same individual will not be permitted to serve as such for more than five consecutive financial years. Where he/she has served as the auditor for two or more financial years and then ceases to be the auditor, that individual may not be appointed as the auditor again until at least a further two financial years have elapsed.

Auditors will also be required to attend every annual general meeting of the company where its financial statements are presented in order to answer questions concerning the audit of such financial statements.

A proposed new provision which will have a material impact on the accounting profession is that auditors of public companies will be prohibited from providing such companies with bookkeeping or accounting services and, to the extent that these would be subject to its own auditing, internal audit or tax advisory services while acting as that company’s auditor.

Financial statements

In order to prevent a company from selecting the method of accounting that best represents its financial position and to harmonise the accounting practices of South African companies with that of the international community, the Bill inserts a new section into the Companies Act which provides that financial statements of public companies must comply with "financial reporting standards", being statements of Generally Accepted Accounting Practice which are issued by the Minister of Trade and Industry by publication in the Government Gazette from time to time on the advice of a newly established, fifteen member body called the Financial Reporting Standards Council (the "FRSC"). These standards are more onerous than the current standards outlined in Schedule 4 to the Companies Act but do not apply to companies which are not public companies. The FRSC will be responsible for establishing financial reporting standards for public companies, which must be in accordance with the International Financial Reporting Standards of the International Accounting Standards Board.

Another fifteen member body, called the Financial Reporting Investigations Panel, is also established. This Panel is charged with the duty to investigate alleged non compliance with financial reporting standards and recommend "appropriate measures for rectification or restitution". Its report may, "if it is in the interests of users", be published in the news media and must be made available for inspection by the public.

A public company and each of its directors or officers who is a party to the issue, circulation or publication of any financial statements which are materially incomplete or which do not otherwise comply with the above requirements will be guilty of an offence. The Bill also makes it an offence for any person to be a party to the preparation, approval, publication, issue or supply of a financial report that is false or misleading in a material respect if such person knows or ought reasonably to suspect that it is false or misleading.