A new Companies Act – choosing and structuring your business entity

This is part 2 of a series of posts about the new Companies Act. You can read the first two parts and other posts about South African corporate law right here.

This post was written by Shirley Fodor during her time as a partner at Jacobson Attorneys

It is fairly common knowledge that the manner in which we do business is largely a question of personal choice and practicality. There is no absolute requirement that an entrepreneur select an incorporated entity as the vehicle through which to run his business: a sole proprietorship may well meet a person’s particular needs or in the case of a family business, a partnership may be well suited. What is important however, is that careful consideration is given to the structure of the business entity chosen, and in particular the potential consequences (including the tax implications) of having selected any particular entity, whether it is incorporated or otherwise.

Companies (and close corporations) are in law considered to be juristic persons. This means that from the date on which it receives its Registration Certificate (under the 1973 Act the Certificate of Incorporation and the Certificate to Commence Business) the company is considered to be a separate legal entity, with rights and obligations which is capable of pursuing those rights and enforcing those obligations by means of its officers. Simply put, the Registration Certificate is the company’s birth certificate, from the moment the Registration Certificate is issued the company stands in law as though it were a person in its own right. Section 19(1)(b) of the New Companies Act sets out that a company has legal capacity and the powers of an individual except to the extent that a juristic person is incapable of exercising such power. In essence this means that:

  • subject to what is set out below, the members of the company and the company itself are separated, with the members in general not being personally liable for the company’s debts;
  • the assets and liabilities belong to the company and not the members;
  • the company itself must enforce any right it may have against a third party for any wrong it may have sustained;
  • management (subject to what is set out in the Memorandum of Incorporation) vests in the directors and not in the shareholders;
  • a share is a personal right, entitling the holder to an interest in dividends, attend and vote at meetings of the shareholders and a return of capital on the winding up of the company.

This is where the common law concept of the corporate veil comes in. The corporate veil refers to the notional line that is drawn between the company and those persons behind it. In most circumstances, one cannot “pierce” the corporate veil in order to attack the persons behind it. This is not however absolute. Where the corporate veil principal is being abused, the courts are entitled to look at the “substance” of the actions taken rather than the legal form utilised, and in so doing personal liability can once again be attracted.

Sections 75 and 76 of the New Companies Act specifically states that a director or officer of a company may be held personally liable for a breach of certain statutorily created duties. These duties include many of those duties which were commonly considered as fiduciary duties of directors, and include the failure to disclose a financial interest, using his position as a director to obtain some form of personal gain or cause harm to the company, or fails to act in the best interests of the company. In such instances, the corporate veil of the company will not protect the directors and officers from personal liability even though the common law position as regards the corporate veil has not been specifically altered or incorporated into the New Companies Act.

Whereas the 1973 Act catered for a public company, a private company and an external company, (with non-profit organisations being dealt with essentially separately) the New Companies Act has two broad categories of company: a profit company and a non- profit company.

Profit companies may be incorporated by one or more persons and fall into four classes:

  • a state-owned enterprise;
  • a public company;
  • a personal liability company; and
  • a private company

For purposes of this discussion only private companies and public companies will be considered in detail as personal liability companies are those private companies utilised by professional associations such as attorneys and accountants who were previously limited to a partnership structure and in terms of section 53 of the 1973 Act were able to incorporate such entities predominantly for the purposes of succession planning. The state-owned enterprise likewise falls outside of the scope of this discussion, we are however happy to answer any direct enquiry on the subject.

As with the 1973 Act, a private company is one in terms of which the Memorandum of Incorporation contains an express prohibition against the offering of shares to the public and restricts the transferability of its shares. The restriction on the transferability of the shares in a private company is one of the defining elements of a private company. The shareholders themselves wish to retain a degree of control over who the other shareholders will be, and if such shareholders want to dispose of their shares, then the remaining shareholders want to have a say in who ultimately holds them.

In the matter of Smuts v Booyens; Markplaas (Edms) Bpk and Another v Booysens [2001] ZASCA 57 (also 2001 (4) SA 15 (A)) the court held that the word “transfer” consisted of a number of steps within a private company setting: (a) an agreement to transfer, (b) the execution of the transfer document, and (c) registration of transfer. In terms of the 1973 Act the restriction on the transferability of the shares in a private company as contained in the articles of association had to be complied with, failing which no valid transfer could take place, even if the purchaser was unaware of the restriction. Private companies under the New Companies Act have retained these features while additional flexibility and simplicity of management has been built into the New Companies Act to cater for smaller businesses.

The primary differences between a private company and a public company are that the transmissibility of the shares are no longer limited, shares may be offered to the public (subject to certain conditions which will be discussed later in this series) and membership in the company is unlimited.

As set out in Part 1 of this series, one of the main objectives of the New Companies Act is to foster a spirit of entrepreneurialism in South Africa by rendering it simple and inexpensive to incorporate a company. In fact the incorporation of a company is now worded in terms of being a right rather than a privilege bestowed by the State.

The incorporation process begins with a “Notice of Incorporation” (in accordance with the provisions of section 13(1) and signed by all members) being filed with the Commission. The Notice of Incorporation must be accompanies by the Memorandum of Incorporation and the prescribed fee. The contents of the Memorandum of Incorporation are those matters set out in section 15 and include the rights, duties and responsibilities of the shareholders and directors within and in relation to the company. It should be noted that the Memorandum of Incorporation may be unique to the company in question (but must still comply with section 15) or the company may elect to utilise the pre-prepared form in the New Companies Act and amend it at will.

At the very least the following matters should be comprehensively dealt with in the Memorandum of Incorporation:

  • the objects and powers of the company (together with any restrictions on that power);
  • composition and functioning of the board of directors (including alternate directors and frequency of meetings);
  • board committees;
  • powers of the board and powers of the shareholders;
  • shareholder meetings and shareholder rights;
  • personal liability and indemnification of directors;
  • amendment of the Memorandum of Incorporation;
  • company secretaries and other officers;
  • disposals of shares by shareholders;
  • conversions of shares into different classes;
  • the ability of the board of directors to create rules.

The ability of the board of directors to create rules is a specific right of the New Companies Act. In terms of section 15(3) of the New Companies Act, unless the company’s Memorandum of Incorporation dictates otherwise, the directors are entitled to make, amend, or repeal any rules relating to the company in respect of any matter not dealt with the in the New Companies Act or in the Memorandum of Incorporation, provided that a copy of such rules are published in accordance with the provisions of the Memorandum of Incorporation and filed with the Commission. Any rules so published will take effect within 20 days after publication or on the date specified in the rule, whichever is the later.

The company’s Memorandum of Incorporation and rules are binding among the shareholders, between the company and the shareholders, between the company and each director, and the company and all prescribed officers and audit committee member.

Companies may still enter into shareholder agreements. However whereas in the past the parties were able to agree that in the event of any inconsistency between the articles of association and the shareholders’ agreement, the shareholders’ agreement would take precedence, under the New Companies Act, all shareholders’ agreements must comply with the New Companies Act and the Memorandum of Incorporation and to the extent that the shareholders’ agreement is inconsistent with either document, the shareholders’ agreement will be void to the extent of the inconsistency.

In terms of item 4(2)(a) of the Fifth Schedule to the New Companies Act, all pre-existing companies may at any time within 2 years following the general effective date, file without charge any amendment to its Memorandum of Incorporation to bring it in harmony with the new Companies Act.

Published by Paul Jacobson

Enthusiast, writer, Happiness Engineer at @automattic. I take photos too. Passionate about my wife, Gina and #proudDad.

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