Ambiguity in the new Companies Act


I was on holiday in July when, out of guilt for ignoring my legal practice, I dragged out a company law book I had brought along for some ‘light’ holiday reading. I was not expecting it to be at all entertaining, so when I finally started reading, I was surprised to find myself laughing out loud by the time I reached page four.

The book consists of 20 articles, each explaining some aspect of the New Companies Act. The first is about the thinking behind the drafting of the new act, including substantial references to the “Guidelines for Corporate Law Reform” of 2004, issued by the Department of Trade and Industry.

Among key aims for the new company law, the guidelines state that it must be:

• “Simple, comprehensive and accessible to business people and their advisers”;

• “Simplicity should be a guiding principle”;

• “It should be possible for small businesses and their advisers to understand the administrative requirements without resorting to expert advice”.

After quoting these very noble aims, the author of this article states: “All of the changes proposed in the passages recited above have been realised in the new act.”I frown and flip back a page to check the name of the author of the article. It is Philip Knight, a Canadian lawyer and – wait for it – principal drafter of the New Companies Act!

To the rest of us, those who did not have a hand in drafting it, the New Companies Act is not only inaccessible to business people, but in many sections impenetrable to highly skilled commercial attorneys. I am not including myself in this category, having only recently rejoined the legal profession after several deeply rewarding years as a law lecturer (sadly, none of the reward is in monetary terms). However, I definitely include myself on the list of lawyers finding much of this act impenetrable.

My skills lie in ‘translating’ legalese and legislation into something non-lawyers can understand; and from this perspective, the new act is proving most tedious. I am laughing because I cannot believe the drafter of the Act would dare to make such audacious claims, when I know that most lawyers in South Africa are currently asking each other what on earth the new act is trying to say.

“Simple, comprehensive and accessible to business people and their advisers”

Shortly after the introduction of the Act on 1 May 2011, I attended a lecture held by the Corporate Lawyers Association of South Africa.I was amazed, and admittedly relieved, to discover I was not the only one having trouble understanding the new act, but every lawyer present expressed their doubts and concerns.

As a result, I have cajoled several bright commercial attorneys from small firms to join my Company Law Think Tank that meets on Fridays to discuss, debate and extrapolate meaning from the new act. We are attempting, informally, to make sense of the Act, so that we are informed enough to give our clients good advice. But we are struggling.

“Simplicity should be a guiding principle”

To explain just one of the issues with which our Think Tank has grappled in the last few weeks, I am going to discuss section 66(4) of the New Companies Act, which states that the Memorandum of Incorporation (MOI) – the document that replaces the old Memo and Articles – may provide for:

(i) The direct appointment and removal of one or more directors by any person who is named in, or determined in terms of, the MIO;
(ii) A person to be an ex officio director of the company as a consequence of that person holding some other office, title, designation or similar status, subject to subsection (5)(a);or
(iii) The appointment or election of one or more persons as alternate directors of the company; and
(iv) In the case of a profit company other than a state-owned company, must provide for the election by shareholders of at least 50% of the directors, and 50% of any alternate directors.

To demonstrate how the above section applies, let us imagine a company owned as follows:

• Ben – 25%

• John – 25%

• Thabo – 25%

• Mfundi – 25%

The MOI can state that there will be three directors, and that “Mfundi may appoint one director”. This would mean no matter who the other two directors are, Mfundi has this right to appoint the third director. She is a person “named in the MOI”.

Alternatively, the MOI could say that “a shareholder who has more than 40% of the total shares may appoint a director”, in which case none of these four would qualify; but if Ben bought out John (subject to whatever agreement the shareholders had in place), this would mean he would have 50% of the shares and can appoint one of the directors. In this version, although Ben is not referred to specifically in the MOI, his right to appoint a director can be “determined” by reference to the number of shares he holds.

The appointment of ex officio directors “as a consequence of that person holding some other office, title, designation or similar status” means the MOI may state that there are four directors and that “the company lawyer shall serve as an ex officio director of the company”.
All of the above are subject to the proviso that all profit companies not owned by the state “must provide for the election by shareholders of at least 50% of the directors, and 50% of any alternate directors”.

Confusion has crept in as to what exactly it means to say that 50% of the directors must be elected by the shareholders. In our Think Tank, we decided the word “election” must have been used deliberately, rather than the word “appointed”. So, although a shareholder may have the right to appoint a director as stated in the MOI, this is separate from the general right of election by all shareholders to elect the remaining 50% of directors.

If the MOI states that the company will have three directors, and one shall be the company lawyer and one shall be appointed by John, that would mean there is only one vacancy left out of the three (33%) to be appointed by the shareholders – this is not allowed.

To follow the law, the MOI would have to provide for four directors in this case so that the remaining two directors (50%) could be elected by the shareholders.If we use this example of four directors again:
• Director 1 to be appointed by John as per the MOI;

• Director 2 to be ex officio director, the company lawyer;

• Directors 3 and 4 to be jointly voted in by Ben, John, Thabo and Mfundi.

A director is elected by ordinary resolution which, in this example, means that as soon as a candidate for directorship is voted for by two or more shareholders (i.e. obtains 50% of the total votes possible), that director will be appointed.

Note that John has a bit more than 25% of the control over appointment of directors because he gets part of the vote regarding directors three and four. However, this does not count for much: Should Ben, Thabo and Mfundi choose not to vote with him, John will never get the 50% required to vote the director of his choice into power.Now that the principles of appointing directors under the new act should be a little clearer, let us look at what happens where there is a 60% to 40% split.

Under the old act, shareholders would often agree they could appoint directors pro rata or “proportionately according to their shareholding”. So let us say Mr Big has 60% and Mr Min has 40%, and their Articles currently allow for five directors, three of them to be appointed by Mr Big and two to be appointed by Mr Min.

Alack and alas, it would appear this is no longer legal regarding the 50% clause. So when our clients who own the business “60/40” instruct us to draw up a new MOI and shareholders’ agreement – “keeping everything the same as it was” – we have to try and figure out how we can give effect to their wishes while ensuring the new act is adhered to.

Remember that at all times, if there are five directors, 2.5 of them must be elected by the shareholders, despite the fact that electing half a director is tricky (although, sadly, appointing a half-witted one is surprisingly easy). Let us say, then, that three directors must be elected by shareholders in general. This leaves only two directors to be appointed, one by Mr Big another by Mr Min.

However, it must be borne in mind that it takes an ordinary resolution (50%) to elect a director, which essentially means Mr Big, with his 60% shareholding, will appoint director 1, and will have the power to pass resolutions for directors 3, 4 and 5. In practice, this would make the ratio of power to appoint directors 4 to 1 in favour of Mr Big.

After much scribbling and calculating, our Think Tank seems to agree that the only way to keep the original power balance is to state in the MOI that Mr Min has the right to appoint two directors, and the remaining three are to be elected by the shareholders together – through an ordinary resolution. The reality of this is that Mr Min controls the choice of two of the directors and Mr Big controls the choice of three of the directors, as they have always had it.

Without trying to confuse everyone completely, another possibility is that the new act allows for the changing of the percentage of votes required for an ordinary resolution for specific matters. So the MOI could require that an ordinary resolution for appointment of directors be changed to 70%. This would protect Mr Min’s rights by ensuring Mr Big will not have sufficient voting power to carry an ordinary resolution, thus he will always require Mr Min’s consent – or they will be deadlocked.Another suggestion is that the shareholders contractually agree that when it comes to the passing of resolutions for the election of directors, they will do so unanimously, to give effect to an undertaking.

Some lawyers are unsure about the wisdom of putting a provision in a shareholders’ agreement that may be found to be ‘inconsistent’ with the MOI. Since the introduction of the new Companies Act, where there is inconsistency between something in the shareholders’ agreement and the MOI, the MOI will take precedence.While all this nonsense about appointing and electing directors may seem theoretical, may I point out that when it is your family company that has to sell 40% of its shares to raise capital, suddenly the voting power and director appointment mechanisms seem awfully important.

“It should be possible for small businesses and their advisers to understand the administrative requirements, without resorting to expert advice”

While it “should be possible”, it is my observation that the drafting of the new Companies Act means it is not possible. Most people will require expert advice to understand it.These days, people do not necessarily call their lawyers because we have all the legislation we need at our Google-trained fingertips.

It takes seconds to look up the Companies Act and find the law that tells you what to do if a shareholder or director alleges that one of the other directors is disqualified or ineligible to be a director. You will find this in section 71(3), which starts by saying that if a company has more than two directors, then this section will apply. If you read on, however, in subsection 8, it says that if a company has “fewer than three directors”, subsection 71(3) does not apply.

More than two directors, but less than three directors! I pondered what number of directors is required in order for this section to apply. And then I thought some more and realised these two bits are saying exactly the same thing: this section will apply if the company has more than two directors (in other words, it has three, four or five directors); and then again it says exactly the same thing in different words – that if there are less than three directors, in other words only one or two, it will not apply. We knew that already, why confuse the reader?

Does this sort of drafting really make it “possible for small businesses and their advisers to understand the administrative requirements, without resorting to expert advice”? I think not.

Conclusion

The appointment of directors is merely one thing that has been changed by the new Companies Act. Attorneys need to ensure they have understood the implications of the new provisions, and not assume they can continue to use clauses from their precedents that are no longer relevant.

The hours I have spent poring over the Act to date and the discussions I have had with other commercial attorneys make it impossible for me to agree that the new Companies Act is “accessible to business people” or that it “provides a firm foundation for certainty”.Toward the end of the article by the drafter of the new act, Philip Knight, he says: “Law, language and life are all inherently ambiguous, and it is therefore impossible always to realise the goal that the law should mean precisely what it literally says.”

Wow! Firstly, this convoluted style of writing makes it hard to work out what he is trying to say, in the same way much of the Companies Act is written in such a manner that it is difficult to work out what is meant.Secondly, it is a cop out (albeit a poetic one) to deflect accountability for ambiguous and cumbersome drafting by saying that “law, language and life are inherently ambiguous”.

As someone whose passion is making sense of the law for people, I fear, Mr Knight, that you and I are not on the same team. I perceive, however, that I may thank you in the long run, but only for bringing many perplexed clients my way.

Amanda Boardman

via Lost in translation

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