19.1 INTRODUCTION
As we have already mentioned the new Act does away with the share capital maintenance rule and focuses on the solvency and liquidity test. Over the years and certainly during the course of the old companies Act, distributions were related to the legal system in place. Creditors and minority shareholders required protection in the event that a distribution was made which was prejudicial to their interests. It was because of this that distributions had to be carefully regulated.
Under the old Act dividends could not be paid out of capital, a company could not acquire its own shares, a company could not generally provide capital for financial assistance for the acquisition of its own shares or shares in its holding company.
In 1999 this changed. With all the above items being allowed subject to the rules that were put in place. The liquidity and solvency test and a special resolution was required before a company could make a distribution.
It was really the total share capital of the company that shareholders put up for risk, and once this capital was lost and liabilities exceeded the assets then the company was insolvent. The only thing that a shareholder could lose was their share capital. There were no rights for creditors to obtain their losses from shareholders. If the strong regulations of corporate governance were not in place then creditors would sustain even bigger losses.
The share capital maintenance rule required a company to consistently maintain the level of funding contributed by its shareholders.
The problem with the share capital maintenance rule is that it certainly did not work in the case of many smaller companies because the funds of small companies were supplied by way of shareholder loan accounts. Shares were created with a nominal value of say R100 or R1,000 on the share capital account. The balance of the funding was provided by shareholders loans. When the shareholders who were directors saw that things were not going according to plan, they would pull out their loan funding to the detriment of creditors who had no say or control over the company. The shareholders loan was ranked the same as other creditor’s funds. This situation was often subject to this abuse. In fact, when banks lend companies money, they may very well insist on a subordination of the shareholders loans, which will allow the banks to get out their money before the shareholders can withdraw loans.
I cannot see that this is going to change with the new Companies Act as by doing away with the share capital maintenance regime and having the solvency and liquidity test the refund of a shareholder’s loan is still not in fact a distribution, but a repayment of a loan. This is a major loophole! Of course, there could be other remedies that creditors might have in terms of the insolvency laws. So, the new Companies Act in doing away with share capital maintenance and introducing the solvency and liquidity test will help in certain instances prevent these situations preventing minority shareholders and creditors being prejudiced in certain circumstances, but certainly not in all cases.
Owing to the fact that the share capital maintenance regime has been dropped it is not necessary anymore to keep the CIPC informed of the movement of share capital the way we use to do in the past (remember the dreaded CM15 form) as they are no longer interested in keeping these records. This means that share issues and buybacks now do not have to be reported to the CIPC. This also means that it is exceedingly important for companies to make sure that the share capital records are perfect from an audit and inspection point of view and it is for this reason that we have to keep good records of share capital. As company secretarial practitioners you do not want the secretarial records to become the center of a dispute in a legal action.
The notion of share capital from a company law perspective basically ceases to exist but of course will continue to exist from an accounting and secretarial practice point of view. The standards for share capital are based on common practice as the company’s act says very little about the housekeeping and maintenance of shares.
The new Companies Act follows a similar approach to the 1999 company law changes. Section 48 deals specifically with the acquisition by a company of its shares and Section 46 deals with other distributions. The definition of distribution in Section 1 of the Act includes a transfer of the consideration for the acquisition by the company of its shares or shares in any company in its group.
The Act provides that all shares of a class must be treated equally, unless the MOI provides otherwise. It also provides that the MOI may entitle the shareholders to distributions calculated in specific ways and may provide for preferences as to distributions or liquidation rights in respect of different classes of shares.
One also needs to look at the liability of directors in in terms of s 77 which would make a director responsible for any loss incurred. Please see Section 77 (3) (e) (vi). In terms of Section 77(3)(e)(vi) of the Companies Act, a director is liable if they were present at a meeting when the board approved a distribution contrary to the requirements of the Companies Act, specifically section 46, and failed to vote against it despite knowing the distribution was in violation of the Act.
The liability of a director in such a scenario arises if after making the distribution, the company does not meet the solvency and liquidity test, and it was unreasonable at the time of the decision to conclude that the company would satisfy the solvency and liquidity test post-distribution