Corporate Law Reform: briefing by Department of Trade and Industry

Meeting report

ECONOMIC AND FOREIGN AFFAIRS SELECT COMMITTEE
20 June 2007
CORPORATE LAW REFORM: BRIEFING BY DEPARTMENT OF TRADE AND INDUSTRY

Chairperson: Ms N Ntwanambi (ANC, Western Cape)

Documents handed out:
Corporate Law Reform: presentation by the Department of Trade and Industry

Audio Recording of the Meeting

SUMMARY
The Companies Bill was formed against the backdrop of a Corporate Law Reform Policy that sought to provide a viable alternative to the formalised, bulky and outdated Companies Act of 1973. Changes in the global and domestic environments and changes in local expectations and standards necessitated a new regulatory framework for corporate activity. There were currently more than three million entities active in the economy. Some of these were informal and unregistered, and a major aim of the Bill was to attract unregistered entities into the formal economy, in line with broader government objectives to bridge the gap between the first and second economies.

Legislation for the Bill was short and simple and had been modelled on similar New Zealand legislation. The procedure for the formation and registration of companies would be simplified.

In contrast to the 1973 Act, which had 43 definitions, the Bill had 100 definitions which further reflected substantive new provisions. Key new definitions included amalgamation, and allowed for different distributions to be subjected to the same processes. It also included the definition of a merger, which was a new concept.

The Bill provided for companies to be categorised differently, and set 25% of shareholders as a default quorum for binding resolutions. Par values were eradicated so that share values were determined by the market. The Bill set out the provisions for take-overs and retained much of the existing scheme.

Major changes were provisions for fundamental transactions to be approved by a court only if there was opposition from a significant minority or if there were procedural irregularities. Business rescue procedures were administered by companies themselves, and workers were protected when a company became insolvent.

The public servants strike had disrupted the timetable for the Bill. Formal introduction of the Bill into Parliament would now happen in April 2008. The Bill would become effective towards the end of 2009 or the beginning of 2010. The Committee would be furnished with explanatory manuals followed by a workshop.

MINUTES
Briefing on Corporate Law Reform
The briefing was conducted by Mr Tshepo Mongalo (DTI Project Manager: Corporate Law Reform).

Introduction
The Companies Act of 1973 had provided the regulatory framework for company law for the last 30 years.

This Act was now outdated and far too formal and consisted of a bulk of information, some of which appeared to be quite unnecessary. The Act was further credit-oriented in its approach and was overly criminal. There had been no substantial review of this Act since 1973, except for the introduction of the Close Corporation (CC) Act in 1984. An urgent need for company law reform had therefore arisen.

The Corporate Law Reform Policy was published in June 2004 and updated in June 2005.

There had been many corporate scandals in South Africa and elsewhere, and this had highlighted corporate governance issues. South Africa needed a corporate law policy in line with other laws such as the Securities Services Act, the Auditing Professions Act and the Public Finance Management Act.

The Corporate Law Reform Policy was in line with broader government objectives to bridge the gap between the first and second economies, and to entrench the benefits of corporate reform as a right rather than a privilege. The Policy was a response to the changes in standards and expectations that had arisen both as a result of socio-political and other changes in the country, as well as changes engendered by globalisation.
The Policy made provision for enforcement of the law and also brought about the need for reform that had been necessitated by transformation within the jurisdictions from which South Africa takes its law. The quest to be on par with international standards was facilitated by the Policy.

Objectives for Corporate Law Reform
Mr Mongalo provided an overview of the objectives that had been identified in the policy framework. The procedures for forming a company would be simplified and the costs thereof reduced. Companies would be more manageable, flexible and transparent, and this would attract investment and enhance standards of corporate governance.

Policy context
Figures on registered and unregistered entities were provided. Close Corporations were in the majority and 99 % of registered businesses were privately owned. All Close Corporations and 70% of private companies were owner managed. Of the 3 757 public companies, only 440 were listed entities. These companies accounted for 60% of the Gross Domestic Product (GDP). The main thrust of the reform process was to attract unregistered entities into the formal economy and pull in those entities not currently on the statistics radar. There were more than three million entities operating in the economy. State-owned enterprises (SOEs) were not dealt with separately for the purposes of corporate law reform, but were considered as private companies.

Scheme of the Bill
Mr Mongalo provided an overview of the scheme of the Companies Bill. The Bill covers all aspects of a company from the time of establishment to the time of winding up, how they were financed, how they were governed, how the provisions of the Companies Act were enforced, how offences were dealt with as well as other matters. The legislation was kept as short and simple as possible. This was a major achievement for the country, as some of those jurisdictions from whom we took our law had bulky and complex legislation. For example, Australia had corporate legislation of mammoth proportions and included all incidental matters. The United Kingdom’s corporate legislation was the largest volume of regulations ever published. South Africa had followed the New Zealand model, and had aimed at legislating for core company law rather than every incidental matter.

Chapter 1: Interpretation, Purpose and Application
In contrast to the 1973 Act, which had 43 definitions, the Bill had 100 definitions which further reflected substantive new provisions. Key new definitions included amalgamation, and allowed for different distributions to be subjected to the same processes. It also included the definition of a merger, which was a new concept.

Mr Mongalo said that the most important provision in Chapter One dealt with categories of companies. Every “for profit” company is either a widely held company, or a closely held company. Closely held companies did not offer securities, including shares, to the public and did not take into account the nature of the shareholder. The number of shareholders no longer played a role and provisions for the transfer of shares were contained within the Memorandum of Incorporation.

Public Interest (PI) companies did not form a separate category per se, but formed an overarching category that could include companies from other categories. One of the reasons for the PI category was to enable provisions for stringent standards and governance to be applied across the board. A Closely Held company could become a PI company if it met at least two of three thresholds designated by the Minister. As soon as the Closely Held company met two of the thresholds, it became a PI company and would then have to comply with stricter provisions as set out in the Bill. Not all Closely Held companies that were PIs needed an Audit Committee. If the holding company had an Audit Committee, the subsidiary did not need one.

Chapter 2: Formation and Registration of Companies
Measures to simplify company formation and registration included provisions to allow a minimum of one person to form a corporation or a for profit company. Company formation was further facilitated through the adoption of a short-term Memorandum of Incorporation.

Chapter 3: Corporate Finance
The Bill provided for shares to have no par value and for pre-existing shares with par values to be preserved in line with transitional arrangements. A par value was an arbitrary value given by a company when a share was issued. The shareholder therefore had no idea of the value of the share. The par value given to shares was particularly low in the early 1960’s, and this low value was endorsed by the 1973 legislation. The eradication of par values meant that the value of the shares would be determined by the market.

The Bill makes provision for all distributions (for example share buy backs, dividends, redemptions) to be treated in the same way. This would be achieved by subjecting all distributions to the solvency and liquidity test. The solvency test determined whether the company was solvent in its balance sheet, that is, whether its assets exceeded its liabilities. The liquidity test determined whether a company could pay its debts. The 1973 legislation had subjected distributions with the same economic outcomes to different tests.

Chapter 4: Corporate Governance and Financial Accountability
This Chapter retained most of the provisions found in the current law but allowed for some significant changes. The quorum for passing an ordinary resolution would be 25% of all shares entitled to vote. Shareholders would be allowed to participate in meetings via electronic communication. Shareholders and directors would be enabled to take binding decisions without holding a formal meeting. This was particularly relevant where there was general consensus on certain issues among those in positions of power.

The current Act stipulated that with regard to a public company, at least three shareholders are required for a resolution to be binding. The untenable result of this was that in instances where a company has a million shareholders, decisions would be taken by an insignificant number of shareholders within that company. The quorum default was set at 25% in order to improve corporate governance standards.

The Bill set out a codified scheme of directors’ duties and in this respect reflected common law without affecting standards of corporate governance. This aspect of the Bill could, in fact, be said to raise governance standards as common law was very subjective. This aspect of the Bill combines subjectivity and objectivity. For example, it was not only the skills and experience of a particular director that would be taken into account. The question “what would a similar director have done?” would also be asked. The Bill provided directors with indemnities and insurance in cases where there was gross negligence.

Chapter 5: Take-overs, Offers and Fundamental Transactions
The Bill set out the provisions for take-overs and retained much of the existing scheme. Major changes were provisions for fundamental transactions to be approved by a court only if there was opposition from a significant minority or if there were procedural irregularities.

Chapter 6: Business Rescue
In its provisions for Business Rescue, the Bill replaced the current judicial management with a modern business rescue regime that was largely self-administered by the company. The Bill protected the interests of workers by recognising them as creditors of the company with a voting interest to the extent of any unpaid remuneration.

Mr Mongalo said that at an international insolvency conference held in Cape Town in June this year, certain recommendations were made regarding business rescue. These recommendations would be incorporated into Chapter Six of the Bill.

Proposed Timetable
Mr Mongalo concluded his presentation by referring to the proposed timetable for the Bill. He said that the public servants’ strike had prevented adherence to the schedule. Updating of the Bill after public comments would now be moved to August 2007. Submission of the Bill to Cabinet would take place in October 2007. Submission to the State Law Advisors would take place in November 2007 and introduction of the Bill into Parliament for passing would happen in April 2008. The Bill would become effective towards the end of 2009 or the beginning of 2010.

Discussion
The Committee expressed the view that intensive debate and discussion on the briefing could not take place at that stage. Most members present had scant knowledge of the terminology and concepts that were referred to. The Committee requested a two-day breakaway session away from Parliament, for instruction with regard to the concepts outlined in the Bill.

Mr Mongalo said that a similar request had been made by the Portfolio Committee, and that the Department had issued Portfolio Committee members with explanatory and instructional manuals prior to the holding of a workshop. These same manuals would be forwarded to the Select Committee.

The meeting was adjourned.