Initial briefing on Company Law Reform Policy

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Trade and Industry

19 August 2004
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Meeting report

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
20 August 2004
INITIAL BRIEFING ON COMPANY LAW REFORM POLICY
 


Chairperson: Mr B Martins (ANC)

Documents handed out:
 

Overview of policy on corporate law reform
South Africa Company Law for the 21st century: Guidelines for corporate law reform

SUMMARY
The objectives of the envisaged new company law are, amongst others, to encourage entrepreneurship and enterprise diversity by simplifying company formation and encouraging transparency and high standards of corporate governance, recognising the broader social roles of enterprises.

The reform of South African Company Law will involve an overall review of company law. Due to time constraints the review will not include partnership law. The review will identify the fundamental rules governing the procedures for company formation, corporate finance law, corporate governance, mergers and acquisitions, the cessation of the existence of a company and the administration and enforcement of the law. It will also consider the relationship between company law and other rules and measures for the protection of the interests of shareholders, creditors, employees, and other participants and interests, such as the state, the environment, the consumers, the suppliers and Black Economic Empowerment initiatives. The law relating to the non-profit organisations and co-operatives would also be covered.

Consultation with Nedlac and the public at large would be conducted between June and September 2004. The Bill would be drafted between September and December 2004. The Department seeks to conclude the process by June 2005

MINUTES
The Department of Trade and Industry briefed the Committee on the company law reform policy. Mr M Moeletsi, Mr T Mongalo and Mr M Netshitenzhe represented the Department.

Introduction
Mr Moeletsi dealt with the objective of the presentation, the background to the policy and the rationale for reform. The purpose of the presentation was to provide an overview of corporate law reform and to update the Committee on the process of reform. The policy document sets out to provide an improved platform for companies to raise capital and also provides a new definition of the roles of a company.

The objectives of the envisaged new company law are, amongst others, to encourage entrepreneurship and enterprise diversity by simplifying company formation and encouraging transparency and high standards of corporate governance, recognising the broader social roles of enterprises.

The Companies Act is 30 years old and the change in political, economic and social environment necessitates changes to the Act. The current Act is excessively formalistic and increases the cost of forming companies.

Mr Mongalo took over from Mr Moeletsi and continued with the briefing.

The scope of the review
The reform of South African Company law will involve an overall review of company law, that is the Companies Act, 1973, the Close Corporations Act, 1984, and the common law relating to these corporate entities. Due to time constraints the review will not include partnership law. The review will identify the fundamental rules governing the procedures for company formation, corporate finance law, corporate governance, mergers and acquisitions, the cessation of the existence of a company and the administration and enforcement of the law. The review will also consider the relationship between company law and other rules and measures for the protection of the interests of shareholders, creditors, employees, and other participants and interests, such as the state, the environment, the consumers, the suppliers and Black Economic Empowerment initiatives. The review will extend to the law relating to the non-profit organisations and co-operatives. Many non-profit organisations are incorporated under section 21 of the Companies Act and the implications of changes for these charitable companies cannot be overlooked.

General guidelines and principles of new company law
One of the most fundamental questions to ask in respect of company law is: In whose interest should the company be run? There is a need to move away from the traditional company law principles that define the relationships between shareholders and directors and managers. Company law also serves broader public interests. Public interest is best regulated through specific laws with company law facilitating through disclosure.

Company formation
Company law should encourage the formation of companies of different sizes in the formal economy. This is important since the formation of companies in the formal economy will, among other things, facilitate access to capital, stimulate innovation and the growth and development of the economy generally. Individually, entrepreneurs will acquire the benefits of limited liability and portfolio diversification. In order to achieve this objective, company law should provide maximum flexibility, create sufficient certainty for equity investors and shareholders, and prevent artificial preferences for certain business forms. The policy seeks to introduce the notion of a single corporate entity that removes distinctions between close corporations, private and public companies. There is a need to simplify the formation requirements so that a layperson can form a corporation. The process of forming a corporation should be automated as far as possible.

It is proposed that the law should set out mandatory provisions (as far as necessary) for all companies and provide optional provisions and default provisions in cases where no election is made. The articles and memorandum of the company should provide for mandatory rules and could allow shareholders to create additional, optional and voluntary requirements. Furthermore, shareholders should have the possibility to opt out of certain mandatory rules if there is agreement amongst, for instance, holders of 90% of the shares. The continued need for the concept of par value and its corollary has long been questioned and has to be done away with. The par value formed part of the concept of capital maintenance which is now superseded by more sophisticated concepts. There is a need to provide more flexibility for companies to raise capital.

The regulation of foreign companies that establish a place of business in South Africa requires consideration. A simple process that allows foreign companies to be registered and maintained in South Africa must be developed, while providing for recourse in cases of misconduct and winding up, particularly with respect to liability for debts, the duties of foreign directors and inter group transactions. One possibility is to base such registration or recognition on a system of reciprocity or accreditation, where the formation and governance requirements of certain jurisdiction are recognised.

Corporate finance
It is important that companies attain maximum flexibility in creating financing mechanisms. The outdated distinction between share premium and par value should be abandoned because it is largely artificial. The capital maintenance rule should be revisited. The idea underlying the rule is that creditors look to the company's funds for payment and, therefore, they stand to be prejudiced if the company pays out its funds by returning share capital. The rule has justified the prohibition of share buy-backs, distributions to shareholders out of capital and on financial assistance for share buy-backs. Section 38 of the Companies Act prohibits a company from giving financial assistance to anyone for the acquisition of shares in it. An argument has been made that this section has a negative impact on black empowerment initiatives. The new law would allow the giving of such assistance provided that directors could show that they acted in the best interests of the company.

The appropriateness of the US capital maintenance rule for South Africa will be investigated. The capital maintenance rule, as implemented and refined in the US, requires that two tests should be satisfied - an equity solvency test (liquidity test) and a balance sheet solvency test (net assets or solvency test). The liquidity test requires that a company should be able to meet its cash-flow requirements and the net assets test requires that assets must exceed liabilities. In these cases, no minimum capital requirement is necessary.

Corporate governance
Corporate governance reviews have formed the core of many of the international corporate law reform processes. The focus would be on ensuring increased transparency and accountability. The emphasis on the reform of corporate governance requirements in the South African context will consist of three components, namely (1) shareholders and investor protection (2) the responsibilities of the board of directors and (3) disclosure. Cognisance will be taken of the broader accountability of managers and directors not only to shareholders, but also to the State and to other stakeholders.

There is a predominance of controlling shareholder groups in South African companies. Consequently there is a need to protect minority shareholders to ensure that the majority does not squeeze them out. South African companies are also characterised by lack of shareholder activism. This calls for the bolstering of managerial accountability standards for executive directors. The lack of shareholder activism is understandable in cases where there are institutional shareholders. Institutions normally do not want to have a hands on approach in companies given the number of companies in which they invest.

There has been a question in South Africa for some time whether we should follow the example of continental Europe in establishing a two-tier board or whether a unitary board structure should be required. While a two-tier board provides for the opportunity for stakeholder representation, experience has shown that this type of Board structure is often inefficient, may deter investment and is not necessarily desirable for stakeholders. Furthermore, South Africa has largely adopted a unitary board structure to date and imposing a legal requirement for a two-tier structure may be costly. For this reason, the position of this policy document is that a unitary board structure be retained, but that stakeholder representation on that board should be optional. The Swedish model for a unitary board with stakeholder representatives will be examined in greater detail, particularly to determine whether stakeholder representatives could be exempted from certain director's duties.

The roles and functions of directors should be clarified. Most directors of companies listed on the Johannesburg Stocks Exchange did not know their responsibilities and where to get guidance regarding their responsibilities. Some companies still have the Chairperson also serving as the Chief Executive Officer. The new legislation would give some guidelines on those responsibilities.

There is a need to develop institutional investors as a force for promoting shareholder democracy and good corporate governance particularly in listed companies. It is also to ensure that controlling shareholders are unable in transactions in which they have some interest. Transactions at arm's length and in the ordinary course of business should be allowed even though some shareholders have some interest in them.

Company law should ensure maximum transparency in regard tot the administration of companies and disclosure of information concerning their affairs. Disclosure should cover financial information, statements on compliance with public interest legislation, including Black Economic Empowerment Act, environmental and labour regulations. Part XI of the Companies Act should be reformed and strengthened taking into account the exclusion of other companies from compliance with filing provisions, non-statutory disclosure requirements and the Financial Reporting Bill.

Mergers and take-overs
The policy does not say much about mergers and take-overs. The division between the Securities Regulatory Panel (SRP) and the Competition Authority (CA) would be maintained. The SRP would continue to examine mergers and acquisitions from the point of view of protecting minority shareholders and the credibility of the markets. The CA examines only the anti-competitive or public aspects of mergers. There would be a new provision for mergers. Corporate rescue provisions should be seen as a part of the broader corporate governance regime. The responsibility should be with the directors to ensure that a company is rescued at the right time.

Administration and enforcement
There should be greater involvement of the state in enforcement of rules. The policy proposes a combination of meaningful criminal, civil and administrative penalties. The current Companies Act provides criminal sanctions even for minor violations and this is not necessary. There should be an independent Commission that would, through the Competition Tribunal see to the enforcement of the new company legislation and the education of shareholders and directors. The DTI would still have the responsibility of making rules and regulations relating to companies. The JSE and the Financial Services Board would act in an advisory function on the regulation of securities trade. It is proposed that the Companies Tribunal should be merged with the Competition Tribunal, as they would deal with similar issues. The Courts would have concurrent jurisdiction. The Companies and Intellectual Property Commission would be responsible for company registration, education and awareness and information collection and dissemination.

Way forward

Consultation with Nedlac and the public at large would be conducted between June and September 2004. The Bill would be drafted between September and December 2004. The Department seeks to conclude the process by June 2004.

Discussion
Mr L Zita (ANC) asked the presenters to explain what the Department envisages as the social role of companies.

Mr Mongalo replied that the policy document is not detailed as the legislation would be. It only sets out policy guidelines and policies. Social responsibility means nothing more than that in decision making the interests of one group do not take precedent over those of another group. The issue has always been whether directors have duties towards people other than shareholders. Some people have always argued that directors only have duties towards shareholders. The policy seeks to change this.

Professor B Turok (ANC) said that annual reports present one of the major problems. Companies manipulate the data in the reports. He asked if there was any way of enforcing the codes relating to the presentation of annual reports. It is very difficult to know who the shareholders are in any given companies. One wonders if there is a way of ensuring that such information is put in the public domain. He was also concerned about bogus Black Economic Empowerment transactions. The problem is, for instance, company B acquires shares in company A. Company is in turn a subsidiary of Company C. This effectively means that Company C is the holder of the shares. He asked if there is any way of forcing the disclosure of the pyramid of control.

Mr Mongalo said that the main issue regarding annual reports is around financial statements. There is a tendency to misrepresent the company's prospects. The proposal is to set some form of reporting standard for particularly listed companies. The new Act would do away with nominee shareholding and the holder of the shares would be reflected in the register of the companies. There should be total transparency and such information would be put in the public domain. There should also transparency on the shareholding in BEE companies.

Professor Turok said that there is a problem of directors rewarding themselves through share transfers. In such cases one finds that the shares transferred to the directors are worth much more than their actual salaries.

Mr Mongalo replied that the having remuneration committee as a way of controlling remuneration has failed dismally. The objective of linking pay to performance has not yet been realised. In some countries shareholders are involved in the determination of directors' salaries. It is hoped that disclosure coupled with shareholder participation would ensure that payment is linked with performance and that there is no manipulation of shares.

Mr T Godi (PAC) asked whether the Department wants to "encourage" or "ensure" transparency.

Mr Mongalo replied that once something is put in legislation everybody would be required to comply.

Mr Zita said that there are two different kinds of capitalism. There is stakeholder capitalism in which it is not only the shareholders that are important but also workers and the community at large. There is also complete shareholder domination. He asked if the Department these into account. He also asked if there are any links between the law on co-operatives and the company law review. It is also important to know if it would be possible for employees to take over the company upon insolvency.

Mr Mongalo relied that the traditional Anglo-Saxon stakeholder capitalism could not be sustained in South Africa. Disclosure and transparency are the main concepts through which to involve other stakeholders. It would no longer be possible for shareholders to take directors to court if they have considered interests of other stakeholders and disregarded those of the shareholder. Taking into account the interests of other stakeholders other than shareholders does not necessarily mean that directors did not act in the best interests of the company. The German two tiers Board system would not be very effective in South Africa.

With regard to corporate rescues, Mr Mongalo replied that the courts would not play pivotal roles like they play in cases of judicial management at the moment. Employees would be given special protection but not necessarily taking over ownership. However, such a possibility is not rules out.

A member was there would be measures to ensure that the second economy would reach the first economy. He asked how the Department seeks to do this.

Mr Mongalo replied that the policy proposes the simplification of the formation of companies. This would facilitate the bridging of the gap between the two economies. There are many informal businesses which would have been successful concerns if they were registered.

Mr S Njikelana (ANC) asked how the Department intended to conduct the consultation process. He also asked if the reform process would look at the relationship between shareholders, senior management and directors. People feel uneasy when there is an overload of executive directors.

Mr Mongalo replied that the draft policy document has already been published. Consultation on the document has already started. The relationship between senior managers, executive and non-executive directors is receiving serious attention. The Department recognises the fact that executive and non-executive directors are not in the same position and therefore executive directors would be subjected to serious scrutiny. National Treasury also supports this.

Mr Moeletsi replied that the policy only articulates principles. He felt that it would be better to have a workshop on the policy at al later stage. It is difficult to answer some of the questions because the Bill has not yet been drafted.

The Chairperson said that this was an initial briefing and therefore a beginning of a process. It is important for members to air their view and articulate what they would like to see incorporated in the Bill.

Mrs D Ramodibe (ANC) asked clarity on how the Department would bring the second economy into the first economy.

Professor Turok said that share manipulation is possible due to the way that shares are organised. There are preferent, voting and non-voting shares. He asked if there is any intention to impose some standards to ensure that ordinary people are not confused. He also asked if the Bill would also deal with the investment policy.

Mr Mongalo said that the document refers to attaching one vote to every share. It would not be possible to have people holding shares but not having any economic power. There would still be preferent shares but the rule one share one vote would still apply. The reason for having preferent shares is primarily to raise capital.

Professor Turok said that many companies are listed overseas. Dual listing poses a problem to tax collectors because one never knows whether the company is domiciled in the Republic or in a foreign country. He asked if the Bill would deal with identifying domestic and overseas ownership and participation. Companies also appoint auditors who do as they say. He asked if the Bill would also address this issue. He suggested that the Bill should also cover whistle blowing.

Mr Mongalo said that the recommendations would have regard to the fact that most companies are now domiciled outside South Africa. A regime would be created to have those companies regulated if their main activities are in South Africa. He acknowledged that auditing remains a major problem. The Department would consider whether to make the Audit committee the final arbiter on the appointment of external auditors. At present the Audit Committee does not have a final say on who could become an auditor. This matter is dealt with the Board.

Mr Moeletsi replied that whistle blowing would be taken seriously. There has been an engagement in the Department on this. He suggested that Mr Mongalo should articulate the Department's view on this in the policy document.

Ms N Khunou (ANC) was concerned that the policy had already been taken to the public before it was presented to the Committee. She also asked the presenter to differentiate between policy and legislation.

Mr Moeletsi replied that they would engage the Director-General on the issue. The Department would also sit with the Minister of Trade and Industry so that they could agree on future processes. There was no intention to overlook the Committee. A policy document is an internal document to assist the Department with parameters within which the Bill should be drafted.

Mr Zita said that the level of inequality between the salaries of ordinary workers and senior management in companies is too much and that South Africa could not sustain them. He asked if the Department has any plan to bridge the gap.

Mr Mongalo replied that various codes of corporate practices and conduct have guidelines on remuneration. There is no legislation on this issue because nobody knows how to link the salaries of top management and those of the workers below. Remuneration committees should, in setting remuneration for top management, have regard to salaries of workers in the lower ranks. If the Department were to legislate on this it would only give guidelines.

Mr Netshitenzhe added that if the remuneration committees were composed by various stakeholders things would change.

Ms Cheng asked if the Department has any strategy of bringing the second economy into the first economy without the first economy swallowing the other. If the second economy is swallowed there would be severe job losses.

Mr Mongalo replied that since it is difficult for people in the second economy to register their businesses, the simplification of company's formation process would bridge the gap between the two economies. Some sort of recognition would be given to businesses from the second economy.

Mr Moeletsi added that company law is part of but not the solution. There are other initiatives within the Department. The legislation should be such that it helps people in the second economy to participate in the formal sector without necessarily being swallowed.

A member asked if there were any specific reasons for excluding the law on partnerships from the reform process. He also asked if the new legislation is intended to amalgamate all laws governing companies.

Mr Mongalo replied that the intention of the Department is to create a single Act for corporate entities. There would a separate chapter for section 21 companies. Partnership law is very huge and needs a separate review. The intention is to discourage people from entering into partnerships. A partnership is not a juristic person. The law is also unclear because it is largely based on common law.

Mr Njikelana said that it is risky to assume that the first economy is at its very best. The very fact that the Department is doing policy review is an indication that a lot still needs to be done. The first-second-economy dichotomy needs to be redressed and a new economy developed.

Mr Mongalo agreed with the sentiments. Bridging the gap does not necessarily mean that the first economy should not be improved upon or promoted. At the moment some Boards of Directors within the first economy still do not comply with proper corporate governance principles. This indicates that the first economy is not yet in its very best.

Mr Godi asked to what extent the policy would have an impact on labour legislation.

Mr Moeletsi replied that the Department does get opportunities to comment on legislation by other Departments. The Department also gives its legislation to outside experts for them to scrutinise it. it is important to know if the Department's legislation conflicts with legislation by other Departments. Where there are conflicts the Department suggests possible amendments to existing laws. Impact cannot be assessed within two months of legislation. Some legislation might look undesirable in the beginning but have positive results in the long run.

Mr Mongalo added that the Department avoids entering in the turf of other Departments without justification. Corporate legislation is mainly intended to regulate relationships between shareholders, directors and other legitimate stakeholders. It is not within DTI's competencies to legislate on labour matters.

Mr Netshitenzhe added that the DTI would not impose itself on other Departments. There is one government in the Republic but many Departments. Departments are now forced to form inter-departmental committees wherein each Department raises its concern before a common product is developed. The former Minister of Justice amended labour laws and the DTI was affected in the process. The DTI was never consulted in the process. With the formation of inter-departmental committees things like this would never happen again.

Mr Rasmeni said that the laws relating to the pricing and dispensing of medicines have a negative impact on trade and employment. He asked if the policy has any mechanisms to monitor other laws pioneered by other Departments so that they do not negatively impact on trade and employment. Some doctors are closing their practices and those who can afford to remain open are retrenching staff.

Mr Netshitenzhe replied that the DTI and Department of Health engaged on this issue extensively and various perspectives were considered. One cannot measure the impact at this stage.

Mr Rasmeni said that it is imperative to ensure that laws that are passed do not assist the first economy in swallowing the second economy. Currently big companies are swallowing the second economy doctors.

The Chairperson ruled that the first-second-economy dichotomy had been flagged adequately. There was no way in which there could be an exhaustive discussion of issues given that this was the initial briefing by the Department.

Mrs Ramodibe asked if the Department would conduct workshops to ensure that even the laymen understand the objectives of the proposed legislation.

Mr Mongalo replied that the Department would conduct information dissemination workshops as from the end of 2005.

A member of the Committee said that the new legislation should indicate how information should be disseminated. It is often said that ignorance of the law is no mistake and this is problematic.

Mr Moeletsi said that information would be disseminated in every corner of the republic. Once the Bill has been drafted the Department would conduct workshop to enlighten people on the law.

Mr Mongalo added that the Department is also looking if there is a need for the continued existence of the doctrine of constructive notice.

The meeting was adjourned.


 

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