Companies Draft Bill: briefing by Department

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
16 March 2007
COMPANIES DRAFT BILL: BRIEFING BY DEPARTMENT

Chairperson: Mr P Martin (ANC)

Documents handed out:
The Companies Bill: Department of Trade and Industry presentation
Companies Draft Bill as of 13 February 2007

Audio Recording of the Meeting

SUMMARY
The Department of Trade and Industry briefed the Committee on the Companies Bill, which was published for comment in February and would most likely be introduced into Parliament in November. The Bill sought to reduce the regulatory burden on small and medium sized firms, to enhance the protection of investors by enhanced governance and accountability, to improve transparency, to achieve minority protection and shareholder recourse and to create a more flexible environment without compromising regulatory standards. It had been widely debated and was negotiated at Nedlac, who had requested that the new legislation align more closely with the Close Corporations Act. The important principles were flexibility, retention of the distinction between listed and unlisted companies, the move to a system based on solvency and liquidity, clarification and codification of director responsibilities and board structures, facilitation of mergers, effective business rescue systems, improvement of transparency, protection of shareholder rights, particularly minority shareholders, enforcement of minimum accounting standards and decriminalisation by replacing the current criminal sanctions, in appropriate cases, with civil sanctions. It was hoped that currently unregistered entities should opt to become regulated, but this would be done by incentives rather than coercion.

The Department summarised the main provisions.  A Commission and a Takeover Regulation Panel would administer the requirements of the Act and a Companies Ombud would facilitate alternative dispute resolution. A Financial Reporting Standards Council would advise on requirements for financial record keeping and reporting. The Bill would repeal the Companies Act of 1973, and provide for the future repeal of the Close Corporations Act. A new standard of solvency and liquidity ran throughout the legislation. The Bill provided for not for profit companies, and classified companies into Widely Held Companies (WHC) and Closely Held Companies (CHC), with public interest companies incorporating all widely held and some closely held companies. The registration process had changed and was far simpler. Name registration was no longer required but was optional. The principles of corporate finance had been modernised and made more flexible. Some of the artificial distinctions had been abolished. The most recent changes to the Companies Act in relation to audits and financial accountability had been incorporated also into the new Bill. Quorum requirements for an ordinary resolution had been raised. There was a codification of Director’s duties. The Chapter dealing with takeovers, offers and fundamental transactions attempted to simplify the arrangements and new concepts of merger and amalgamation of companies were introduced. The Chapter on Business Rescue contained many changes, and drew on international practice as well as incorporating protection for employees and minority shareholders. The Chapter relating to enforcement had moved to civil penalties, with the criminal sanction being restricted to reckless trading, serious contraventions, fraud and misleading the public. A provision for whistleblowers had been included. The institutional framework was set out.

Questions by Members addressed the rights of workers, self standing mergers, the registration and names processes, the eight-year period to determine whether the Close Corporation legislation should be repealed,  the business rescue situation, the cross-participation of the Departments of Justice and Trade and Industry in the new insolvency legislation, the solvency / liquidity test, indemnity for Directors, and independence of auditors.

MINUTES
Companies Bill: briefing by Department of Trade and Industry (dti)
Ms Astrid Ludin, Deputy Director General, dti, stated that objective of the presentation was to give the policy context of the proposed Bill published for comment in February. It would only be introduced later in the year, but since it was in the public domain the Department thought it would be useful to give the Committee an introduction to it.

The new Bill represented a significant departure from current legislation. The need for substantial reform was informed by a number of factors. Company law had not been substantially reviewed for 34 years. The global and domestic environment had changed substantially since 1973 and there had been amendment to other related laws. The old Companies Act of 1973 was now outdated, highly formalistic and contained unnecessary burdens. Company law influenced investor sentiment.

There were 3.1 million enterprises in South Africa, of which 1.7 million were registered entities, and there were also around 750 000 business in the informal sector and about 700 000 sole proprietorships. At present companies were classified as close corporations, private companies, public companies, incorporated companies and external companies. The majority were close corporations. Only 440 of the 3 757 public companies were listed entities, although they accounted for 60% of gross domestic product (GDP). The drafters of the new Bill therefore had to draft legislation that was appropriate for closely held firms yet had sufficient rules around governance and accountability for public companies. dti had also sought to attract unregistered entities to the formal sector. The idea was to create incentive rather than to force compliance.

The objectives of the new Bill were to reduce the regulatory burden on small and medium sized firms, to enhance the protection of investors by enhanced governance and accountability, to improve transparency, to achieve minority protection and shareholder recourse and to create a more flexible environment without compromising regulatory standards.

The broad basis of the Bill had been negotiated at National Economic Development and Labour Council (NEDLAC). Nedlac had requested that the new legislation should be more closely aligned to the Close Corporations Act rather than the current Companies Act. It should also retain provisions for not-for-profit companies. It was agreed not to deal with cooperatives and partnerships in this legislation. Flexibility was an important principle running through the Bill. It was agreed to retain the fundamental distinction between listed and unlisted companies. In terms of corporate efficiency it was agreed to move from a capital maintenance system to one based on solvency and liquidity. It was agreed that there would be clarification of board structures and director responsibilities. There would be a remedy to avoid locking in minority shareholders to inefficient companies. It was also agreed that the law would facilitate mergers in the true sense. The current scheme of judicial management was to be replaced with a more effective business rescue system.

Transparency was to be improved. There must be recognition of director accountability and appropriate participation by stakeholders. There should be standards for truth and accuracy in public announcements and prospectuses. There should be protection of shareholder rights, and increased protection to minority shareholders. Minimum accounting standards would be applied. It was also agreed to revise the system of regulation, and in particular to decriminalise the law wherever possible, and instead to enforce through appropriate bodies and mechanisms. There would be a better balance between adequate disclosure and over regulation.

Ms Ludin summarised the policy processes that had been followed and listed those consulted. The policy document was published for comment in June 2004 and simultaneously introduced to Nedlac. There were workshops and engagement with government departments and regulators. The policy document was then reviewed to reflect the dti's response to the comments. Drafting instructions began in March 2006 and the Chapters were drafted and tested individually. The Bill was submitted to Cabinet in October 2006 and was published for comment in February 2007. A number of extensions for comment had been granted. There would be substantial engagement on the Bill. Dti hoped to take the Bill back to Cabinet by the end of June or early July and then submit it to the State Law Advisors for certification. The Bill was likely to be introduced to Parliament around November 2007. It had been tabled already at Nedlac.

Ms Ludin then proceeded to take the Committee through the main provisions of the Bill.

The long title of the Bill outlined the aim to provide for the incorporation, registration, capitalisation, organisation and management of for-profit and not for profit companies. It would define relationships, provide for efficient mergers, amalgamations and takeovers and the rescue of failing firms. It would provide appropriate redress for investors and third parties. A Commission and a Takeover Regulation Panel would administer the requirements of the Act and there would be a Companies Ombud to facilitate alternative dispute resolution. There would further be a Financial Reporting Standards Council to advise on requirements for financial record keeping and reporting.

The new Bill would repeal the Companies Act of 1973, and would also provide for the future repeal of the Close Corporations Act. One of the objectives was to create incentives for companies to operate in the formal domain, and when this happened there would no longer be any need for the Close Corporations Act. There had been substantial debate on this issue. A compromise had been reached that dual legislation would continue for a period of eight years. After that time there must be an assessment whether the Close Corporations Act was still needed. If not, it would be repealed. If there was a need, then the provisions dealing with the repeal in this Bill would fall away.

Chapter 1 dealt with definitions. The most important was the solvency and liquidity test, applicable as a test through the legislation. It provided that the assets of a company must be sufficient to meet its liabilities at a particular point in time, as well as twelve months after that point. It applied to all entities registered in terms of this legislation or previously registered. It also applied to not for profit companies, but there was a limited application. It did not necessarily apply to registered financial institutions as other Acts would cover them, and the Minister could exempt certain industries from certain provisions if satisfied that there was another piece of legislation providing an equivalent provision. Transitional provisions were also included in this Chapter. Existing companies had three years to change their Articles to comply with the new legislation and convert the Articles to a Memorandum of Incorporation.

The current legislation provided for not for profit companies through the Section 21 provisions. Since there was not yet other legislation to govern these companies, they had also been included in the Bill. The Bill distinguished between widely held companies, who traded in their shares, and closely held companies, which did not. It also made provision for public interest companies, which would be subject to additional requirements on governance, transparency, and the need for an audit committee. All widely held companies were public interest companies, but it could also include some closely held companies. The test of inclusion would be size or operation in a sector that was held to be in the public interest. Ms Ludin stated that companies taking deposits would be public interest companies.

The most substantial changes were contained in Chapters 2 and 6 of the Bill.

Registration would henceforth be a right, not a privilege. That meant that as many obstacles to registration would be removed. There were therefore minimal requirements for registration. The incorporators needed to complete and lodge a Notice of Incorporation, a basic one-page document, with the Regulator. There was no need for certification. The Regulator would assign a registration number that would enable the company to trade. There was maximum flexibility in the design and structure. The Memorandum of Incorporation was the sole governing document, and the Bill envisaged a standard memorandum being attached as a schedule. There were certain mandatory provisions, but others that were optional, such as shareholders being able to decide whether there must be an audit of a closely held firm.

The Bill retained the existing regime for company names and registration but name registration was no longer compulsory. Company names would be restricted only so far as necessary to protect the public from misleading names or to protect intellectual property rights of other owners. Society would be protected also from names that were hateful or had other negative connotations. This should speed up the process of registration. The main differences in the registration process were summarised in tabular form..

Chapter 3, relating to Corporate Finance, sought to modernise the principles and create more flexibility. It did away with outdated principles, such as nominal capita and par values. It allowed financial assistance for the purpose of share acquisition, subject to the solvency and liquidity test and to shareholder resolutions. There was a new scheme for debentures, doing away with the old distinctions between different debt instruments. All distributions were now to be treated in the same way ad were subject to the solvency and liquidity test. There was modernisation and simplification of the scheme for primary and secondary debentures.

Chapter 4, dealing with Corporate Governance and financial accountability, retained to a large extent what was currently in the legislation. The changes recently approved such as rotation of auditors and audit committees were retained. The drafters had however raised the quorum requirements for an ordinary resolution to 25% of all shareholders entitled to vote. Shareholders could also participate by electronic communication.  Decisions could be taken by round robin or teleconference. The Bill also set out a codified regime of Director's duties, including fiduciary duties and reasonable care. The existing provisions in regard to financial records and statements were retained, but closely held companies did not have to appoint auditors, unless they were also public interest companies.

Chapter 5, dealing with takeovers, offers and fundamental transactions retained the Takeover Code and Panel, schemes of arrangement, mandatory offers and squeeze out transactions. It had however tried to make the Chapter more facilitative. Currently schemes of arrangement required court approval. In the new Bill this was only required if a significant minority of 15% was opposed to the transaction, or if there was procedural irregularity or a manifestly unfair result. If a minority dissented from the transaction they could then have their shares valued to ensure a fair value. New concepts of merger and amalgamation of companies were introduced.

Chapter 6 related to Business Rescue, and was a fundamental departure from the exiting legislation. It was likely to be hotly debated. It replaced the current system of judicial management with a modern business rescue regime, which would be largely self-administered by the company, under independent supervision. Any stakeholder retained the right to call for court intervention. The interests of shareholders, creditor and employees were recognised and all could participate in developing a business rescue plan. The interests of workers were  recognised in that they would be recognised as creditors and have voting interest in respect of unpaid remuneration, require to be consulted in the business plan, have the opportunity to address creditors and have a group right to buy out any dissenting creditor. This provision had drawn on international practice. Many provisions were derived from the US Chapter 11, UN guidelines and Australian provisions. However, the rights for employees were a South African innovation. It envisaged that the business rescue should be complete within about three months, and therefore it could not be used to delay insolvency.

Chapter 7 related to remedies and enforcement. Criminal penalties would remain for reckless trading and wrongdoing and serious contraventions. The High Court remained the principle forum for remedies. The Policy Document had made mention of a tribunal , but this had been removed. There were additional remedies for shareholders including appraisal rights, the right to apply to have a director declared delinquent or under probation,  and a derivative action provision for a wrong done to the company rather than shareholders. The provision for whistleblowers had been included at the request of the Portfolio Committee.

Chapter 8 dealt with the institutional framework. There would be a new Companies Ombud to deal with resolution of shareholder disputes, and assist in resolution, and it would also be a forum for companies to appeal administrative decisions made by the Companies and Intellectual Property Commission (CIPRO). Although there was provision for appeals other than to a court, the Court was not precluded.

Dti would take over the Financial Standards Reporting Council, created under the latest amendments to the Companies Act. The Securities Regulation Panel (SRP) would be responsible for approving offers, but its governance would change, as it would be constituted by the Minister with 13 members. CIPRO would be responsible for registration, enforcement and education. The current Act permitted the Minister to appoint inspectors and enforcement functions currently resided in dti. It was envisaged that the two functions would be merged into one institution that was outside the Public Service but still an organ of the State. Some changes resulted from discussions with NT and Minister of Finance. The institution would be modelled more closely on the Revenue Services (SARS), and most of the responsibility would reside in the Commissioner.

Ms Ludin concluded that the new Bill was anticipated to reduce the cost of registration, the regulatory burden on small and medium sized firms, to improve transparency and accountability of public interest firms, and improve regulatory oversight and enforce redress for shareholders.

Discussion
Mr D Dlali (ANC) asked for clarity on the interests of workers, particularly on their right to buy out any dissenting creditor who had voted against approving a rescue plan. He asked if they would have one vote as a group.

Ms Ludin answered that employees would be treated as creditors if they were owed money, and therefore should be entitled to approve a rescue plan. If any creditor, including an employee union opposed the business rescue plan and wanted to proceed to insolvency, the union could buy out the dissenting creditor.

Mr Dlali asked how this Bill would deal with issues similar to those which had arisen in the Harmony/Goldfields transactions, where shareholders were disputing what issues should be taken on board first.

Mr Tshepo Mongalo, Project Manager: Corporate Law Reform Process, dti, said this did present a number of challenging situations and also related to the common law duties on the content of the prospectus. He pointed out that the Bill, in addition to providing for existing affected transactions currently available under Section 414 of the Companies Act, provided for a self-standing merger and amalgamation, and an independent assessor would assess whether all the rights were protected under the merger. The Bill envisaged that in addition to schemes of arrangement, the self-standing merger would allow  merging companies to consolidate all their assets in a newly incorporated company that would be the holder of all rights and liabilities of the amalgamated companies.

Mr L Labuschagne (DA) asked if the simplified registration would apply to something like a gold mining company, and if there would be different categories of procedure for widely and closely held.

Ms Ludin replied that dti had envisaged one registration process that should not distinguish between different types of companies. There were different requirements after registration. A closely held firm would not have to make its Memorandum of Incorporation public, although it must be accessible, but a Public Interest corporation would have to make it public. The differences mostly related to accountability and transparency. Financial records would need to be in the public domain.

Mr Labuschagne asked if the Bill would do away with the "Pty" or "CC" notation on the letterheads.
He asked if the prospectus was a requirement of the Johannesburg Stock Exchange (JSE) or would be required under the new legislation.

Mr Mongalo said the categorisation of companies went together with their identifying features. There would be notations of "WHC" and "CAC", to replace the old terms. The prospectus was a requirement for public offerings under Chapter 4. It would still be required in these circumstances, as it would ensure that primary offerings were effected in a fair and transparent manner.

Mr Labuschagne enquired whether there might not be some uncertainty in relation to reservation of names. He was worried that both companies might have the same name, if no reservation was required, and felt that there was not presently much regulatory burden in reserving a name.

Ms Ludin replied that the dti had not done away with the system of name reservation but it was no longer compulsory. A company could trade with a number. If it wanted to use a name, it would normally go through he name registration. A company would not be able to register a name already registered, but the reservation process was optional.  The current system was two-tier, in that the name had to be reserved before registration and before companies could trade. The Bill created more flexibility, as they could trade with a number, but had not undermined the system of names.

Mr Mongalo emphasised that under the current legislation the name reservation was a self-standing process, and the process would stop if the name was not available. The new Bill would not give rise to inconsistencies because a name similar to one already in use would not be accepted, but this would not stop the whole process, because the number would be given and the company would be allowed to start trading.

Mr S Njikelana (ANC) asked how the eight-year period for repealing the Close Corporation legislation had been determined.

Ms Ludin said that this was based upon a ten-year assessment. Dti believed that ten years was a reasonable period within which to assess the need for continued existence of the Close Corporation Act. The investigation would take place after eight years and the remainder of the process would probably take up the remaining two years. It would only be possible to test the legislation after about the first three to five years of its operation.

Mr Njikelana commented that the business rescue system was a good approach. He had previously had doubts whether the Department of Justice was the correct department to be administering business rescues, and the involvement of dti was welcomed.

Ms Ludin noted the comment and said that the Department of Justice (DOJ) and outside stakeholders were involved in the original process. This Bill, the Corporate Law Reform process and the Insolvency process were all ongoing concurrently. The dti and DOJ had participated together in a Task Team and decided that business rescue and insolvency should probably not be dealt with in one piece of legislation. They agreed that the best split would be for the DOJ to deal with insolvency and dti to deal with rescue. A representative of DOJ had been on the drafting team, and dti would be participating in the DOJ's process on insolvency. The current Companies Act dealt  with compulsory winding up and liquidation of companies. Those provisions would remain in effect until there was legislation to repeal and replace them. Voluntary winding up had been built into this Bill. This would clarify the split and give DOJ sufficient opportunity to develop and align its legislation with this Bill. DOJ had also initiated another internal process around business rescue.

Mr Mongalo added that it would not be workable for dti to link into the unfinished processes around insolvency, as this would pre-empt the DOJ’s legislation. Business rescue replaced judicial management, which was always dealt with under the Companies Act. It would have been a serious omission to leave this out of the Bill. If the DOJ insolvency legislation were in future to deal with business rescue of other entities, then the legislation could be aligned if needed.

Mr Njikelana asked what were the safeguards against abuse of name registration if it was not compulsory.

Ms Ludin said that the main abuse did not lie in the registration of the name, but in the practice that although one name was registered, the company could trade under a different name, which created the potential to mislead the public. The Consumer Bill, which would come to the Committee shortly, did contain a process to register trading names, which would be kept with CIPRO, so the Registers would be retained in one place.
 
Dr P Rabie (DA) noted that the asset liability ratio of companies was important. He referred to the Reserve Bank requirements, and said that public companies had certain amount of reserves and cash. He asked whether there had been any feedback on the new requirements and if the interests of creditors would be  safeguarded.

Ms Ludin said that the response had been good. The current legislation provided for a dual system. Dti was proposing to move only to one system, that of solvency and liquidity, which was generally welcomed by business because it gave it more flexibility. This system should give the same protection to a creditor, as a company should always be solvent and always be liquid. There should not be short-term obligations to investors if all money was tied up in long term investments. The intention was to safeguard creditors.

Mr Mongalo said that the problem had always been that the  Close Corporations Act seemed to endorse the idea of the solvency/liquidity test through the requirements in relations to financial assistance for acquisition. The Companies Act had tried to introduce the test in 1999 but did not go far enough. The solvency and liquidity test was required under section 85 for share buy-backs,  and for dividends in terms of section 90 but not under section 19(a) for redeemable preference shares. The question was why some distributions should be subjected to the solvency /liquidity test and others not. The economic significance of both was the same.

Mr Njikelana asked the presenters to give some examples of decriminalisation, and what would replace the criminal penalties.

Ms Ludin said that in the current legislation the failure to lodge documents such as annual statements was a criminal offence.

Mr Mongalo added that there was no policy justification for criminalising certain provisions. Where this was the case, these penalties had been replaced with administrative and civil penalties that were more effective. The failure to lodge forms, for instance, should not be a criminal offence. It was virtually impossible to enforce as such. Civil penalties were more effective.  Misleading the public was treated very seriously, to align with the Public Audit Act, and so was inclusion of false information in the prospectus or financial statements, trading under insolvent circumstances, and attempts to defraud other creditors. The Commission had the power to issue compliance notices in relation to other matters, and failure to comply would be endorsed as contempt of Court and implemented through that process. Civil penalties such as imposition of personal liability upon directors and shareholders was an effective civil penalty that had been retained.

Ms Ludin added that under the current law the Minister could appoint an inspector into a matter at the request of the shareholders. The shareholders could in theory take the inspector’s report and pursue any wrongdoing in a civil court. Dti had found that small shareholders lacked resources to take the matters forward and therefore did not obtain redress. Courts were an expensive process. Dti had therefore decided to set up the Tribunal process, which should hopefully make the process of redress more accessible. The Bill also provided that a complainant could cede his or her case to the Commission, who would have standing in a civil court to take up the matter. That had achieved the important policy objective to improve shareholder activism. There should be some kind of a means test, therefore there was no obligation on the Commission to take forward all cases, and it would not use the resources of the State where there were well-resourced shareholders.

Mr Labuschagne said that he had understood that the Act provided that a Company could provide financing for a director to defend himself in Court. If so, he asked whether the company could do the same for any shareholder.

Mr Mongalo said that there was such a provision, however it did not necessarily provide for indemnity in all instances as it would only protect directors where there was not gross negligence. That was in line with international developments,  particularly since the need to retain and have more effective and committed directors was important for the growth of the economy. If South Africa had not provided for indemnification and insurance this would act as a disincentive to become a director. There was no provision that the same assistance be given to shareholders. A Director had the responsibility to act on behalf of the company. The shareholder had no such responsibility, and therefore no such protection. 

Mr Dlali asked what protection there was around the audits.

Mr Mongalo replied that those companies required to appoint auditors, which would be the public interest companies, also had to comply with the requirements for rotation of auditors and the auditors were not permitted to undertake certain services. The person responsible for the audit must be independent.

Mr Njikelana commented that it would be helpful for dti to indicate how responsive the Bill was to the policy framework.

The Chairperson responded that there would be further briefings by the Department and there would also be public hearings, which would investigate the  policy parameters

The meeting was adjourned.