topic 13

What is "capital maintenance," and why was it replaced by the solvency and liquidity ("S&L") test in the 2008 Act?

Capital maintenance was the common-law/1973 Act approach of protecting creditors by preserving a company's stated share capital (restricting distributions to profits, prohibiting the return of capital to shareholders). It proved unsuccessful and was replaced because the S&L test protects creditors' interests more effectively than the old capital maintenance rules.

For which five corporate actions does the Act require the solvency and liquidity test to be applied?

Financial assistance for the acquisition of securities (s 44); loans or financial assistance to directors (s 45); distributions, e.g. dividends (s 46); cash payment instead of capitalisation shares (s 47); and acquisition by a company of its own shares (s 48).

What are the two limbs of the solvency and liquidity test under section 4(1)?

(1) Solvency: the company's assets, fairly valued, must equal or exceed its liabilities, fairly valued; and (2) liquidity: it must appear that the company will be able to pay its debts as they become due in the ordinary course of business for the ensuing 12 months (both limbs must be satisfied — "AND", not "OR").

On what financial information must the solvency and liquidity test be based, per section 4(2)(a)–(b)?

Accounting records that meet the requirements of s 28, and financial statements that meet the requirements of s 29; the company must consider a fair valuation of its assets and liabilities, including reasonably foreseeable contingent assets and liabilities (whether or not arising from the proposed distribution) — it may also consider other valuations reasonable in the circumstances.

When applying the S&L test to a distribution, what must a company NOT include as a liability, per section 4(2)(c)?

Unless the MOI provides otherwise, the company must not include, as a liability, the amount that would be required to satisfy the preferential rights of shareholders (upon a hypothetical liquidation at the time of the distribution) with rights that would take preference over those of the shareholders receiving the distribution.

How does section 1 define "distribution" in paragraph (a)?

A direct or indirect transfer by a company of money or other property (excluding the company's own shares) to or for the benefit of one or more holders of any of the shares of that company, or of another company within the same group of companies, whether as a dividend, a payment in lieu of a capitalisation share, consideration for the acquisition of shares, or otherwise, in relation to shares held.

Name two things that are NOT "distributions" under the Act.

(1) Payment made in satisfaction of an appraisal right under s 164 (s 164(19)); and (2) distributions made in the course of winding-up/liquidation of the company (expressly excluded from the definition of "distribution" in s 1).

What are the three requirements for a valid distribution under section 46(1)?

(a) It must be pursuant to a board resolution, an existing legal obligation of the company, or a court order; (b) it may be made only if it reasonably appears that the company will satisfy the S&L test immediately after completing the distribution; and (c) the board must pass a resolution acknowledging that it applied the S&L test and reasonably concluded that the company would satisfy it.

How is the S&L test applied where a capitalisation share award allows a shareholder to elect cash instead, per section 47(2)?

Even though not all shareholders may elect cash, the company must apply the S&L test on the assumption that ALL shareholders will elect to receive the cash payment instead of the capitalisation shares.

What must happen if a distribution is not fully carried out within 120 business days of the S&L test being applied, per section 46(3)?

The company must again apply the S&L test, and the board must pass another resolution acknowledging that the test was reconsidered and that it is reasonable in the circumstances to conclude that the company will satisfy the test.

How does the timing of S&L compliance differ where a "distribution" takes the form of incurring a debt (paragraph (b) of the definition), per section 46(4)?

Where the distribution consists of the company incurring a debt for the benefit of a shareholder, the S&L requirements must be satisfied at the time the decision is taken — the company does not need to satisfy the requirements again when the debt is actually paid out.

When does a director incur personal liability for an unlawful distribution, per sections 46(6) and 77(4)?

Where the director was present at the meeting when the distribution was approved (or participated in making the decision) and failed to vote against it despite knowing it was contrary to s 46 or the Act (s 46(6)); liability then arises under s 77(3)(e)(vi) read with s 77(4), if the company did not satisfy the S&L test immediately after the distribution and it was unreasonable to have concluded that it would.

How does section 1 define "knowing," "knowingly" or "knows" for purposes of director liability?

The person either (a) had actual knowledge of the matter, or (b) was in a position where they reasonably ought to have had actual knowledge, ought to have investigated to the extent that would have provided actual knowledge, or ought to have taken other measures that would reasonably be expected to have provided actual knowledge.

How is the amount of a director's personal liability for an unlawful distribution calculated, per section 77(4)(b)?

It is the difference between the maximum amount the company could lawfully have distributed and the amount actually recovered by the company for itself (e.g., if R100 was distributed but only R80 was lawful, and the company recovered R7 of that excess, the director is liable for R13).

What relief is available where a distribution is found to be unlawful, per section 77(5) and section 218(1)?

The company, or a director facing personal liability, may apply to court to have the board's decision set aside; the court has wide powers, including ordering shareholders who received the distribution to repay it. However, a distribution prohibited by s 46 is not automatically void — it remains valid unless and until a court declares it void (s 218(1)).

What are three common-law problems associated with a company acquiring its own shares?

Any three of: using company funds for a non-commercial purpose; "trafficking" with its own shares; enabling insider trading; prejudicing existing shareholders; or directors abusing the mechanism to entrench or expand their own control.

Give two legitimate commercial benefits of a company acquiring (buying back) its own shares.

Any two of: supporting the share price against speculators; providing an exit for employees who leave the company's employment; defending against a hostile takeover; acting as a buyer of last resort for unlisted shares; or increasing earnings per share.

How does an acquisition of own shares fall within the "distribution" definition, per paragraph (a)(iii), and what two steps does the acquisition involve?

Paragraph (a)(iii) of the "distribution" definition includes consideration paid by a company for the acquisition of any of its own shares. The acquisition involves two steps: (1) the agreement to acquire — governed by s 48(2)(a), which requires the board's decision to satisfy the requirements of s 46 (distributions); and (2) the payment (consideration given) — which itself constitutes the "distribution" and must independently satisfy s 46's requirements.

What two structural limits apply to a company's issued shares after it acquires some of its own shares, per section 48(3)?

The company's issued shares may not, after the acquisition, be held only by a subsidiary (or subsidiaries); and they may not consist only of convertible or redeemable shares.

When must a share buy-back be approved by special resolution of shareholders, per the operative (amended) section 48(8)?

Where shares are to be acquired from a director, prescribed officer, or a person related to either (a); OR where the acquisition does not result from a pro rata offer made to all shareholders (or a class of shareholders) or from transactions effected on a licensed stock exchange under the Financial Markets Act (b).

Summarise the full set of requirements for a company acquiring its own shares.

The directors (board) must approve the acquisition; the S&L test must be satisfied; after acquisition the company's issued shares cannot be held only by a subsidiary nor consist only of convertible/redeemable shares (s 48(3)); and a special resolution is required if the buy-back is from directors, prescribed officers, related persons, or is not via a pro rata offer/stock exchange transaction (s 48(8)).

In which two circumstances does section 48 NOT apply to an acquisition of shares, per section 48(1)(a)–(b)?

(1) Where the company acquires shares by satisfying a shareholder's appraisal rights under s 164; and (2) redemption of redeemable shares under s 37(5)(b) — though in both cases, s 46 (distributions) remains applicable.

What is the status of shares once reacquired by the company under section 35(5)(a)?

The shares become authorised but unissued shares — South African law does not recognise "treasury shares" (shares held in the company's own name as an asset); reacquired shares simply return to the pool of authorised, unissued shares.

What happens if an agreement to acquire the company's own shares does not comply with the section 48 requirements, per sections 48(4)–(6)?

The agreement remains enforceable unless it is contrary to the requirements (s 48(4)); the company bears the onus of proving that it was contrary to the requirements (s 48(5)); and if it was contrary, the company must approach a court within 2 years to have the agreement set aside (s 48(6)).

When is a director personally liable in relation to an unlawful acquisition of own shares, per sections 48(7) and 77(3)(e)(vii)?

Where the director was present at the meeting at which the acquisition was approved and failed to vote against it, despite knowing that it was contrary to the requirements of s 48.

May a subsidiary acquire shares in its holding company, and what is the maximum permitted, per section 48(2)(b)(i)?

Yes, but the total number of shares of any class held collectively by all subsidiaries in the holding company may not exceed 10% of the number of issued shares of that class.

What voting restriction applies to shares held by a subsidiary in its holding company, and how does this connect to the "distribution" definition?

Such shares carry no voting rights while held by the subsidiary. This acquisition also falls within the "distribution" definition, para (a)(iii)(bb) — consideration for an acquisition by any company within a group, of shares of another company within that same group.

What are "capitalisation shares," and how does an election to receive cash instead affect the S&L analysis, per sections 47(1)(c) and 47(2)?

Capitalisation shares are additional shares issued to existing shareholders (in lieu of a cash dividend), funded out of the company's reserves rather than fresh consideration. Where the company instead makes a cash payment to a shareholder in lieu of a capitalisation share, that payment constitutes a "distribution" (s 47(1)(c)) and, as set out in s 47(2), the S&L test must be applied on the assumption that all shareholders elect to take the cash payment.