The Governing Documents of Companies
and
Companies Financial Reporting
The purpose of this presentation is to look at more issues arising out of the Companies Act 71 of 2008 which will be or become pressing before or at the commencement of the Act. For purposes of clarity, I will be referring to the Old Act and the New Act to differentiate between the current and the superseding statute respectively.
My discussion will be divided into two distinct parts:
- Financial reporting
In this part of the discussion I will consider the controversial issue of the financial reporting regime introduced by the New Act. The discussion will include auditing requirements.
- Issues relating to governing documents of the company,
This is an important issue. Even before the New Act comes into force, the compliance of companies’ governing documents with the New Act’s provisions should be a pressing consideration. The second part of the discussion will focus on exactly what the New Act provides in relation to the governing documents of companies. To aid the discussion, and to illustrate the practical relevance of the issue, I will shortly consider shareholders’ agreements and their position in the workings of a company.
Please interrupt me with questions, although I might ask that some questions be retained for discussion after the presentation is done.
2 Financial Reporting
Every company must keep “accurate and complete accounting records”, which should be kept at or accessible from its registered head office. This is a drastic simplification from the Old Act, which required specific types of books to be kept, for example register of fixed assets, books containing day-to-day entries of cash received and paid, records of goods sold and purchased, and statements of annual stocktaking.
Whenever “any financial statements” are provided to any person for whatever reason, then there are a number of requirements to which those statements should adhere:
- Satisfy prescribed financial reporting standards (Draft Reg 21).
- Present fairly the state of affairs and business of the company, and explain transactions and financial position of the business.
- Show the company’s assets, liabilities, equity, income and expenses as well as other prescribed information.
- Date produced and period to which applicable.
- Certificate indicating whether statements were audited or independently reviewed.
- Name and professional designation professional designation of person who prepared or supervised the preparation of the statements.
Apart from any other statements, every company is required to prepare “annual financial statements” within 6 months of financial year end.
Up until this point, all companies are affected equally with regards to bookkeeping. When the auditing requirements of the Act are considered, however, different types of companies are treated differently.
One of the big changes introduced by the New Act is the fact that not all companies will be required to audit their financial statements. This has received a fair amount of press, particularly because the auditing profession is hostile towards the change. Some detractors of the Act have also argued that this leaves a great possibility for abuse. Some of this criticism is clearly warranted. However, this change in attitude is commensurate with the stated goal of the Act that smaller enterprises should be accommodated by the company law regime.
With regard to auditing requirements, three categories of companies can be distinguished:
- Those that will have to be audited.
- Those that will have to be independently reviewed.
- Those who will neither have to be audited nor independently reviewed.
2.1 Category 1 – Compulsory audit:
- Public companies.
- Voluntary audit at the “option of the company” – which probably means the board, although nothing bars the Memorandum from including such a requirement
- Prescribed in regulation
Which we will now consider in greater detail.
Prescribed in regulation:
Draft regulations have been published by the DTI.
In terms of those regulations, the following companies will have to be audited:
1. State-owned companies.
2. Any company that holds assets in a fiduciary capacity for a broad group of unrelated persons
As primary activity, or
As an activity incidental to its main business as contemplated in section 65(2) of the Consumer Protection Act.
3. Certain non-profit companies (Reg 29(1)(b))
four categories, if it –
(i) was incorporated -
(aa) directly or indirectly by the state, an organ of state, a state-owned company, an international entity, a foreign state entity or a foreign company;
or
(bb) was incorporated primarily to perform a statutory or regulatory function in terms of legislation, or to carry out a public function at the direction of an organ of the state, a state-owned company, an international entity, or a foreign state entity;
or
(ii) it solicits or accepts donations from the general public and –
(aa) its assets in the immediately preceding year exceeded R 60 Million;
or
(bb) solicits or accepts donations from the general public and its current expenditures for the immediately preceding year exceeded R120 million.
It’s not as though your stuck once you’ve crossed any of these hurdles. The auditing requirements only apply to a year in which the company satisfies the minimum requirements for that company to be audited. If, in the following year, the company no longer satisfies the requirements, no audit will be necessary.
2.2 Category 2 – Independent review
The relevant section in effect makes independent review the default option by determining that all companies not subject to a compulsory audit and not exempted shall have their annual statements independently reviewed. This means that the vast majority of companies will fall into the category of companies that will have to have their annual statements independently reviewed. What this provision of the Act will mean in practice, has come to light more clearly woth the publication of the Draft Regulations.
Varying standards for independent review are determined by the draft regulations. Different review standards are set for companies with a turnover of under R5 million per annum, those with a turnover of between R5 million and R100 million, and those companies with a turnover of over R100 million. Review standards are international standards, such as ISRE 2400 and ISRS 4400.
Some of the provisions of the act regarding the appointment, disqualification, rotation and powers of auditors are made applicable to those responsible for independent review.
2.3 Category 3 – Exempted companies
Certain categories of companies, where the probability of abuse is seen as small, are exempted from auditing AND independent review of their annual statements. Nothing however limits the capability of these companies to adopt auditing or independent review voluntarily or from prescribing this in the Memorandum of Incorporation.
Firstly, it is important to note that only private companies can be exempted. No other form of company can be exempt from the obligations to have annual statements audited or independently reviewed. I.e. non-profit companies, public companies, private liability companies or state-owned companies cannot be exempt.
If a company is a private company and it falls within one of two further categories, then it will be exempt from auditing and independent review.
Categories:
1. One person holds, or has all the beneficial interest in, all the issued share capital of the company.
2. Every person who holds or has a beneficial interest in issued shares of the company is also a director.
This applies subject to one exeption: if there is only one director and that person is a person contemplated in section 69(12), that is where a disqualified person is allowed to be a director.
(people removed from an office of trust for misconduct involving honesty, AND persons who committed certain offences, may under specific circumstances still be directors of companies)
2.4 Conclusion
To summarise: must keep records; any statements provided must meet certain criteria; with regards to oversight over annual statements companies can be divided into three categories, being those that must be audited, those that must be independently reviewed, and those that are exempt. Only private companies of a certain type will be exempt, and the majority of companies will have to have their annual statements independently reviewed.
This represents the most important aspects of financial reporting requirements laid down in the New Act. Any questions?
All right, this then brings us to the second part of this presentation, relating to the governing documents of companies.
3 The Governing Documents
Under the Old Act, the governing documents of any company comprised Articles and Statutes. The New Act does away with this distinction and brings the governing documents of companies into a single document called the Memorandum of Incorporation. To avoid unnecessary verbosity, I will refer to this simply as “the Memo”. This document will be the supreme law of the company to which all other rules and arrangements, barring those imposed by the Act, will be subject. Companies are afforded a window period of two years after the date on which the New Act comes into operation to get their house in order and adopt new or amended Memoranda.
Under the Old Act, issues of internal management of the company were to a greater or lesser extent regulated by the Articles. This document could be amended by a shareholders’ resolution, but was seen as contractual in nature. Any later contract between members which contradicted the terms of the Articles therefore could supersede the Articles in those specific respects.
Under the New Act, this will not be possible. The New Act does away with the contractual nature of the governing documents of companies. Amending a Memo will only be possible through a shareholders’ resolution.
In order to avoid any bureaucratic inefficiency in this situation, the New Act specifically provides for Rules of the Company to provide for issues of internal management. Such Rules will be adopted by the Board and will be binding and in force, provided that they must be put to a vote at the next shareholders’ meeting. At that stage, the shareholders’ may direct the Rule or Rules. Any rules inconsistent with the Memo or the Act are void to the extent of the inconsistency.
A distinguishing feature of the New Act is that it includes a number of alterable provisions. These provisions usually set a minimum threshold with regard to an issue, but allow that a company may vary or depart from the default option in the Memo of that company. I have started compiling a list of these provisions, and at this stage I have found at least 60 alterable provisions of this sort. In this discussion one such alterable provision has been mentioned, namely that auditing of a company’s annual statements might be prescribed in its Memo.
Other examples of alterable provisions are:
Section 19(1)(b) – Memo may exclude certain aspects of the legal capacity of a natural person for purposes of the company’s capacity.
Section 37(1) – Memo may oust the presumption that all shares in a class of shares are pari passu, thus potentially creating sub-classes of shares.
Section 44(2) – Board may authorise financial assistance for acquiring the shares of the company, unless forbidden by the Memo
Section 45(2) – Board may authorise financial assistance for directors/officers of the company/related company/interrelated company, unless restricted by the Memo.
Section 39 (3) – Memo may exclude the right of first refusal of current shareholders of a private company in respect of shares issued by the company.
(such a right exists only in relation to private companies)
Section 63(2) – Electronic meetings and electronic participation are allowed in respect of a shareholders’ meeting, unless Memo determines otherwise.
In order to illustrate the wide-ranging practical importance of the issues of governing documents and alterable provisions, let us consider shareholders’ agreements.
Due to the fact that shareholders’ agreements under the Old Act could have the effect of amending the Articles of the company, and had the added benefits that it was free of formalities and could remain confidential, shareholders’ agreements have taken up an important place in the commercial world. Arrangements surrounding the practical side of BEE transactions have also traditionally been incorporated into shareholders’ agreements.
The New Act recognises the existence of shareholders’ agreements, but specifically provides that such agreements are void to the extent of their inconsistency with the Memo of the company or the Act. This means that there is no way in which to “contract out” of the provisions of the New Act, unless this is done in the Memo while exercising an option afforded by an alterable provision.
One provision that is regularly seen in shareholders’ agreements is a clause that determines a manner in which directors of the company will be appointed. On my reading of the New Act, these provisions cannot survive the coming into operation of the New Act, because they will be rendered unenforceable.
At this stage, let’s turn to specific scenarios relating to shareholders’ agreements:
This is due to the wording of section 68, which is a typical alterable provision:
(1) Subject to subsection (3), each director of a company, other than the first directors or a director contemplated in section 66 (4) (a) (i) or (ii), must be elected by the persons entitled to exercise voting rights in such an election, to serve for an indefinite term, or for a term as set out in the Memorandum of Incorporation.
(2) Unless the company's Memorandum of Incorporation provides otherwise, in any
election of directors-
(a) the election is to be conducted as a series of votes, each of which is on the
candidacy of a single individual to fill a single vacancy, with the series of
votes continuing until all vacancies on the board at that time have been filled; and
(b) in each vote to fill a vacancy-
(i) each voting right entitled to be exercised may be exercised once; and
(ii) the vacancy is filled only if a majority of the voting rights exercised
support the candidate.
Subsection 3 refers to the interim appointment of a director in case of a vacancy.
Of course, if the shareholders’ agreement merely echoes the Memo on this point, it will be saved from extinction. This does not moot the point, because the reason for including a provision regarding the appointment of directors in a shareholders’ agreements might have been confidentiality, which is lost if the provision is to be fully stated in the Memo.
The New Act provides for ex officio directors, but these may only be appointed if provided for by the Memo. Direct appointment by a party or parties remains an option, as long as the issue is dealt with in the Memo. Confidentiality and the advantage that a shareholders’ agreement is free of formalities are lost if the appointment of directors is fully canvassed in the Memo.
Another situation that might cause uncertainty and unwanted litigation is the possible situation of conflict between the Rules made by the Board and a Shareholders’ Agreement. The New Act specifically states that Shareholders’ Agreements may not be inconsistent with the Memo and are void to the extent of such an inconsistency. However, no such provision exists in relation to the Rules made by the Board.
In my opinion, in cases where a shareholders’ agreement and the Rules of the company clash, the latter will be preferred by the Courts. But how then to ensure a beneficial structure of internal management before the company is incorporated? It seems that, although there are ways to ensure such a beneficial structure, these do not include shareholders’ agreements to any large extent.
4 Conclusion
In the short amount of time for which I had the privilege of your attention, it is naturally impossible to canvass all the ways in which the New Act will impact on the workings of companies in South Africa. This presentation attempted to highlight certain issues which should already be occupying the minds of persons who operate in or through use of companies. It should be clear that ensuring compliance with and full utilisation of the New Act will be a large task.
Although the coming into operation of the New Act has not been given a fixed date by the Government, this date does seem to be fast approaching. The most prudent option is probably to start preparing for the New Act well in advance.
Renier Kriek |
