What constitutes 'financial assistance'?
South AfricaWithout Prejudice
Section 44 of the Companies Act 71 of 2008 governs the instances when a company may provide financial assistance for the purchase of the company's securities. (It is important to note that section 44(1) carves out the application of the entire section 44 for financial assistance given in the ordinary course of business by a company whose primary business is lending money.)
The protection afforded in terms of section 44 aims to shield interested parties, such as creditors and shareholders, from unwarranted financial exposure, to promote the notion that company money should be used for a proper purpose and to guard against persons with insufficient funds gaining control of a company at the company's expense.
The provision of financial assistance can be done "by way of a loan, a guarantee, the provision of security or otherwise" (my emphasis). It is apparent from the wording of the Act that the term "financial assistance" is couched in broad terms and it appears that it has been left to the common law to determine its scope. In particular, the vexed issue of the words "or otherwise", appearing at the end of the listed methods of advancing financial assistance, has been the source of much debate and uncertainty among corporate lawyers and clients alike.
It is critical to understand when corporate actions amount to financial assistance, as the consequences for omitting to follow the provisions of section 44 are dire. If a board of directors decides to advance financial assistance in a manner or on terms inconsistent with the requirements of the company's memorandum of incorporation (MOI) or the Act, such decision will be void to the extent of such inconsistency. In addition, if a director were involved in making a decision that is declared void in terms of section 44, and failed to vote against such decision knowing that it was inconsistent with the company's MOI or the Act, then the director would be liable for any loss, damages or costs sustained by the company as a direct or indirect consequence.
In order to understand what is meant by the term "financial assistance", attention must be given to the judicial consideration of section 38 of the Companies Act 61 of 1973, as (unfortunately) our courts have not yet been tasked with interpreting section 44 of the 2008 Act.
In determining if financial assistance has been given, the courts have held that the "commercial realities" of a transaction must be considered (see Charterhouse Investments Trust Ltd v Tempest Diesel Ltd (1986) 1 BCLC ) (Charterhouse) and the financial assistance must actually be given to someone with the view to providing aid or help (see Sterileair (Pty) Ltd v Papallo (1998) 29 ACSR). The courts have said that if a person is merely given that to which they are entitled, for example a dividend or a debt that is due, owing and payable, then financial assistance will not arise for the purposes of the Act (see Gardener v Margo 2006 (6) SA 33 (SCA)).
Building on this notion, the court in Gradwell (Pty) Ltd v Rostra Printers Ltd (1959) 4 SA 419 (A) (Gradwell), when interpreting the purpose of financial assistance, said that the direct object of the provision of financial assistance was relevant when determining if the transaction fell within the ambit of the Act. It was held that if there existed no direct nexus or a sufficiently close relationship to the purchase of securities, then the advancement of financial assistance would not fall within the scope of the Act.
The judgment in Gradwell gave rise to the so-called impoverishment test. In short, the test examined whether a company had become poorer by virtue of the transaction and, if so, financial assistance was deemed to have been given. This test was subsequently criticised and reduced to merely a helpful guide, as it did not make provision for the giving of security or a guarantee, both of which would not involve a movement of money from a company, but both of which fell within the ambit of the definition of financial assistance in the Act (see Lipschitz NO v UDC Bank Ltd (1979) 1 SA 789 (A)).
In Lewis v Oneanate (Pty) Ltd (1992) 4 SA 811 (A) (Lewis) the court provided much needed clarity as to what was meant by financial assistance. The court held that it was any assistance of a financial nature, given directly or indirectly for the purpose of or in connection with the purchase of securities. The court in Lewis held that the impoverishment test was useful but not always appropriate and that one must give consideration to the true nature of each transaction.
What constitutes "financial assistance"?
Consider the following example - Company A wishes to acquire shares in Company B, who in turn wishes to sell shares to Company A. Company A procures finance from one of its shareholders, Company C, to acquire the shares in Company B. As security for the finance, Company B grants Company C a put option in relation to the shares Company C holds in Company A.
It is evident from the example that there will be an acquisition of Company B's shares by Company A. Supposing that the put option is an indispensable requirement by Company C to finance the acquisition of shares by Company A, will Company B be deemed to have provided financial assistance to Company A for the purchase of its shares?
Assume that the put option creates a contingent liability that Company B will have to carry on its balance sheet for the duration that it is exercisable by Company C. In terms of the impoverishment test, as postulated in Gradwell, the put option will not constitute financial assistance as no money has flowed from Company B. In terms of the test set out in Lewis, where the threshold for financial assistance is set at "any assistance of a financial nature", it can be argued that the put option will constitute financial assistance by virtue of its record on Company B's balance sheet.
On balance and with due consideration of the test in Gradwell, coupled with the "commercial realities" consideration in Charterhouse, it appears likely that Company B is providing assistance that is financial in nature and that same will trigger the provisions of section 44 of the Act.
The common law is a useful measure of what constitutes financial assistance, but unfortunately it does not provide a definite rule. As with most areas of law that are cloaked with interpretational uncertainty, a case by case analysis is always best practice.
Ultimately the board of directors of a company are encumbered to apply their minds when determining if financial assistance is given. Such consideration will need to be made with due cognisance of the liability attributable to directors who fall foul of the provisions of section 44 of the Act. In this regard, directors will be well advised to procure advice from competent legal counsel and exercise a conservative approach towards the authorisation of financial assistance.