In a stressful economic environment, many companies are gravitating towards alternative resolution measures to retain value. Business rescue increasingly being viewed as a solution to resolve challenges that face companies that are financially distressed.
A successful rescue proceedings require funding sourced either externally or internally. While it is difficult to source external funds during business rescue for various reasons, there are alternative sources of funding that are internal or within an organisation, i.e. Debtors discounting to increase collection rate, accelerated sales of stock at a discount, rental relief. These are some of the funding options that a company in financial trouble can explore to raise working capital that is needed
The fundamental question
The fundamental question is whether some of these funding options that can be explored internally can be regarded as providing financial assistance to another company even though it is not a related company, for example rental relief to a tenant, in terms of section 45 of the Companies Act.
Section 45 of the Companies Act 71 of 2008 governs direct and indirect financial assistance to the directors, prescribed officers as well as certain companies and corporations with the purposes of protecting shareholders and creditors
The Hogan Lovells article points out that section 45 does not expressly define financial assistance but rather sets out a list that includes lending money and guaranteeing any debt or obligation, but it has a number of exclusions. Or so we thought – A recent Supreme Court of Appeal (SCA) judgment in South Africa has provided clarity regarding what actions would be considered financial assistance (if it is a closed list or examples of items).
Section 45(3) provides that to the extent that any such financial assistance is provided directly or indirectly by a company to a:
- Director or prescribed officer of the company or of a related or inter-related company (as defined in the Companies Act);
- related or inter-related company or corporation; or
- member of a related or inter-related corporation; or
- person related to any such company, corporation, director, prescribed officer or member,
Image By: Canva
such must be provided pursuant to – (i) an employee share scheme; or (ii) a special resolution of the shareholders adopted within the previous two years approving the financial assistance and (iii) the board has considered and been satisfied that:
- immediately after providing the financial assistance, the company would satisfy the solvency and liquidity test.
- the terms under which the financial assistance is proposed to be given are fair and reasonable.
- any conditions or restrictions set out in the company’s memorandum of incorporation relating to the provision of financial assistance have been satisfied.
The article adds that if a company does not pass these resolutions, the Act provides that the provision of such financial assistance would be void (not voidable, as it cannot be ratified).
On 13 December 2022, the SCA delivered its judgment in Constantia Insurance Company Limited v The Master of the High Court, Johannesburg and Others1 (the Constantia SCA Case).
The court dealt with a number of issues, but for purposes of this article, we focus on:
- The court’s ruling regarding the list of financial assistance is construed as an exhaustive list.
- Application of the board’s mind when passing its resolution to approve the financial assistance and the result of failing to comply with such and the remaining provisions of section 45.
In the Constantia SCA Case, the Court considered whether the indemnity provided amounted to financial assistance. By doing so, the provisions of section 45 were scrutinised based on the word includes which the Court stated generally denotes a term of extension, where the primary meaning of the term that is defined is well known and the word includes introduces a meaning or meanings that go beyond that primary meaning. The Court found that this was not the case in section 45 as all matters listed (and excluded) fell within the primary meaning, and therefore, the intention of section 45(1) is to determine the ambit of the term with certainty (i.e. it provides a closed list). However, the section still refers directly and indirectly. On this basis, the indemnity was considered to be financial assistance as it indirectly secured obligations within the meaning of section 45(1)(a).
Clear purpose
The Hogan Lovells article points out that the Court in the Constantia SCA Case made it clear that the purpose of the provisions of section 45(1) is to ensure that the board has applied its mind to the facts and satisfy itself in terms of section 45(3)(b) that it is appropriate to place its assets at risk when providing such financial assistance. The Court noted that formal and procedural requirements must be distinguished from substantive requirements for the validity of a resolution or agreement and that the board passing its resolution and being satisfied on the matters is a substantive requirement.
In contrast, the requirement for the company that passed the financial assistance resolution to provide written notice to its shareholders in terms of section 45(5) of the Companies Act is procedural. Accordingly, failure to meet this requirement would not void the financial assistance.
Image By: Canva
Key takeaways
As key takeaways, please note that:
- a board of directors failure to consider and satisfy themselves to the terms of financial assistance and passing the required resolutions would result in the provision of such financial assistance being void.
- section 45(1) list of financial assistance is intended to be a primary closed list of items in which a company may directly or indirectly provide to (i) director or prescribed officer of the company or of a related or inter-related company (as defined in the Companies Act), (ii) related or inter-related company or corporation, (iii) member of a related or inter-related corporation, or (iv) person related to any such company, corporation, director, prescribed officer or member.
- Working capital solutions that can be explored internally may not be classified as assistance in terms of section 45 of the Companies Act.
A game of nuance
Regarding the relief offered by section 45, the successful application may come down to nuance.
Key questions may include:
- Is the relief being provided to a director or prescribed officer of a qualifying company?
- Will the company that the relief is being offered to pass the liquidity test after being offered the financial relief?
It will also take a lot of patience and foresight from shareholders/creditors to approve this. Without throwing too many proverbial terms around, they really need to see the big picture when considering this. What are the long-term returns associated with this relationship?
