MERCANTILE LAW 292
TOPIC 11 – CORPORATE FINANCING: SECURITIES
Companies Act Chapter 2 Part D “Capitalisation of profit companies”
Company needs funds to carry on business
Funding = external (loans) or internal (shares)
Shareholders’ Credit Loan Accounts
Shareholders of small private companies often deliberately choose to invest
the major part of their funds in the company in the form of a loan rather than in
the form of shares. This loan is reflected in the books of the company as a
liability.
Although the funds are provided by a shareholder, they are not provided in
that capacity. They therefore form part of external funds as opposed to
shareholders' equity. The loan is often referred to as a credit loan account.
The terms of the loan are a matter for agreement. It may even be interest
free. As regards the repayment of the loan, there will often be no obligation
on the company to pay regular instalments to repay the capital amount of the
loan.
The loan will often be repayable on demand, which in effect means at the
convenience of the shareholder. A shareholder is particularly likely to demand
repayment should the shareholder decide to sell his or her shares.
The balance of the credit loan account may comprise of a loan by the
shareholder of to the company, as well as for example dividends or a salary
(for services rendered by the shareholder to the company) not paid to the
shareholder in cash. Repayment of a shareholder's credit loan account by the
company is not subject to the solvency and liquidity test as that amount is not
received as shareholder, but as creditor of the company.
The practice of financing small private companies mainly through
shareholders' loans as opposed to share capital can result in the company
becoming technically insolvent, in that the liabilities, including these
shareholders’ loan accounts, exceed the assets. In these circumstances, it
, may be necessary for the shareholders, in their capacity as creditors for the
loan accounts, to enter into a subordination agreement with the company.
The essence of a subordination agreement is that the enforceability of the
shareholder's claim as creditor for repayment of the credit loan account is
made dependent upon the solvency of the company and the prior payment of
its debts to other creditors. (See Ex parte De Villiers & Another NNO: In re
Carbon Developments (Pty) (Ltd) (in liquidation) 1993 (1) SA 493 (A) 504F-G.)
However, when it comes to the solvency and liquidity test in section 4, section
4(2)(b)(i) provides that a fair valuation of the company’s assets and liabilities
must include any reasonably foreseeable contingent liabilities. A credit loan
account subject to a subordination agreement is arguably a contingent liability.
It therefore appears that a subordination agreement cannot be used to assist
a company to pass the statutory solvency test.
A shareholder's credit loan account must be distinguished from a
shareholder's debit loan account. This is money lent by the company to the
shareholder and is therefore included among the company's assets on the
balance sheet.
,Legal nature of a share
Share = one of the units into which the proprietary interest in a profit company
is divided
Security = any shares, debentures or other instruments, irrespective of their
form or title, issued or authorised to be issued by a profit company
Once a share is issued has rights
What is a share?
o Shares are the assets of shareholder
o Shares are moveable property and are transferable (s 35(1)).
o Do not exist physically (intangible)
Case law
o Standard Bank v Ocean Commodities: “Bundle of personal rights
entitling the holder thereof to a certain interest in the company, its
assets and dividends.”
o What is a personal right? Right against a specific person.
E.g. shareholder has a personal right against the company.
E.g. dividends, surplus after liquidation, right to certain
information, to vote
Rights
o Right to dividends (distributions)
o Right to surplus after liquidation
o Participation rights (limited and indirect), i.e. right to vote.
o Right to certain information (ss 26 & 31(1), Clutchco (Pty) Ltd v Davis
2005 (HHA), PAIA), e.g. annual financial statements.
Companies amendment bill proposal in relation to section 26 proposes the payment of prescribed
maximum charges for copying and inspection of information amongst others.
Duties
o Compliance with MOI and company rules (s15(6))
o Company may not issue shares to itself (s35(3))
, Par value shares
o Abolished (s35(2)) subject to item 6 of schedule 5
o Indication of the minimum value a company will receive to sell a share
(not the market value)
Date issued What is allowed
Issued before 1 May 2011 Keep or convert shares
Authorised and some issued before 1 May May issue par valued shares to a maximum
2011 of the authorised shares.
Not authorised before 1 May 2011 May not authorised new PV shares
Authorised but not issued before 1 May May not start issuing
2011
Authorised shares
A company can only issue shares that are authorised.
Authorised shares grant no rights – only once they’re issued are the rights
obtained (s 35(4)).
Shares with different rights: are split into different classes (see later).
Company must outline in MOI the details of the authorised shares (s 36).
MOI:
o Classes and designation of shares, class rights (preference and
limitations) and quantity of authorised shares s36(1)(a) and (b).
o Quantity unclassified shares the board will classify when issuing s36(1)
(c).
o Unspecified shares – rights determined by board when issuing s36(1)
(d).
Amendment of authorised shares:
o Amendment of MOI w.r.t. authorised shares (s36(2))
Special resolution by shareholders
Board may in some circumstances amend unless MOI provides
otherwise
o When may board amend MOI w.r.t. authorised shares? (s 36(3))
When changing the number of authorised shares in each class.
To reclassify authorised unissued shares
Classify unclassified shares
Determine rights of unspecified shares
TOPIC 11 – CORPORATE FINANCING: SECURITIES
Companies Act Chapter 2 Part D “Capitalisation of profit companies”
Company needs funds to carry on business
Funding = external (loans) or internal (shares)
Shareholders’ Credit Loan Accounts
Shareholders of small private companies often deliberately choose to invest
the major part of their funds in the company in the form of a loan rather than in
the form of shares. This loan is reflected in the books of the company as a
liability.
Although the funds are provided by a shareholder, they are not provided in
that capacity. They therefore form part of external funds as opposed to
shareholders' equity. The loan is often referred to as a credit loan account.
The terms of the loan are a matter for agreement. It may even be interest
free. As regards the repayment of the loan, there will often be no obligation
on the company to pay regular instalments to repay the capital amount of the
loan.
The loan will often be repayable on demand, which in effect means at the
convenience of the shareholder. A shareholder is particularly likely to demand
repayment should the shareholder decide to sell his or her shares.
The balance of the credit loan account may comprise of a loan by the
shareholder of to the company, as well as for example dividends or a salary
(for services rendered by the shareholder to the company) not paid to the
shareholder in cash. Repayment of a shareholder's credit loan account by the
company is not subject to the solvency and liquidity test as that amount is not
received as shareholder, but as creditor of the company.
The practice of financing small private companies mainly through
shareholders' loans as opposed to share capital can result in the company
becoming technically insolvent, in that the liabilities, including these
shareholders’ loan accounts, exceed the assets. In these circumstances, it
, may be necessary for the shareholders, in their capacity as creditors for the
loan accounts, to enter into a subordination agreement with the company.
The essence of a subordination agreement is that the enforceability of the
shareholder's claim as creditor for repayment of the credit loan account is
made dependent upon the solvency of the company and the prior payment of
its debts to other creditors. (See Ex parte De Villiers & Another NNO: In re
Carbon Developments (Pty) (Ltd) (in liquidation) 1993 (1) SA 493 (A) 504F-G.)
However, when it comes to the solvency and liquidity test in section 4, section
4(2)(b)(i) provides that a fair valuation of the company’s assets and liabilities
must include any reasonably foreseeable contingent liabilities. A credit loan
account subject to a subordination agreement is arguably a contingent liability.
It therefore appears that a subordination agreement cannot be used to assist
a company to pass the statutory solvency test.
A shareholder's credit loan account must be distinguished from a
shareholder's debit loan account. This is money lent by the company to the
shareholder and is therefore included among the company's assets on the
balance sheet.
,Legal nature of a share
Share = one of the units into which the proprietary interest in a profit company
is divided
Security = any shares, debentures or other instruments, irrespective of their
form or title, issued or authorised to be issued by a profit company
Once a share is issued has rights
What is a share?
o Shares are the assets of shareholder
o Shares are moveable property and are transferable (s 35(1)).
o Do not exist physically (intangible)
Case law
o Standard Bank v Ocean Commodities: “Bundle of personal rights
entitling the holder thereof to a certain interest in the company, its
assets and dividends.”
o What is a personal right? Right against a specific person.
E.g. shareholder has a personal right against the company.
E.g. dividends, surplus after liquidation, right to certain
information, to vote
Rights
o Right to dividends (distributions)
o Right to surplus after liquidation
o Participation rights (limited and indirect), i.e. right to vote.
o Right to certain information (ss 26 & 31(1), Clutchco (Pty) Ltd v Davis
2005 (HHA), PAIA), e.g. annual financial statements.
Companies amendment bill proposal in relation to section 26 proposes the payment of prescribed
maximum charges for copying and inspection of information amongst others.
Duties
o Compliance with MOI and company rules (s15(6))
o Company may not issue shares to itself (s35(3))
, Par value shares
o Abolished (s35(2)) subject to item 6 of schedule 5
o Indication of the minimum value a company will receive to sell a share
(not the market value)
Date issued What is allowed
Issued before 1 May 2011 Keep or convert shares
Authorised and some issued before 1 May May issue par valued shares to a maximum
2011 of the authorised shares.
Not authorised before 1 May 2011 May not authorised new PV shares
Authorised but not issued before 1 May May not start issuing
2011
Authorised shares
A company can only issue shares that are authorised.
Authorised shares grant no rights – only once they’re issued are the rights
obtained (s 35(4)).
Shares with different rights: are split into different classes (see later).
Company must outline in MOI the details of the authorised shares (s 36).
MOI:
o Classes and designation of shares, class rights (preference and
limitations) and quantity of authorised shares s36(1)(a) and (b).
o Quantity unclassified shares the board will classify when issuing s36(1)
(c).
o Unspecified shares – rights determined by board when issuing s36(1)
(d).
Amendment of authorised shares:
o Amendment of MOI w.r.t. authorised shares (s36(2))
Special resolution by shareholders
Board may in some circumstances amend unless MOI provides
otherwise
o When may board amend MOI w.r.t. authorised shares? (s 36(3))
When changing the number of authorised shares in each class.
To reclassify authorised unissued shares
Classify unclassified shares
Determine rights of unspecified shares
