How Transferable are Private Company Shares?

how transferable are private company shares

Transferability of shares, pre-emptive rights and s39

The general rule is that shareholders have the right to deal freely with their shares. In terms of section 8(2)(b), a private company's MOI must prohibit the company from offering any of its securities to the public and restricts the transferability of its securities. In other words, in the case of private companies, such restriction is obligatory.

The courts are however reluctant to restrict transferability (Greenhalgh v Mallard; Delavenne v Broadhurst; Smith v Fawcett Ltd; Moodie v W&J Shepherd (Bookbinders) Ltd; Greenacre v Falkirk Iron Co Ltd; Estate Milne v Donohoe Investments (Pty) Ltd; Bellairs v Hodnett; Commercial Grain Producers Association v Tobacco Sales Ltd).

As far as the company (whether private or public) is concerned, restrictions are usually imposed to allow existing shareholders a measure of control over the identity of the company's shareholders to either maintain an existing pattern of control, or to prevent one or more shareholders from obtaining control by purchase from other shareholders.

Transfer as interpreted by our courts means the restricting of the transfer of the beneficial ownership of the shares.

A common restriction on transferability is making the right of transfer subject to a right of pre-emption. This provision in the MOI may read as follows:

A shareholder who wishes to dispose of his or her shares must first offer the shares to the other shareholders of the company pro rata to their existing shareholdings at a price to be determined in a prescribed way. Transfer in terms of the MOI shall include the cession of shareholders right.

(otherwise a shareholder could evade a restriction on transferability).

The price then at which other shareholders may acquire the shares may either be fixed or may be left to the valuation or determination by a third party, for example the company's auditor, and should the company know which option it prefers this option must be built into the above paragraph in the MOI, concomitant with the following:

The provision giving the pre-emptive right shall provide that the third party's valuation is to be accepted as conclusive, and the seller and the purchaser of the shares are bound by the valuation in the absence of fraud or collusion or a mistake amounting to a material departure from his or her instructions.

Take note that the fact that the auditor to whom a valuation is entrusted is also a shareholder of the company does not preclude him or her from proceeding with the valuation, provided that an honest judgement is exercised.

In the event that the Memorandum of Incorporation empowers the directors to allocate the shares among such shareholders of the company as the directors decide, the directors do not have to allocate the shares to the bidding shareholders in proportion to their shareholding. In fact, a bidding shareholder need not be allocated any shares.

A shareholder is not bound to sell his or her shares to the members unless one or more of them agree to take up all the shares offered.

Where a shareholder ignores a pre-emptive right and sells his or her shares, the sale to the purchaser is valid. However, the shareholder cannot cede his or her rights to the purchaser in terms of the sale. The purported cession of the rights to the purchaser is invalid.

The purchaser is left with an action for damages against the member and if the other members do not agree to take up all the shares offered, (and the member is bound to sell to them those shares which they agree to take up), a right to claim cession of the balance of the shares.

The shareholders of a company may enter into any agreement with one another concerning any matter relating the company, subject to the proviso that any such agreement must be in compliance with the 2008 Companies Act, as well as the Company's Memorandum of Incorporation.

Any provision of such an agreement that is inconsistent with the Act or the Company's MOI is void to the extent of the inconsistency. Accordingly, in terms of the 2008 Act, an MOI of a Company takes precedence over Shareholders Agreements.

Section 39(2) of the Companies Act, provides that each shareholder of a private company has a right before any other person who is not a shareholder of that company, to be offered and to subscribe for a percentage of the shares to be issued equal to the voting power of that shareholders general voting rights immediately before the offer was made, where the company is then compelled to make an offer to all of its voting shareholders pro rata to their respective percentages of the total number of voting rights, before it may issue any shares to a third party.

Nowhere in the Act is it stated that the Shareholders Agreement must be incorporated into the MOI. The Shareholders Agreement is a private document. It is not filed with the Companies Commission (CIPC) and it is not available for inspection by the public.

The binding force of the Shareholders Agreement stems from the law of contract, whereas section 15(6) of the Act, governs the status of a Company's MOI and all MOIs need to be filed and registered with CIPC.

The disadvantage of a Shareholders Agreement is that it binds only those shareholders who are party to it. It does not bind any new shareholders, unless they consent to be bound. Furthermore, there is no mechanism for the alteration of a Shareholder Agreement whereas section 16 of the Companies Act applies to the amendments of the MOI.

Accordingly, the default position is that unless the Shareholders Agreement provides otherwise, the consent of each party to the Shareholders Agreement will be required to amend it.

Under Subscription of Shares in sub-article 2.5 of our MOIs, here is an enhanced version which you can insert under this sub-article:

Subscription of Shares

  1. In the event that the Company proposes to issue any shares, other than shares issued in terms of options or conversion rights in terms of section 39(1)(b), or capitalisation shares in terms of section 47 or if the consideration for any shares that are issued or to be issued is in the form of an instrument such that the value of the consideration cannot be realised by the Company until a date after the time the shares are to be issued, or is in the form of an agreement for future services, future benefits or future payment by the subscribing party in terms of section 40, each Shareholder of this Company shall have a right before any other person who is not a Shareholder of this Company, to be offered and to subscribe for a percentage of the shares to be issued, equal to the voting power of the said Shareholderӳ general voting rights immediately before the offer was made. Section 39(1)(b)(i)(aa)(bb) and section 39(1)(b)(ii)
  2. The Company shall be obliged to make an offer to all the voting Shareholders of this Company, pro rata to their respective percentages of the total number of voting rights, before the Company may issue any shares to a third party.
    The rights of Shareholders to participate in an offer to subscribe for shares of the Company are unrelated to the equity or participation rights attached to the issued shares held by the Shareholders.
  3. A shareholder who wishes to dispose of his/her shares must first offer the shares to the other shareholders of the company pro rata to their existing shareholdings at a price to be determined in a prescribed way. Transfer in terms of the MOI shall include the cession of shareholders right.
    The provision giving the pre-emptive right shall provide that the third party's valuation is to be accepted as conclusive, and the seller and the purchaser of the shares are bound by the valuation in the absence of fraud or collusion or a mistake amounting to a material departure from his or her instructions.
  4. The Memorandum of Incorporation limits, negates and restricts the conditions set out in section 39(2) of the Act with respect to all and any classes of shares of the Company. The Memorandum of Incorporation permits the Shareholders of the Company to vary the pre-emptive rights on share issues in any manner they deem fit and the Shareholders may elect to have no pre-emptive rights should they choose so. Section 39(3), Section 39(4)(a)(b)
  5. A Shareholder may subscribe for fewer shares than the Shareholders would be entitled to subscribe for under section 39(2) and shares not subscribed for by a Shareholder of the Company within a reasonable time, may only then be offered to any and all other Shareholders to the extent permitted by the Memorandum of Incorporation. Section 39(2)
    Such a Shareholder shall not have the automatic right to be offered, or to apply for more than that Shareholder's pro rata entitlement if the other Shareholders of the Company subscribe for a portion of their respective entitlements only.
    In the event that none of the existing Shareholders of the Company subscribe for the said shares, the Memorandum of Incorporation hereby permits with an Ordinary Resolution of Shareholders to offer the shares to third parties.

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