Company or Close Corporation
With the advent of the new Company Law no new Close Corporations can be formed and registered from 1 May 2011. However a Close Corporation that existed at 30 April 2011 has two options:
New Close Corporations are prescribed, which not only translates into the phasing out of Close Corporation, however gradual, but leaves all new entrepreneurs with only one option for new incorporation and that is Companies under the new Companies Act. There is a clearly discernible tendency to subject the Close Corporation to more and more onerous administrative duties and arragements. This is illustrated by the approach to supplant numerous arrangements of the Close Corporations Act by that of the new Companies Act, by repealing the first and incorporating large tracts of the latter by reference. It is unfair to expect the Close Corporation to perform optimally in a legal milieu for which is was not designed and to encumber it with duties and obligations contrary to its very nature and fundamental design philosophy.
The reason for the Close Corporations Act, 1984 (Act No 69 of 1984) was the provision of a free-standing limited-liability vehicle for the single entrepreneur or a small number or Members to meet their limited liability and perpetual successive requirements without burdening them with undue legal requirements.
Conversion from Close Corporation to Company
In terms of Schedule 2 of the Companies Act, an existing Close Corporation may convert into a Company by filing a Notice of Conversion, a filing fee, a written Statement of Consent approving the conversion signed by Members of the Corporation holding in aggregate at least 75% of the Members’ interest in the corporation, and a Memorandum of Incorporation (MOI).
The Companies Act does not provide for the conversion of a Close Corporation into a non-profit Company. Schedule 2 item 2(1) refers only to Shareholders and not to Members. Only a profit Company has Shareholders. In terms of Schedule 1, a non-profit Company does not have Shareholders but may have Members. It need even not have any Members. It is required to have Members only if its MOI provides for it to do so.
Since a juristic person may not directly or indirectly be a Member of a Close Corporation, a Close Corporation may not be under the ‘ownership control’ of a juristic person. A Close Corporation may not be converted into a state-owned Company.
As with a Company’s MOI, the Association Agreement of a Corporation constitutes a contract between the ‘Corporation’ and the Members and between the Members inter se.
Concomitant with a Company’s MOI, the Association Agreement also contains the alterable and unalterable provisions of the Close Corporations Act. The alterable provisions are regulated by the Association Agreement.
There is no constructive notice of the provisions of an Association Agreement. Knowledge of internal restrictions on Members’ powers contained therein is not imputed to outsiders. They are entitled to assume that each Member has the necessary authority to act on behalf of the Corporation in a transaction, irrespective of whether the transaction was entered into for the carrying on of the business of the corporation.
An Association Agreement must enforce a mandatory provision that the Corporation will be bound to the transaction only if the Member has expressed or implied authority from the Corporation.
Sale of Corporate Asset
Any Member of a Corporation can now be compelled in terms of section 49 to purchase the interest of another Member, whether he wants to or not.
Furthermore, a court may now order the sale of a corporate asset to enable a prejudiced Member to be paid out for his interest subject to the proviso that the Corporation’s Solvency and Liquidity Test must be maintained.
It is up to the Association Agreement to provide that the fair value of a member’s interest be determined first.
Solvency and Liquidity Test
As with a Company, all Close Corporations are now subject to the Solvency and Liquidity Test. Section 4 of the Companies Act states that a Company satisfies the Solvency and Liquidity Test if the assets of the Company, fairly valued, equal or exceed the liabilities of the Company, and it appears that the Company will be able to pay its debts as they become due in the ordinary course of business.
Sections 39, 40 and 51 of the Close Corporations Act apply the Solvency and Liquidity Test to a corporation and states that payment by a Corporation to a Member shall only be made if after such payment is made, the Corporation’s assets, fairly valued, exceed all its liabilities; the Corporation is able to pay its debts as they become due in the ordinary course of its business and if such payment will not render the Corporation unable to pay its debts as they become due in the ordinary course of its business.
The application of the Solvency and Liquidity Test to a Corporation is thus stricter than the application of the Solvency and Liquidity Test to a Company.
Furthermore, in a Company, a Director’s liability for any loss, damages or costs sustained by a Company as a consequence of a Director failing to vote against a distribution in contravention of section 46 of the Companies Act or failing to vote against financial assistance by the Company for subscription of securities of the Company or financial assistance and loans to Directors arises only if it was unreasonable at the time of the decision to conclude that the Company would satisfy the Solvency and Liquidity Test.
In a Corporation, when the Corporation makes a payment to a member contrary to the provisions of section 51 of the Close Corporations Act, the Member shall be liable to the Corporation for any such payment received.
Accounting and Disclosure
- Annual Financial Statements: Within six months after the end of every financial year, annual financial statements in one of the eleven official languages will have to be prepared by the Close Corporation’s Members. Previously the period was nine months.
- Compulsory Audit of Financial Statements: Previously, audits for Corporations were carried out where they serve a meaningful purpose, and not simply because they were required by legislation. The Companies Act introduced a compulsory audit of the financial statements of certain Close Corporations. A Close Corporation may be required by the regulations made in terms of the Companies Act to have its annual financial statements audited. The regulations prescribe the categories of Close Corporations that are required to have their respective annual financial statements audited, taking into account whether it is desirable in the public interest, having regard to the economic or social significance of the corporation, as indicated by its annual turnover, the size of its workforce, or the nature and extent of its activities. A qualifying Close Corporation’s financial statements must comply with sections 30(3) to (6) of the Companies Act. The annual financial statements may also be audited voluntarily at the option of a Close Corporation.
- Accountability: A Close Corporation may voluntarily elect the enhanced accountability and transparency provisions of Chapter 3 of the Companies Act. In such an event, the provisions of Chapter 3 of the Companies Act, read with the changes required by the context, apply to such a corporation and prevail over any conflicting provision of the Close Corporations Act.
- Financial Reporting Standards: The Minister, after consulting with the Financial Reporting Standards Council, may make regulations prescribing financial reporting standards or the form and content requirements for summaries of financial statements of Close Corporations, as if those regulations have been made in terms of the Close Corporations Act. These regulations must promote sound and consistent accounting practices. In the case of financial reporting standards, they must be consistent with the International Financial Reporting Standards of the International Accounting Standards Board or its successor body.
The business rescue provisions in Chapter 6 of the New Companies Act apply to Close Corporations.
Disqualification from Participation in Management
Disqualification of a person to act as Director of a Company will in general also exclude that person from managing a Close Corporation. Section 47(1)(c) of the Close Corporations Act is amended to incorporate all the grounds of disqualification of a Director of a Company specified in section 69(8) of the Companies Act, as well as the provisions of sections 69(9) to (11) of the Companies Act.
Despite being disqualified on one of the grounds detailed in section 69(8)(b) of the Companies Act, a person may participate in the management of a Close Corporation if 100% of the Members’ interest in the Corporation is held by that disqualified person or the disqualified person and other persons who are all related to that disqualified person, and each person has consented in writing to the disqualified person participating in the management of the Corporation.
The provisions of the new Companies Act relating to an application to declare a Director delinquent or under probation are applicable to a Member of a Close Corporation as well.
A person who has been placed under probation by a court in terms of section 162 of the new Companies Act or section 47(1C) of the Close Corporations Act may not participate in the management of the business of a Corporation, except to the extent permitted in the probation order.
Winding-up and Liquidation
The Companies Act provides for transitional arrangements that retain the current disposition set out in chapter 14 of the 1973 Companies Act for the winding-up and liquidation of Companies until such time as the new uniform insolvency legislation is enacted. However, if there is any conflict between the provisions of chapter 14 of the 1973 Companies Act and part G of chapter 2 of the new Companies Act, concerning the winding-up of solvent companies and deregistration of companies, the provisions of the latter prevails.
These transitional arrangements also apply to the liquidation of a Close Corporation in respect of any matter not specifically provided for in the Close Corporations Act or in the business rescue and compromise provisions of the new Companies Act.
The main impact of the company law reform process and particularly the new Companies Act on the South African Close Corporation may be summarised as twofold.
Firstly, the prescription of new Close Corporations. This not only translates into the phasing out of Close Corporations, however gradual, but leaves small entrepreneurs with only one option, e.g. to incorporate as a Company with a customised MOI.
Secondly, Close Corporations are now subject to the public interest score calculation.
For a Close Corporation which does not convert to a Company, it is essential for Members of a corporation to draft a customised Association Agreement. It is the statutory control document which ensures that the Corporation and its Members comply with both the Companies and the Close Corporations Acts, to identify levels of authority and responsibility of the members and to minimise liability exposure of both the Corporation and its Members.