6 November 2004 by

Beware the bogeyman

The macro-economic rationale that lies at the heart of black economic empowerment (BEE) is to address the widespread disparities of ownership of productive assets, participation in the economy and skewed social welfare by means of state intervention. However, the economic realities of the targeted beneficiaries of BEE provide the most fundamental challenge to the implementation of broad-based economic empowerment.

One of the most significant difficulties is the funding of transactions designed to achieve targeted levels of black ownership, within the meaning of the Black Economic Empowerment Act of 2003. And, if truth be told, the more broadly based the putative black acquirers are, within the meaning of that Act, the more chronic is the lack of funding or access thereto.

Lawyers have responded to the challenge with a range of innovative schemes to facilitate the acquisition of equity, including vendor finance, complex asset swaps, reverse listings, leveraged buy-outs, earn-outs (by way of deferred or convertible preference shares) linked by formulae to earnings targets and variations of older models. A number of recently concluded or announced transactions use one or more of these schemes. Time will tell whether these deals, having ostensibly addressed the funding challenges, actually achieve the level of accreditation for the black ownership that lies at the heart of their creation. Judging from the terms of their announcement, a few appear to be little more than extremely contingent option schemes that may or may not translate into exercisable strikes. Others seem to push the boundaries of the oldest corporate law bogeyman, section 38 of the Companies Act, to the limit.

Section 38 prohibits (subject to certain exceptions) a private or public company from providing financial assistance, directly or indirectly, for acquiring the shares in that company or its holding company. This prohibition is designed to prevent company resources being used to the potential prejudice of minority shareholders and creditors. Contravention of section 38 carry severe penalties - apart from criminal sanctions for the company, its directors and officers, such transactions are void. Although the section is couched in extremely wide terms and is not subject to a mere impoverishment test, two elements must be present for it to apply, namely the giving of financial assistance and the nexus between such financial assistance and the acquisition of the shares of the company.

It is possible to structure a transaction so that even though the one element is present, the other is arguably not. Our courts have in the past found that there has been no contravention of this prohibition where the financial assistance granted was not sufficiently in connection with the acquisition of shares in the company. The courts have been persuaded in these cases that the purpose of the transaction was a commercial rationale rather than the acquisition of shares.

Within the context of BEE transactions, the financial assistance can take a variety of forms. These range, inter alia, from an asset swap that inflates the BEE assets being swapped for those of the target company, to discounting the shares of the target company. However, in this context, the transfer of ownership of shares in a target company is the main objective of the transaction, leaving little room for avoiding the prohibition. It remains to be seen whether a disgruntled minority shareholder or creditor challenges a BEE transaction on this basis and whether a sufficiently cogent commercial rationale can be found by arguing that the transaction was driven by the need for the company to remain economically viable in circumstances where it faced (direct or indirect) BEE regulatory coercion.

Ironically, one of the exceptions to the prohibition allows companies the opportunity to provide financial assistance to employees wishing to acquire shares in the company, if this is part of an employee incentive scheme. These shares may be acquired either at market price and/or through vendor financing, discounting (or variable discounting), or combinations thereof, in a tax effective manner. It is submitted that long-term employees provide ideal 'partners' in the business, and share a common interest in the company's longevity, prosperity and competitiveness. And yet, surprisingly few companies have thus far used this facility.

Therefore, in engaging in BEE transactions, companies should take care in concluding sustainable and commercially viable transactions which meet the requirements of the unfolding BEE regulatory environment and achieve the intended ownership and scorecard objectives, while remaining within the parameters of our company law.

Brent Williams

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