9 February 2021 by Dispute Resolution Alert

Are shareholder irrevocable undertakings enforceable?

Irrevocable undertakings are commonplace in commercial transactions. These undertakings are typically relied upon when making investments or entering into commercial transactions with counterparty companies. Shareholder undertakings to vote in a certain way are an important type of undertaking in this context. It was therefore a matter of significant commercial importance when the validity of such undertakings was recently considered became a question for consideration in the High Court and Supreme Court of Appeal in Women in Capital Growth (Pty) Ltd and Another v Scott and Others (1193/2019) [2020] ZASCA 95.

Briefly, the facts of the case were as follows. During February 2019, the respondents, as shareholders of the third applicant (the company), each gave irrevocable undertakings in favour of the first and second applicant (proxies), for the benefit of the company. The shareholders opposed the application and sought, by way of a counter application, to have the irrevocable undertakings declared unlawful, invalid and unenforceable. It later became apparent that the shareholders did not intend to honour their obligations under the irrevocable undertakings and regarded such undertakings as invalid and unenforceable.

The company and the proxies issued urgent proceedings out of the High Court seeking declaratory relief that would oblige the shareholders to vote in accordance with their irrevocable undertakings at the next shareholders meeting. The shareholders opposed the application and sought, by way of a counter application, to have the irrevocable undertakings declared unlawful, invalid and unenforceable.

The basis for the shareholders’ contention that the undertakings were unlawful was that they contravened sections 58(8)(c) and 71(2)(b) of the Companies Act 71 of 2008.

The first legal issue: Section 58(8)(c) of the Companies Act provides as follows:

“If a company issues an invitation to shareholders to appoint one or more persons named by the company as a proxy, or supplies a form of instrument for appointing a proxy the company must not require that the proxy appointment be made irrevocable.”

The second legal issue: Section 71(2)(b) requires that a director must be afforded a reasonable opportunity to be heard before a vote is taken to remove him. The idea behind this provision is that the director in question may be able to change the minds of those who were to vote for his removal. Accordingly, so the argument goes, the shareholders are required to listen to what the director has to say before making a decision and should not be held to irrevocable undertakings to vote one way or the other.

In regard to the first legal issue, the court held that section 58(8)(c) is only applicable in circumstances where the company issues an invitation to shareholders to appoint persons named by the company as a proxy and, in this case, the company had issued no such invitation. The company was not a party to the undertakings and a reading of the undertakings did not support the interpretation that the undertakings were sought by the company. Accordingly, the court held that the undertakings did not fall foul of section 58(8)(c).

In regard to the second legal issue, the court noted that it was not referred to any authority for the proposition that there are statutory constraints on the powers of shareholders to remove directors. On the contrary the court cited precedent that any agreements by shareholders regarding their votes in a general meeting is valid and does not derogate from the company’s right to elect or remove a director upon requisite number of votes. Furthermore, the validity of agreements between shareholders that, for example, preclude a mode of removal of directors has long been recognised. Accordingly, the court held that there is no prohibition on agreements between shareholders to determine how their best interests should be served in exercising their voters’ interests. Further to this, the shareholders of accompany do not stand any fiduciary relationship and thus are under no duty to exercise their votes bona fide in the interests of the company as a whole.

In regard to the director’s right to be heard prior to a vote for his removal, the court noted that this was a provision relating to process and procedure, and did not put substantive constraints on the exercise of the power to remove. In other words, the court could intervene in the event that there were procedural irregularities but was not in a position to do so for reasons that impact on the substance of the reasons for a removal.

For the above reasons, the court declared that the respondents were bound by their irrevocable undertakings and dismissed the counter application.

The matter was taken on appeal to the Supreme Court of Appeal by the shareholders. The appeal was dismissed on the basis that any decision would have no practical effect or result, given that the agreements that were the subject of the undertakings had already been implemented.

The judgment, which promotes commercial certainty, will be welcomed by businesses whose transactions are undertaken on the basis that they have security and protection based on these types of shareholder undertakings.

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