Drafting Memorandum of Incorporation (MOI) share structures – Important considerations

Drafting Memorandum of Incorporation (MOI) share structures – Important considerations
15 May 2020

Before diving into the important considerations relating to the drafting of share structures in MOIs, a brief general overview of an important consideration that must be kept in mind when drafting an MOI is required.

Where you amend any provision as stipulated in the Companies Act, No. 71 of 2008 (the “Act”) ensure you do not alter an unalterable provision to such an extent that the Act does not allow (note – unalterable provisions are alterable to some extent. These provisions may be made more onerous as contemplated in section 15 (2) (a) (iii) read with section 15 (2) (d) of the Act).

If there is a conflict between the MOI and the Act, the Act will prevail. It is accordingly important to keep the above consideration in mind when drafting share structures in MOIs.

TYPES OF SHARES

The nature of a share is important to understand when drafting the share structure of the Company. A share in a company consists of a bundle of personal incorporeal rights against the Company.

There is a general misconception that the Act makes provision for various types of shares that have specific rights assigned to these shares in terms of the Act. Although this is not entirely inaccurate, the Act does not contain a list of types of shares with specific rights, limitations, preferences and terms.

Instead, the Act provides a more flexible approach in terms of which the rights, limitations, preferences and terms of each type of share can be specified in the MOI and assigned to a particular class of share (the class of share you can name whatever you want and does not necessarily have to be associated with the rights limitations, preferences and terms attached to such a share). In other words, a Class A Ordinary Share in one company can have different rights limitations, preferences and terms compared to a Class A Ordinary Share in another company.

The specific rights relating to the particular class of shares must be drafted carefully, and the drafter must ensure that the rights assigned to the different classes of shares do not contradict one another.

Generally, each type of share has associated with it:

  • voting rights (these can for example be general, special, conditional, or limited voting rights)
  • rights to dividends (these rights can for example be preferential, cumulative, noncumulative, or partially cumulative)
  • participation in distribution on liquidation (these rights can for example be preferential)

The aforementioned is not the only type of rights that can be attached to a share and numerous possible types of shares can be created. For purposes of this note, we will provide a discussion on some of the more popular types of shares.

ORDINARY SHARES

Generally, ordinary shares are shares that are fully participating as to the dividends, capital and surplus assets on winding up and has associated with it general voting rights (usually 1 vote per share (this is however variable)).

PREFERENCE SHARES

These types of shares generally enjoy a preference in respect of dividends and/or return of capital.

Usually, a specific preference share dividend is attached to a preference share, making these types of shares similar to debt instruments (see other considerations below). This preference dividend can be cumulative in nature, giving the holder a right to both arrear and current preference dividends.

The other rights associated with preference shares can also be varied, for example:

  • Voting rights
    The preference shareholders may or may not have general voting rights, and the number of voting rights attached to a specific preference share is also a variable and can be made conditional.
  • Participation rights
    It is possible to structure the preference share as a participating preference share in terms of which the preference shareholders will have the right to participate in surplus profits of the Company with the ordinary shareholders. The participation of the preference shareholders can also be limited and/or conditional.
  • Conversion rights (see section 37 (5) (b) of the Act)
    A conversion right can be attached to the shares which can be exercised by the holder in terms of which the preference share is convertible to a different class of share.
  • Redemption rights (see section 37 (5) (b) of the Act)
    A redemption right can also be attached to the shares in terms of which the Company can redeem the preference share on terms and conditions stipulated in the Company’s MOI.
  • Participation on liquidation
    A right can be created in favour of the preference shareholders in respect of its capital and any arrear preference dividend to rank above any claims that the other shareholders may have to share in the residue of the Company on liquidation.

A note of caution: There are still Legal Practitioners that want to make use of a Preference Share Subscription Agreement, to determine the preferences, rights, limitations and other terms associated with the preference share. Under the 2008 Act, it is doubtful whether this is possible when considering section 36 (1) (b) (ii) of the Act.

FOUNDER / VENDOR SHARES

These types of shares are usually issued as remuneration for promoters for services rendered in the formation of companies or to persons who have sold assets to the Company. Generally, these are deferred shares, meaning that there is a restriction placed on these shares that no dividend can be paid to the shareholder in a particular year unless the ordinary shareholders first paid a certain amount for that year.

UNCLASSIFIED SHARES

Section 36 (1) (c) of the Act, stipulates that a Company’s MOI may authorise a stated number of unclassified shares, which is subject to classification by the board of the Company. The directors of the Company assign the classification to these shares (for example, Class A Vendor Shares, etc.). Note, the preferences, rights, limitations and other terms must be stipulated in the MOI it is only the class designation that must be assigned by the board.

CLASSIFIED SHARES WITHOUT ASSOCIATED RIGHTS (“BLANK CHEQUE STOCK”)

Section 36 (1) (d) of the Act, stipulates that a Company’s MOI may set out other class of shares without any specific associated preferences, rights, limitations or other terms of that class, for which the board of the Company must determine the associated preferences, rights, limitations or other terms. Depending on who your client is, a “blank cheque stock” must be handled with care.

BOARD’S POWERS

The board has wide-ranging powers in respect of the authorised share capital if not restricted in the MOI. The power of the board to exercise the functions as in section 36 (3) of the Act is, however, an alterable provision.

OTHER CONSIDERATIONS

Where the company is required to operate withing the scope of specific legislation (for example section 12J of the Income Tax Act, No. 58 of 1962) or where parties are desirous to make use of certain relief contemplated in tax legislation (for example section 42 Asset for Share rollover relief), the distinction between equity shares and non-equity share may be of importance.

Generally, the ITA distinguishes between “equity shares” and shares that are not equity shares. Principal to the distinction is the limitation of two of the rights attaching to a share, being the right to dividends and the right to capital. An “equity share” is defined as:

…any share in a company, excluding any share that, neither as respects dividends nor as respects returns of capital, carries any right to participate beyond a specified amount in a distribution…” [own emphasis]

Accordingly, a share that restricts both dividend rights and rights to capital to a specified amount is not an “equity share”. Rights to participate in, or vote at meetings of shareholders, are disregarded to determine whether a share is an “equity share”.

GENERAL NOTES

A veto right contained in the MOI, which effectively negates the voting rights of other shareholders is valid and enforceable, and by purchasing shares in a company, that is the bargain to which the shareholder (or member in the case of an NPC company) assents to. Use of this right, like a majority voting right, should not be prejudicial, unjust or inequitable (The Wilds Home Owners Association and Others v Van Eeden and Others [2013] JOL 30393 (SCA)).

Notwithstanding anything stipulated in the MOI, each share issued by a company has associated with it an irrevocable right of the shareholder to vote on any proposal to amend the preferences, rights, limitations and other terms associated with that share.

CONCLUSION

Over complicated share structures can often do more harm than good when trying to raise capital for the company. Just because the Act provides for so many possible variations to preferences, rights, limitations and terms relating to shares, does not mean you need to try and make provision for all of the variations in your MOI.

Using the contracts.tech contract creation tool you will be able to create a bespoke MOI with different classes of shares in minutes. Give it a try today.

See also:

(This article is provided for informational purposes only and not for the purpose of providing legal advice. For more information on the topic, please contact the author/s or the relevant provider.)
Martin Kotze
Martin Kotze

Martin Kotze holds a BCom LLB degree from the University of Pretoria and is an admitted Legal Practitioner, Conveyancer and Notary Public. He is the managing director of MJ Kotze...

De Wet de Villiers
De Wet de Villiers

De Wet de Villiers holds the BAcc.LLB degree from Stellenbosch University. De Wet joined PwC’s corporate and international tax team in Cape Town as a Tax Consultant in 2011. During...

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