Requirements for providing guarantees – Financial assistance to companies

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18 Dec 2019

Simply put, a guarantee is a promise by one person to perform on behalf of another. It usually takes the form of an agreement to pay for, or effect performance of, certain obligations by the guarantor on behalf of a third party who is primarily liable for that payment or performance. It is therefore used as security for payment or performance obligations. A guarantee can be issued by a related party or a non-related party, but there are different requirements.

Section 45 of the Companies Act 71 of 2008 (the “Act”), deals with loans and other financial assistance. If a company is providing financial assistance (which includes guarantees) to a related or inter-related company, careful consideration must be given to this section. A company is considered to be a related or inter-related company if the guaranteeing company has control, directly or indirectly, over such company to the extent that the guaranteeing company is able to exercise, or control the exercise of, a majority of the voting rights in such company or it has the right to appoint directors who control a majority of the votes at a board meeting of such company. Most commonly the related party issuing a guarantee would be the parent company.

Thus, section 45 of the Act will be applicable to a company that acts as the guarantor in favour of its related or inter-related company.

A company may also provide a guarantee in favor of an unrelated company, but then section 45 of the Act does not have application.

In terms of South African law, a company possesses all the legal powers and capacity of a natural person, except to the extent that i) the company is incapable of exercising such power or possessing such capacity; or ii) the company’s memorandum of incorporation provides otherwise.

This principle is incorporated under section 43 of the Act which provides that the board of directors of a company may authorise the company to issue a secured or unsecured debt instrument at any time, except to the extent provided otherwise by the company’s memorandum of incorporation.

To the extent that a company is not restricted by its memorandum of incorporation and it has the legal capacity to exercise its powers, any decision made by the board, on behalf of the company, to issue a guarantee will be governed by the directors’ fiduciary duties to the company, specifically to act in good faith and for a proper purpose and in the best interests of the company. Accordingly, the board will need to determine whether or not it will be in the best interests of the company to stand-in as guarantor and issue a guarantee in favour of the unrelated company and if not, the board should withhold the guarantee.

Practically speaking, providing a guarantee in favour of an unrelated company is a matter of judgement and may not be in the best interests of the company if there are no prospects of the company gaining any commercial benefit. However, South African law does not explicitly require that the decisions of a company must result in commercial benefit, and the company is therefore free to make any decisions, within good judgement, regardless of the resultant commercial benefit.

Where a transaction lies beyond the capacity of a company and the company is restricted by its memorandum of incorporation, the company is generally capable of ratifying the transaction by passing a special resolution of the shareholders to authorise the transaction. An exception to this is the provision of financial assistance. If a company’s memorandum of incorporation prevents the company from granting financial assistance, any provision of financial assistance in contravention of the company’s power and capacity (or the Act) is not capable of ratification. As such, to the extent of the restriction provided in the company’s memorandum of incorporation, the board and the shareholders of such company may not have the power to pass a resolution to authorise the provision of the guarantee in favour of the unrelated company.

In conclusion, the legal requirements under South African law cannot prevent a company from standing in as guarantor and issuing a guarantee in favour of an unrelated company. However, the company will need to have the legal capacity and power, in terms of its memorandum of incorporation, to provide the financial assistance and the board has a fiduciary duty to determine whether, and be satisfied that, they will be acting in the best interests of the company by providing the guarantee and that the terms under which the guarantee is provided are fair and reasonable to the company.

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(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.)
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