How and why parent companies should “ground” their subsidiaries

21 Dec 2020

In terms of section 112 of the Companies Act 71 of 2008 (“Companies Act”), a disposal by a company of all or the greater part of its assets must be approved by a special resolution of the shareholders of the company, prior to the disposal taking place. Unless stated otherwise by a company’s memorandum of incorporation, a special resolution requires approval of at least 75% of the shareholders’ voting rights exercised on the resolution.

A special resolution of the shareholders will not be required if the disposal is between a wholly owned subsidiary and its holding company (for example, a “drop-down” transaction, in terms of which a parent company transfers a majority of its assets to its wholly owned subsidiary). In order for this exemption to be applicable, the holding company must demonstrate, with regards to the subsidiary, that all of the general voting rights are held or controlled by the holding company or another subsidiary or nominee of the holding company (as contemplated in section 3(1)(b) of the Companies Act).

The pertinent issue is that section 3(1)(b) does not appear to envisage the existence of ‘control’ beyond the disposal that constitutes a drop-down transaction, especially with regard to circumstances where control ceases immediately after the transaction (which should put into question whether ‘control’ existed at the time of the transaction for purposes of exempting the holding company from obtaining a special resolution of its shareholders approving the transaction). From a practical perspective, we understand that a company should be exempt from obtaining approval from its shareholders if the assets forming part of the drop down transaction are held at the subsidiary level for a significant period thereafter; however, what if the subsidiary is simply being used as a conduit for the transfer of the assets to another unrelated party?

Section 115(2)(b)(iii) of the Companies Act does provide that a transaction will require a special resolution by the shareholders of the holding company if: (i) the transaction constitutes a disposal of all or the greater part of the assets of a subsidiary of the holding company; and (ii) having regard to the consolidated financial statements of the holding company, such disposal by the subsidiary constitutes a disposal of all or the greater parts of the assets of the holding company. Unfortunately, it appears that this section will not resolve the aforementioned concern if the asset does not constitute a greater part of the assets of the holding company on a consolidated basis.

Having regard to the above, companies should take special care when drafting the constitutive documents of companies within the group so as to ensure that assets disposed by virtue of a drop down transaction cannot subsequently be disposed of by the subsidiary without first being approved by the shareholders of the parent company.

See also:

• Employee incentive schemes: Retaining and incentivising key employees during uncertain times
• What is the purpose of an IP holding company?
• Drafting written resolutions – Important considerations
• An alternative purchase price mechanism for M&A transactions
• Understanding the concept of a delinquent director\
• A reflection on conflict of interest and misappropriation of corporate opportunity under modern company law in South Africa

(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.)