Drafting share subscription agreements – Important considerations
Provided by Contracts Tech
We specialise in contract automation. Our solutions are geared towards automating the legal future - helping you manage your entire contract process, from start to finish. Through collaboration and input by various legal e... more
By Martin Kotze and De Wet de Villiers
12 May 2020
Especially in smaller and medium companies, the issuance of shares is often done haphazardly without due regard to proper process or possible consequences.
I’m sure you have been involved in a situation where the “Boss” phones you up and instructs you to do a share issuance by converting a portion of his loan account as consideration for the shares. Furthermore, he tells you the effective date of the subscription must be somewhere last month. This instruction certainly places you in a difficult situation. However, not advising on the possible pitfalls relating to share subscriptions can place you in an even worse situation.
The purpose of this note is to provide a high-level overview of important considerations that must be kept in mind when drafting a Share Subscription Agreement.
The power to issue shares was subject to the authority of the shareholders (members) in terms of s 221 of the 1973 Companies Act. Under the Companies Act, 2008 (the “Act”) the default position is different. The board of the Company must approve the share issuance (as always, there are exceptions, as will be discussed below).
The default position can be amended, and the Company’s MOI may require the shareholders of the Company to approve all share issuance (such inclusion will likely fall under section 15 (2) (a) (iii) of the Act as a higher standard, greater restriction or a more onerous requirement).
Section 39 (2) of the Act provides for a statutory pre-emptive right.
Each shareholder of a Company has a right, before any other person who is not a shareholder of that Company, to be offered and, within a reasonable time to subscribe for, a percentage of the shares to be issued equal to the voting power of that shareholder’s general voting rights immediately before the offer was made.
Notwithstanding section 39 (2) of the Act, the Company’s MOI can limit, negate, restrict or place conditions upon the rights contemplated in section 39 (2) of the Act.
Furthermore, the above statutory pre-emptive right does not apply to:
- Public or state-owned companies (except if MOI of these companies provides otherwise)
- Shares are issued and the consideration for the shares will not be received immediately (section 40 (5) to (7) of the Act)
It accordingly follows, as a point of departure, one should firstly look at the MOI of the Company which will be issuing the shares before commencing with the drafting of your Share Subscription Agreement. The shareholders’ agreement may also contain pre-emptive rights or other terms and conditions that may impact on the share issuance. Generally, the pre-emptive rights in the shareholders, are pre-emptive rights binding the shareholders of the Company and relate to the transfer of existing issued shares.
Furthermore, the Company may also have entered into agreements imposing negative obligations on the Company that restrict the issuance of further shares (for example, the consent of a Lender may be required to increase the issued share capital of the Company).
Although not necessarily related to the drafting of your Share Subscription Agreement, a word of caution: The shares must be issued for adequate considerations (which must be determined by the board) as contemplated in section 40 (1) (a) of Act. If you are advising the board of a company that proposes to issue further shares, ensure that you familiarise yourself with the meaning of “adequate consideration” as contemplated in the Act. A director of the Company may open him or herself up to possible personal liability if such a director fails to vote against a decision to allot and issue shares knowing such allotment and issuance will be contrary to the provisions of section 41 of the Act.
Section 41 (2) of the Act determines that a special resolution of the shareholders of the Company is required, if the shares are issued to a —
a. director, future director, prescribed officer, or future prescribed officer of the Company;
b. person related or interrelated to the Company, or to a director or prescribed officer of the Company; or
c. nominee of a person contemplated in paragraph (a) or (b).
A “person” “related or “interrelated” to the Company has a defined meaning in the Act. See section 1, the definition of “person” and section 2 of the Act.
Section 41 (2) of the Act provides for exceptions where shareholder approval for a share issuance as contemplated in section 41 (1) of the Act, will not be required.
If the shares will be issued to person contemplated in section 41 (1) of the Act and an exclusion contemplated in section 41 (2) of the Act does not apply, then:
- it is advisable to include a condition precedent in the share subscription agreement specifically relating to the approval of the share subscription by the shareholders of the Company.
A further situation where the approval of the Company’s shareholders will be required is:
- where the voting power of the class of shares that are issued or issuable as a result of the transaction or series of integrated transactions will be equal to or exceed 30% of the voting power of all the shares of that class held by shareholders immediately before the transaction or series of transactions.
Again, it is advisable to include a condition precedent relating to the share issuance should a share issuance be proposed as contemplated in this paragraph.
It may be that the Company is desirous to issue shares to a person and the arrangement involves some kind of “financial assistance” as contemplated in section 44 (2) of the Act (note, financial assistance contemplated in section 44 (2) of the Act, does not include lending money in the ordinary course of business by a company whose primary business is the lending of money “excluded financial assistance”).
Provided that arrangement is not excluded financial assistance and provided further that the arrangement is not pursuant to an employee share scheme, a special resolution of the shareholders of the Company will be required to approve the financial assistance relating to the share issuance.
The special resolution requirements contemplated in section 44 of the Act is often something that is missed, specifically in situations where “financial assistance” is not provided to a “director” or “prescribed officer”. The provisions in section 44 relate to “any person” and are not limited to “directors” or “prescribed officers”.
It must further also be remembered that the financial assistance and share issuance also relates to a situation where a company provides financial assistance to a person who subscribes to shares in a related or inter-related company of the Company that is providing the financial assistance.
When authorising the “financial assistance” to enable a person to subscribe to the shares, the directors of the Company will need to apply the solvency and liquidity test, be satisfied that terms of the financial assistance are fair and reasonable to the Company and that the “financial assistance” is not contrary to the Company’s MOI.
If the Board of the Company resolves to provide financial assistance for the subscription of the shares, and such financial assistance is not consistent with section 44 of the Act, then a director that failed to vote against the provision of such financial assistance may open him or herself up to possible damages claims for which he or she may be held personally liable as contemplated in section 77 (3) (e) (iv) of the Act.
COMPETITION AUTHORITY APPROVAL
The share subscription may also trigger a change in control as contemplated in the Competition Act. Firstly, you will need to establish whether there will be an acquisition or establishment of control over the whole or part of the business of the Company as contemplated in the Competition Act (see section 12 of the Competition Act).
If there is an acquisition or establishment of control as contemplated in the aforesaid paragraph, then you will need to have a look at the thresholds and categories of mergers to determine whether approval from the Competition Authorities is required. There is a basic merger threshold calculator on the Competition Commissions website – http://www.compcom.co.za/mergers-threshold-calculator/
The creation and transfer of the rights to the shareholder are specifically excluded from being a disposal by the Company for capital gains tax purposes (par 11(2)(b) of the Eighth Schedule).
Furthermore, a share issue is not a transfer of securities for Securities Transfer Tax (STT) purposes.
From the subscribing shareholder’s perspective, subscribing for shares in a Company establishes a cost (being the base cost of the asset) for the shares in the hands of the shareholder. This cost is relevant when the shareholder subsequently disposes of the shares. Furthermore, the Company’s contributed tax capital will be increased with the same amount. If a Company issues shares to a person by virtue of that person’s employment or holding of an office as director, the value of the shares could be subject to income tax (PAYE) in the hands of the employee or director and not capital gains tax (section 8C of the ITA).
Having a “one-pager” Share Subscription Agreement may be what your client has in mind. The Act, however, tries to balance the interest of various stakeholders and not only that of the “Boss”. When things go south, you want to be in the position to show that you have advised on potential pitfalls—using the contracts.tech, contract creation tool you can create a share subscription agreement in minutes, while being guided through various important considerations relating to a share subscription Agreement.
- Drafting of share buyback agreements – Important considerations
- Drafting of sale of share agreements – Important considerations
- An alternative purchase price mechanism for M&A transactions
- Intellectual Property valuations as an aid and an add-on to accounting valuations
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 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...