Are you sure that you are a shareholder?

09 Dec 2022

The consequences of failing to comply with the relevant provisions of the Companies Act necessary to prove your shareholding and some possible remedies

1. Introduction

The mere holding of a share certificate does not guarantee that you are a shareholder of a company. Instead, the Companies Act 71 of 2008 (“Companies Act”) contains various provisions pertaining to the authorisation and issue of shares, as well as the steps that must be taken in order to ensure that such shareholding is reflected correctly.

It occurs often in practice where persons or entities believe they are shareholders in a company, only to find out that the shares which they believe they hold are a nullity or such shareholding is not reflected in the relevant documents relating to that company.

Imagine a scenario where, for example, Mr. X acquires 100 ordinary shares in a start-up private company for nominal value by way of a subscription. He works tirelessly to grow the business and succeeds. Then, after five years, Mr. X wishes to exit the company by selling his shares at R50 000 a share to a bona fide purchaser. The purchaser, after conducting a due diligence investigation, advises Mr. X that it no longer wishes to implement the transaction on the basis that the shares held by Mr. X, from a legal perspective, do not exist. Although this is a catastrophic scenario, the fact is that it occurs more often than it should.

The scenario contemplated above may arise in situations where Mr. X has acquired shares in a company which were not properly authorised in the first place and/or the securities register of such company has not been updated to reflect his shareholding accordingly.

The focus of this article is primarily on shareholding in private companies.

2. Companies Act requirements

As a starting point, it is necessary to note that the Companies Act differentiates between authorised and issued share capital. “Authorised” shares are those which the company is entitled, by its memorandum of incorporation (“MOI”) to issue, but which have not been issued.[1] The “issued” share capital refers to those shares which are authorised and issued.[2] Therefore, when one is to acquire shares in a company by way of a subscription, they will subscribe for the authorised shares in a company, which, once acquired, will reflect as the issued share capital in a company.

Section 36 of the Companies Act provides that all preferences, rights, limitations and the terms associated with a class of shares must be contained in the MOI. Such MOI must be endorsed by the Companies and Intellectual Property Commission (“CIPC”), and if there is any confusion as to which MOI is effective at any time, the Companies Act provides that the latest version endorsed by the CIPC takes preference over all other versions.[3] Therefore, the authorised shares are created by setting out such shares in the MOI, filing the MOI at the CIPC and the CIPC endorsing such MOI.

In terms of section 38(1) of the Companies Act, the board of a company may resolve to issue shares of the company at any time, but only within the classes, and to the extent, that the shares have been authorised by or in terms of the company’s MOI, in accordance with section 36 of the Companies Act. Section 38(2) of the Companies Act states that where a company issues shares that have not been authorised or which are in excess of the number of authorised shares of any class, such issue may be retroactively authorised by board resolution within 60 business days following such issue.

The issued share capital in a company may be evidenced by certificated securities or uncertificated securities.[4] Simply put, certificated securities are those evidenced by a share certificate, as reflected by an entry into the physical securities register of a company, whilst uncertificated securities are evidenced by an entry into an uncertificated securities register.

Regardless of whether a not a company issues certificated or uncertificated securities, section 50 of the Companies Act requires that such company maintain a securities register. The purpose of the securities register or the uncertificated securities register (in the case of uncertificated securities) is to provide all of the requisite information relating to the authorised and issued share capital of the company, the current shareholders of the company and all previous transactions relating to the authorised and issued share capital of the company.[5] The securities register will serve as prima facie proof which, in the absence of evidence to the contrary, becomes conclusive proof of all of the facts recorded in it.[6]

In light of the aforegoing, in order to legitimately acquire shares in a company by way of a subscription, it is important to ensure: (i) that the shares have been properly authorised in the MOI which is endorsed by the CIPC; (ii) that the board has resolved to issue those shares and that all the relevant resolutions have been passed,[7] failing which, such issue must be retroactively authorised by a board resolution within 60 business days of issue; and (iii) that the securities register has been updated accordingly to reflect such shareholding.

3. Consequences of failing to comply with the Companies Act

Section 38(3) of the Companies Act states that if the shares issued have not been properly authorised or are in excess of the authorised share capital and the retroactive resolution has not been passed, then:

• such share issue is a nullity to the extent that it exceeds the authorised shares;
• the company concerned must return to any person the fair value of the consideration received by the company in respect of such shares;
• any share certificates evidencing such shares must be cancelled; and
• any director of the company who voted on the issue of the shares or failed to vote against the issue of the shares knowing that such shares were not authorised, is liable for any claim relating to loss, damages and/or costs arising out of the issue of the unauthorised shares.

If the shares have been issued legitimately but not recorded in the securities register, then such person is prima facie not a shareholder of the company.

4. Possible remedies

In terms of the invalid issuing of shares, as contemplated in section 38 of the Companies Act, the position may be rectified by: (i) the company ensuring that its MOI is amended to reflect the correct shares and/or the number of authorised shares, and then ensuring that such MOI is filed and accepted at the CIPC; and (ii) the shareholder whose shares which were deemed a nullity may re-subscribe for such shares, in which the subscription price will be set-off against the claim which such shareholder will have against the company for the improper issuing of such shares arising in accordance with section 38(3)(b) of the Companies Act. It is important to note that this remedy above is only possible if all the parties concerned are in agreement. If there is a dispute, then it may not be possible to implement the proposed transaction and the purported shareholder will only be left with the claim against the company. Furthermore, if such shares are re-issued at a subscription price which is below the market value of such shares, then certain tax consequences may arise.[8]

In terms of the securities register not reflecting the relevant shareholding, it is possible for the company secretary or other person in charge of maintaining such register to ensure that it is updated accordingly. Again, however, this is only possible where all the relevant parties agree that the securities register should reflect such shareholding. If there is a dispute, then the person or entity concerned will need to make an application to court to rectify the securities register of the company in terms of the common law, section 161 of the Companies Act, and possibly section 163 of the Companies Act.

Regardless of the remedies available, the agreements and/or ancillary documents required to give effect to such remedies must be considered by a legal expert, particularly in the fields of company law and tax law.

5. Conclusion

The mere holding of a share certificate does not guarantee that you are a shareholder of a company. It is extremely important in this regard that such shares were authorised and issued legitimately and that the securities register of the company reflects such shareholding. If you are uncertain, it is highly advisable that you contact your auditors, company secretary and/or attorneys to obtain clarity. If it turns out that the shares are a nullity or that the securities register is inaccurate, then such issues must be resolved internally, provided that all of the parties agree. If not, then it may be necessary to institute court proceedings.

In any event, this article highlights the importance of ensuring that all the relevant documentation of the company are correct and up to date when acquiring shares in a company, the failure of which may lead to unwanted consequences.

References:

[1] Section 35(4) of the Companies Act
[2] Ibid
[3] Section 18(2) of the Companies Act
[4] Section 49 of the Companies Act
[5] Section 50(2) of the Companies Act
[6] Section 50(4) of the Companies Act
[7] See section 40 and section 41 of the Companies Act
[8] Section 58(1) of the Income Tax Act 58 of 1962

Article sourced from Lanham-Love Galbraith-van Reenen Attorneys.

See also:

• Memorandum of incorporation versus a shareholders agreement – Some important considerations
• The approval of a scheme of arrangement by shareholders
• Removing a minority shareholder
• Could shareholders inadvertently cancel their Shareholders Agreement?

(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.)