When good close corporations go bad

August 1st, 2017
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By Edrick Roux and Lucinda Horn

‘Enjoy the little things, for one day you may look back and realise they were the big things’ Robert Brault. This is both a valuable life lesson and an irrefutable truth when it comes to many legal matters where a small variation to the norm can have an exceptionally large effect from a legal perspective.

This becomes even more relevant when two extraordinarily complicated legal fields, such as the laws surrounding close corporations (Close Corporations Act 69 of 1984 (the CC Act)) and the law of Trusts (Trust Property Control Act 57 of 1988) begin to intertwine, as laws generally do.

Trusts, being extremely flexible sui generis entities, which provide various benefits from a risk protection and estate duty perspectives, often form the lynch pin of complicated estate plans. Practically this means that they often overlap with the business interests of estate planners, who by virtue of their success, and with expert assistance from attorneys and other skilled estate planning professionals, usually made comprehensive estate plans aimed at reducing estate duty and ensuring that family businesses would continue in operation long after they have passed away.

Quite often this includes the transferring of member’s interest of a close corporation (CC) to a Trust, or by allowing a Trust to be the founding member of a CC from the get go.

What follows is a brief discussion on the rules surrounding CC and Trusts.

Can a Trust be the member of a CC?

In terms of the provisions contained in the CC Act  (s 28) there must be at least one, and no more than ten, members of a CC, which originally were limited to only being allowed to be natural persons (s 29(1) of the CC Act).

However, this position was altered by s 1 of the Close Corporations Amendment Act 17 of 1990 by way of the insertion of s 29(1A) of the CC Act, which reads as follows:

‘The provisions of subsection (1) shall not apply to the membership of a corporation of a natural person who holds that membership for the benefit of a trust inter vivos if immediately before 13 April 1987 a natural person held membership of the corporation for the benefit of the trust …’ (our italics).

Accordingly, an inter vivos Trust, was now allowed to hold membership interest in a CC, subject, however, to the following prerequisites of s 29(1A)(a) – (d) of the CC Act –

‘(a) no juristic person shall directly or indirectly be a beneficiary of that trust;

(b) the member concerned shall, as between himself or herself and the corporation, personally have all the obligations and rights of a member;

(c) the corporation shall not be obliged to observe or have any obligation in respect of any provision of or affecting the trust or any agreement between the trust and the member concerned of the corporation; and

(d) if at any time the number of natural persons at that time entitled to receive any benefit from the trust shall, when added to the number of the members of the corporation at that time, exceed 10, the provisions of, and exemption under, this subsection shall cease to apply and shall not again become applicable notwithstanding any diminution in number of members or beneficiaries’ (our italics).

Therefore, there should all of the abovementioned requirements be met, there should be no prohibition to allow a Trust, via one of the trustees who will be required to attend to all of the necessary aspects, to hold the relevant member’s interest.

Complications with regards to a Trust being a member of a CC

In light of the above it is clear that there is no prohibition on a Trust being a member of a CC, however, there are several complications that may arise, which would make it less desirable for a Trust to be such a member.

The first complication arises from the general wording, which is usually present in most Trust templates. Generally speaking juristic persons form part of the category of discretionary beneficiaries in terms of the Trust deeds. This clearly disqualifies the Trust, however, this can easily be remedied by way of attending to an amendment of the Trust deed to remove all juristic persons from the category of the beneficiaries.

The far more pressing concern arises from the provisions contained in s 29(1)(d) of the CC Act, which are often overlooked. In order to determine how many members are in office on a given Trust, one must take into account all of the natural persons who qualify as beneficiaries of the Trust.

In many cases this should not be a problem, since the number of members should effectively still be less than ten, at least at the date of the creation of the Trust. However, should the trustees ever become too lax in their administration of the Trust and this level exceeds ten, then the exemption that allows for the Trust to hold the member’s interest will become inoperative and furthermore, in accordance with the provisions contained in s 29(1)(d) of the CC Act they can never become applicable again irrespective of whether the number of beneficiaries are subsequently reduced.

This seems to lead to two distinct scenarios –

  • where the Trust was not the only effective member of the Trust, then the membership effectively falls away and the full membership should revert to the remaining member(s) as a deemed disposal by the Trust (this will likely occur in accordance with the provisions of s 33(1)(a) or alternatively s 37 of the CC Act);  or
  • the creation of a legal anomaly where there are no members left in the CC.

The second option is particularly problematic as it prohibits the capability of the CC to effectively function, including attending to the day to day management and operations of the CC, which could in extreme situations lead to the Registrar of CC (as defined in s 4 of the CC Act) deregistering the CC in terms of the provisions contained in s 26(1) of the CC Act.

For obvious reasons this is not a desirable result and could lead to severe detriment of the employees of the CC, as well as the potential beneficiaries of the Trust, which in turn could result in the trustees being held accountable for damages suffered due to their inability to foresee and attend to protecting against this eventuality.

Prevention is better than cure

In order to avoid any potential issue from impacting the ability of the Trust to hold the member’s interest in a CC, the authors submit the following:

  • Should the desired objectives of the Trust make it a necessity, or should it be desired to do so, the Trust deed must be scrutinised in order to make sure that powers and duties afforded to the trustees authorise them to hold member’s interest of a CC.
  • The Trust deed must be drafted in such a manner as to ensure that there is no chance that any juristic person may be benefitted, whether directly or indirectly.
  • Provisions must be inserted into the Trust deed to create deeming provisions, which deems the member’s interest held by a specific individual to be disposed of to another member, or potential member, immediately prior to the number of members exceeding ten (this aspect must be closely monitored by the trustees as s 29(1A)(c) of the CC Act specifically states that the CC is not obliged to observe any obligations or provisions of the trust).
  • As the CC is not obliged to give effect to the provisions of the Trust deed it would also be prudent to incorporate provisions similar to those referred to in bullet three above in an association agreement signed by the members in order to ensure that it is given effect to. This would also be in accordance with the provisions of s 37(a) of the CC Act.
  • An extreme alternative may also be to limit the number of beneficiaries in the Trust to ensure that they can never exceed the threshold set by the CC Act, however, this will limit the flexibility and usage of the Trust. As such this should only be considered as an extreme alternative.

The abovementioned will of course serve to prevent any unintended consequences, however, it must be noted that they could result in Capital Gains Tax (CGT) consequences arising from the disposal of the member’s interest in order to avoid a legally untenable situation.

Where s 29(1A) of the CC Amendment Act has come into effect

Cases where the provisions of s 29(1A) of the CC Amendment Act has come into effect and there are other members, the effect would seem to be that the member’s interest, which was held by the Trust was disposed ipso iure to the remaining member(s).

This may also result in CGT consequences arising, as the member’s interest has been disposed of.

Where there are no other members, which is to the knowledge of the authors a legal anomaly and an issue, which has not yet been tested by court, it would seem that the only solution would be for the former member to approach the court for a declaratory order to have the member’s interest disposed of to one of the beneficiaries of the Trust, or some other individual who qualifies for membership of a CC (as per the provisions of s 29(2) of the CC Act), in order to ensure that the normal business activities of the CC can continue.

Although generally speaking only the members of the CC would have the necessary locus standi to approach the court for relief in this regard, the unique nature of such an application should allow for the locus standi to extend to individuals who have a sufficient interest in the CC, similar to the position that would apply in the case of Trusts (see Theron and Another NNO v Loubser NO and Others 2014 (3) SA 323 (SCA) and Kidbrooke Place Management Association and Another V Walton and Others NNO 2015 (4) SA 112 (WCC)).

Failing which, it is conceivable that the Registrar of CC will have the relevant corporation deregistered, which could have extremely wide reaching negative consequences for all of the relevant stakeholders. It must be noted that the CC will also be prohibited from initiating liquidation proceedings in accordance with s 67 or 68 of the CC Act, as there are no members to make the relevant resolution.

Conclusion

From the above it is clear that there are a wide range of negative consequences, which may arise should these circumstances occur, and although the authors have attempted to provide practical solutions it remains to be seen how these aspects will be dealt with in practice.

What is clear, however, is that either of these scenarios are best avoided in practice as prevention is better than cure.

Edrick Roux LLB (UP) is a legal adviser in the Trusts and Estates Division at PricewaterhouseCoopers Africa and Lucinda Horn LLB (UP) is an attorney at Dyason Attorneys Inc in Pretoria.

This article was first published in De Rebus in 2017 (Aug) DR 26.

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