The ‘rocky’ road has been paved, or has it? Directors right to refuse transfer of shares

November 1st, 2014
x
Bookmark

Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd and Others 2014 (5) SA 179 (WCC)

By Pierre le Roux and Jarryd Mardon

The case of Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd  and  Others  2014  (5)  SA 179 (WCC) involved an application  concerning  the  refusal by the board of the first respondent (GHS) to approve a transfer by the applicant (VC) to the second respondent (MC) of the shares held by VC in GHS. As such, VC sought to compel GHS to register the transfer by claiming relief in terms of s 163 of the Companies Act 71 of 2008 (the Act).

The case is of great relevance in the company law landscape in South Africa as Rogers J provides guidance to lawyers in  considering  three  important issues. Firstly, the judgment confirms the legal validity of a clause in a private company’s   Memorandum   of   Incorporation (MOI) entitling a company’s board to refuse a transfer of shares without giving reasons. Secondly, it considers the scope of the new s 163 of the Act, which replaced s 252 of the Companies Act 61 of 1973 (the 1973 Act). Thirdly, it provides a thorough and well-considered evaluation of the inter-relationship between s 76 and s 163 of the Act.

The legal validity of such a clause

Counsel for the applicant argued that in the modern era it is objectionable for a company’s board to be entitled to refuse a transfer without giving reasons. This view reflects a sense of surprise, which is generally held by the public when they hear of the existence of such seemingly draconian powers.

Rogers  J  considered  South  African and foreign legal authorities in concluding that this type of clause is a common inclusion in the MOIs of private companies. It is normally inserted in a MOI to ensure that the company complies with s 8(2)(b)(ii) of the Act. The judgment also confirms that ‘there is no general duty on a person holding a fiduciary position to give reasons for his actions to those to whom his duties are owed’.  Further to this point, a strong argument is put forward as to why the ‘administration of corporations would become unwieldy if directors were bound on request to provide reasons for their decisions’ in the context of share transfers. There may be sound business reasons not to provide reasons as disclosure may jeopardise the company’s business relations with third parties, that may result in the disclose of matters of strategy or force the company to publicly state reservations, which it has concerning a proposed transferee. As a result of these considerations, the judge rejected the contention that such a clause in a private company’s MOI is bad in principle in our law. This finding should lay to rest concerns that some directors and lawyers may have had in respect of the enforceability of and reliance on such clauses. A board may, however, discover that it will have to disclose its reasons in order to successfully defend their decision in court proceedings – as was the case in this matter.

The scope of the new s 163(1)(a) of the Act

Section  163(1)(a)  entitles  a  shareholder or a director of a company to apply for relief under the section if ‘any act or omission of the company, or a related person, has had a result that is oppressive or unfairly prejudicial to, or that unfairly disregards the interests of, the applicant’ (our emphasis).

The predecessor of s 163 was s 252 of the 1973 Act. It is doubted by Rogers J as to whether the new wording materially alters the character of the conduct that was held to fall within the scope of s 252 of the 1973 Act as ‘the test focuses on the effect of the conduct complained of’. Section 252 had dealt with conduct that was ‘unfairly prejudicial, unjust or inequitable’.

Rogers  J  answers  the  question  of scope of the new s 163(1)(a) in expressing respectful disagreement with the observation of Moshidi J in Peel and Others v Hamon J&C Engineering (Pty) Ltd and Others 2013 (2) SA 331 (GSJ) to the effect that the inclusion of the phrase ‘unfairly disregards the interests of’ the applicant indicates ‘a far wider basis on which relief may be sought’. It is confirmed by Rogers J that the old s 252 had also covered ‘interests’ and not only the enforcement of ‘rights’, therefore establishing that the scope of the new provision has not been greatly widened.

It is not, however, enough for an applicant to show that the conduct complained of is ‘prejudicial’ to his rights or ‘disregards’ his interests, but he must show that the prejudice or disregard has occurred ‘unfairly’.

Inter-relationship between s 76 and s 163 of the Act

The judge considered the evolution of the statutory and judicial position in England and acknowledged that the unfair-prejudice remedy could extend beyond unlawful conduct. This, however, could leave a board in a quandary. Such a board will be damned if they comply with s 76 by acting in the interests of the company (and run the risk of being attacked in terms of s 163) and damned if they do not act in the interests of the company in an effort to prevent an attack on their decision in terms of s 163 (and in so doing fall foul of s 76).

It is trite in law that if the board exercises  a  power,  conferred  on  them by the company’s MOI and in so doing also  meets  the  standard  imposed  by s 76 then they act lawfully. The question then is whether a shareholder who is prejudiced by the decision can in those circumstances complain that the exercise of powers is ‘unfairly’ prejudicial to him? This is problematic because such a case may bring the invocation of the unfair-prejudice remedy into conflict with other principles of company law, namely, that of majority rule and the binding nature of the company’s constitutional documents.

In our view, and to avoid a conflict between these two provisions, it seems that s 163 should be interpreted in such a manner that excludes the element of ‘unfairness’ in all cases where a board has acted lawfully. A shareholder can expect no more of its board than that it acts lawfully. Such a conclusion was lacking in the judgment, and if it had been made by Rogers J, would in our opinion have provided the most suitable legal equilibrium on this issue. The door, therefore, remains open for the argument that despite complying with s 76 a decision of the board may still be subject to attack under s 163. What must a board do to protect itself in those circumstances – contravene s 76 to save itself from attack under s 163?

Rogers J held that the circumstances of a case would have to be ‘exceptional’ before one could find that a board decision, taken in accordance with the standard established by s 76, had caused a shareholder prejudice, which can properly be described as ‘unfair’ within the meaning of s 163. The judge listed some circumstances that could possibly qualify as such, which included informal arrangements and legitimate expectations amongst shareholders in small companies. As stated above, in our view it is difficult to envisage a circumstance where a legally unenforceable expectation could outweigh the interests of the company. Further, where such an expectation does exist, the board will nonetheless be compelled to act in the best interests of the company as required by s 76. In such a case, the decision should not, in our view, be treated as unfairly prejudicial as the binding provisions of the MOI and s  76  should  invariably  have  preceded any expectation of a shareholder.

Compliance with s 76

The  duties  of  directors  in  exercising their powers have been codified by s 76. The power must be exercised in –

  • good faith for a proper purpose;
  • in the best interests of the company; and
  • with the degree of care, skill and diligence required as described in s 76(3).

Section 76(4)(a) sets out the circumstances in which the obligations imposed by s 76(3) will be satisfied by a director. Rogers J’s judgment focuses on the notion that the duty to act in the best interests of the company is not an objective one. In other words, what is required is that the directors, having taken reasonably diligent steps to become informed, should subjectively have believed that their decision was in the best interests of the company and that this belief must have had ‘a rational basis’.

The rationality criterion as laid down in s 76 is an objective one and takes the form of a threshold requirement. Rogers J held that the principles in case authorities on the exercise of public power are similarly applicable to the ‘rationality’ requirement for the proper exercise of powers by directors. Such authorities have held that the requirement of rationality concerns the relationship between the decision and the purpose for which the power was given.

As regards the requirement of exercising the power for a ‘proper purpose’, in terms of s 76(3)(a), the test is objective in that once one has ascertained the ‘actual’ purpose for which the power was exercised by the board, then it must be determined whether the ‘actual’ purpose falls within the purpose for which the power was conferred, where the latter amounts to an issue of interpretation of the empowering provision. In this regard, it was suggested that the ‘overarching purpose for which directors must exercise their powers is the purpose of promoting the best interests of the company’.

Did GHS comply with its fiduciary duties under s 76?

Rogers J concluded, in considering the facts and circumstances placed before him, that GHS’ directors were bona fide of the opinion that the best interests of the company would be served by not allowing MC to increase its shareholding, because MC had a vision and ambitions that were adverse to GHS’ interests and its strategy for long-term contracts with producers.

The ‘actual’ purpose for which GHS’ board exercised the power to refuse the proposed transfer fell within the intended purpose of the empowering provision that was to enable the board to prevent a person from acquiring an increased shareholding where this was considered to be contrary to the best interests of the company.

Lastly, it was held that the directors’ genuine belief had a rational basis in uncontested facts, as prescribed by s 76(4) (a)(iii).

It was, therefore, concluded that the board, in refusing to approve the transfer, had met the standards set by s 76 of the Act and on this basis, the refusal was lawful.  The judge still had to consider whether despite the fact that the board acted lawfully the refusal was nevertheless “unfairly prejudicial” to the applicant, but held that the case did not fall within any of the exceptional circumstances mentioned above to qualify as such.

Conclusion

Directors can, with confidence, apply the provisions of a MOI that allows them to refuse to provide reasons for their decisions, while complying with their fiduciary duties. The rules formulated in this judgment should be of great assistance to boards of directors when confronted with decisions that will result in prejudice for some of their shareholders and when they wish to determine whether or not their decisions comply with s 76. A resolution of a board adopted lawfully in compliance with s 76 should in most, if not all cases, be safe from attack in terms of s 76 and s 163.

  • Werksmans, Cape Town, acted on behalf of the first respondent’s in this case.

Pierre le Roux BCom LLB (Stellenbosch) Grad Dip Tax (UCT) is an attorney at Werksmans Attorneys in Stellenbosch and Jarryd Mardon BCom LLB (Rhodes) is a candidate attorney at Werksmans Attorneys in Cape Town.

This article was first published in De Rebus in 2014 (Nov) DR 40.