Simulated agreements: Dressing up transactions

November 1st, 2017
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By Chantelle Humphries and Don Mahon

The application of the National Credit Act 34 of 2005 (the NCA) can have onerous consequences for money lenders. It requires strict compliance with its provisions relating to registration of credit providers, reckless lending and notice.

This has resulted in a number of money-lenders dressing up their transactions as something other than credit agreements, in order to circumvent the provisions of the NCA. Although it is trite that a court will have regard to the substance of an agreement, rather than its form, it is not always easy to determine when an agreement is such a simulated transaction.

The legal position

The test to determine simulation is two-fold. As stated by Lewis JA in Commissioner for the South African Revenue Service v NWK Ltd 2011 (2) SA 67 (SCA) at para 55:

‘In my view the test to determine simulation cannot simply be whether there is an intention to give effect to a contract in accordance with its terms. Invariably where parties structure a transaction to achieve an objective other than the one ostensibly achieved they will intend to give effect to the transaction on the terms agreed. The test should thus go further, and require an examination of the commercial sense of the transaction: Of its real substance and purpose. If the purpose of the transaction is only to achieve an object that allows the evasion of tax, or of a peremptory law, then it will be regarded as simulated. And the mere fact that parties do perform in terms of the contract does not show that it is not simulated: The charade of performance is generally meant to give credence to their simulation.’

There are two forms of simulated transactions. Firstly, if parties make an agreement as a sham or pretence (eg, to mislead the fiscus), then they do not intend to create obligations and their simulated agreement is invalid (see Long Oak Ltd v Edworks (Pty) Ltd 1994 (3) SA 370 (SE) at 375-379). If the simulated agreement is a disguise for some other type of transaction, the court will strip off the form of the simulated agreement and reveal its true nature, so that the law may operate.

Secondly, where parties enter into an agreement and act in accordance with the agreement but for a different purpose than that which the agreement contends for.

If a transaction or agreement is genuine a court would give effect to it and, if not, the court would give effect to the underlying transaction that it concealed (see Zandberg v Van Zyl 1910 AD 302, Vasco Dry Cleaners v Twycross 1979 (1) SA 603 (A) and Michau v Maize Board 2003 (6) SA 459 (SCA)).

Whether an agreement is genuine depends on a consideration of all the facts and circumstances surrounding the transaction. A court will examine the transaction as a whole, including all surrounding circumstances, any unusual features of the transaction and the manner in which the parties intended to implement it, before determining in any particular case whether the agreement was simulated (see Roshcon (Pty) Ltd v Anchor Auto Body Builders CC and Others 2014 (4) SA 319 (SCA) at paras 27, 32 and 37).

In the matter of Hippo Quarries (Tvl) (Pty) Ltd v Eardley 1992 (1) SA 867 (A) the court looked at the form of a transaction and concluded that the parties genuinely intended to give effect to that which they had apparently agreed. In Commissioner for Inland Revenue v Conhage (Pty) Ltd (Formerly Tycon (Pty) Ltd 1999 (4) SA 1149 (SCA) Hefer JA found that sale and leaseback agreements, which had unusual terms but which made good business sense, were honestly intended to have the effect contended for by the parties.

In the Hippo Quarries case, the court drew a distinction between motive and purpose, on the one hand, and intention on the other, in trying to determine the genuineness of a contract, and of the underlying intention to transfer a right, where the transfer was not an end in itself. Nienaber JA said:

‘Motive and purpose differ from intention. If the purpose of the parties is unlawful, immoral or against public policy, the transaction will be ineffectual even if the intention to cede is genuine. That is a principle of law. Conversely, if their intention to cede is not genuine because the real purpose of the parties is something other than cession, their ostensible transaction will likewise be ineffectual. That is because the law disregards simulation. But where, as here, the purpose is legitimate and the intention is genuine, such intention, all other things being equal, will be implemented.’

In S v H Friedman Motors (Pty) Ltd and Another 1972 (3) SA 421 (A) the contracts in question were designed to avoid legislation regulating moneylending transactions. In order to obtain funds to acquire a motorcar, an individual would sell his car to a bank. The bank would immediately resell the car to the individual for a higher price, but would reserve ownership in the car until the full purchase price was paid – a hire-purchase contract. The individual would pay a cash deposit and monthly instalments and on payment of the full purchase price ownership of the car would revert to him. The same object would usually be achieved through a loan of the price by the bank to the individual, repayable with interest. Colman J, in S v Friedman Motors (Pty) Ltd and Another 1972 (1) SA 76 (T), considered that the transactions might be loans, disguised as sales, or genuine sales, depending on the parties’ intention. He said at 80 G – H:

‘If two people, instead of making a contract for a loan of money by one of them to the other, genuinely agree to achieve a similar result through the sale and repurchase of a chattel, there is no room for an application of the maxim plus valet quod agitur quam quod simulate concipitur. The transaction is intended to be one of sale and repurchase, and that, at common law, is what it is.’

In the Friedman and Conhage cases, where the courts held that the parties intended their contracts to be performed in accordance with their tenor, there were sound reasons for structuring the transactions as they did. The purchaser of the car in the Friedman case was required to give security in return for the funds advanced by the bank. A pledge would have deprived him of the car and its use. Hence the sale and resale: It allowed the purchaser to keep and use the car. In the Conhage case the sale and leaseback of manufacturing equipment permitted the manufacturer to retain possession of the equipment. There was a commercial reason or purpose for the transactions to be structured as they were. In both instances there was a genuine transfer of ownership. Had the purchaser failed to pay the seller he would have lost the right to become the owner in due course.

Conclusion

Although it may not always be easy to determine whether an agreement is simulated or not, the authorities quoted above provide some useful guidelines in determining this question. Whether an agreement is genuine depends on a consideration of all the facts and circumstances surrounding the transaction. A court will examine the transaction as a whole, including all surrounding circumstances, any unusual features of the transaction and the manner in which the parties intended to implement it, before determining in any particular case whether the agreement was simulated.

Chantelle Humphries LLB (UJ) is an advocate at Bridge Group in Johannesburg. Don Mahon LLB (UP) is an advocate at Maisels Group in Johannesburg.

This article was first published in De Rebus in 2017 (Nov) DR 20.

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