Legal framework for acquisition by a company of its own shares

September 1st, 2017

By Mlunghisi Duncan Tlemo

A procedure for acquisition by a company of its own shares is primarily regulated by the provisions of ss 46 and 48 of the Companies Act 71 of 2008 (the Act). The board of directors of a company may authorise a re-acquisition, provided that prior to effecting such re-acquisition the solvency and liquidity test has been applied by the board.

The board of directors must vote on the decision whether to approve a buyback or re-acquisition of shares by the company of its own shares. Only board approval is, therefore, necessary and shareholder approval is not required for a repurchase in general.

However, in terms of s 48(8) of the Act, a proposal by the board for a re-acquisition, if considered alone or together with a whole series of integrated transactions, is more than 5% of the issued shares of any class of shares of the company then the re-acquisition must comply with the requirements of ss 114 and 115 of the Act.

A buyback falls within the definition of ‘distribution’ as defined in s 1 of the Act. Since some of the shareholders in the subsidiary (target) company can elect to receive cash as a consideration, the requirements of s 46, therefore, must be complied with (the term ‘distribution’ is used to refer to payment made to shareholders either as a return on share capital or as a return of share capital. See K van der Linde ‘The regulation of distributions to shareholders in the Companies Act 2008’ (2009) 3 TSAR 484).

Thus, in addition to passing a resolution approving a buyback, the board must, before making a distribution (re-acquisition), apply the solvency and liquidity test. A proposed repurchase will pass the solvency and liquidity test if the board is satisfied that –

  • the assets of the company, as fairly valued, equal or exceed the liabilities of the company, as fairly valued; and
  • it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months following such repurchase.

According to Piet Delport and Quintus Vorster, (Henochsberg on the Companies Act 71 of 2008 (Durban: LexisNexis) at 54) ‘factual solvency’ (when it appears) is ‘based on all reasonably foreseeable financial circumstances that assets [of the company] are in excess of its liabilities … [this] is purely a balance sheet test, ie a particular moment … while in respect of liquidity it must appear, based on all reasonably foreseeable financial circumstances, that the company will be able to pay its debts as they fall due in the ordinary course of business for 12 months after the test was applied. If the test is in respect of a distribution, the distribution must be made out of net assets and after the distribution the liquidity test must be complied with for 12 months.’

Re-acquisition of shares exceeding 5% of the shares in the subsidiary company

If the re-acquisition proposed exceeds 5% of the issued shares in the subsidiary (target) company, the decision for approval shall vest on the shareholders of subsidiary company. In terms of s 48(8)(a), a special resolution approving the proposal by the majority (acquiring) company to acquire its own shares must be passed with a support of at least 75% votes by the shareholders, if the shares are re-acquired from directors or from prescribed officers (‘prescribed officer’ means a person who, within a company, performs any function that has been designated by the minister in terms of s 66(10). The definition of ‘prescribed officer’ as substituted by s 1(1)(x) of the Companies Amendment Act  3 of 2011).

In consequence of the above, minority shareholders can be prevented from participating in the decision to approve a buyback by virtue of holding minority voting rights in the ordinary shares of a company.

Section 115 requires approval by a special resolution adopted by persons entitled to exercise voting rights on such a matter, at a meeting called for that purpose and at which sufficient persons are present to exercise, in aggregate, at least 25% of all of the voting rights that are entitled to be exercised, or any higher percentage as may be required by the company’s Memorandum of Incorporation.

Provided the acquiring company has given notice to shareholders (including minority shareholders) in the subsidiary company of a meeting to consider adopting a resolution to repurchase its shares in terms of s 115 of the Act, minority shareholders may opt to exercise their appraisal rights in terms of s 164 of the Act. In terms of this section, dissenting shareholders, may give the company a written notice objecting to such resolution and demand that the company pay them ‘fair value’ for all their shares.

Minority shareholders may invoke the appraisal remedy in terms of s 164 if he or she –

  • notified the company in advance of the intention to oppose a special resolution contemplated in this section; and
  • were present at the meeting and were entitled to vote, and voted against that special resolution.

However, minorities may only seek relief in terms of s 164 of the Act, if the resolution to approve the re-acquisition has been passed and adopted accordingly.

When shares within the proposed percentage of the intended re-acquisition are held by directors or prescribed officers of the company

Under this situation a company proposing to re-acquire its own shares (that exceed 5%) and, which shares are to be re-acquired from some of the directors and prescribed officers of company, the procedure set out in s 114 (read with s 117(1)(c)) of the Act, which regulates fundamental transactions, affected transactions, offers and takeovers must be followed. This transaction will trigger the application of s 114(e), which deals with schemes of arrangement.

Schemes of arrangement includes –

  • consolidation of different classes of securities;
  • a division of securities into different classes;
  • an expropriation of securities;
  • an exchange of securities; and
  • re-acquisition by the company of its own securities.

‘Fundamental transactions’ includes a scheme of arrangement.

A company may implement the proposed scheme of arrangement with the holders of any class of its securities, provided the required approval under s 115 (op cit) have been obtained.

Stephanie M Luiz (‘Some comments on the scheme of arrangement as an “affected transaction” as defined in the Companies Act 71 of 2008’ (2012) 15 PER 101 at 107) says ‘the question arises whether, … any proposal by a company to re-acquire some of its shares in terms of section 48 would constitute a scheme of arrangement as contemplated in section 114.’

Luiz goes on to say that it is clear that a re-acquisition in terms of s 48, which results in the company re-acquiring more than 5% of the issues shares of any particular class of the company’s shares triggers the application of ss 114 and 115 of the Act. However, it will be prudent for such a company to note that re-acquisitions by a company of its own shares does not automatically become a scheme of arrangement as defined.

That said, the company must, before the proposed re-acquisition is put to the shareholders’ vote, be required to retain the services of an independent expert who so qualifies to prepare a report. The independent expert must satisfy the qualifications of competence, experience and independence as set out in s 114(2)(a) of the Act.

The independent expert so appointed shall be required to prepare a report to the board of company and cause it to be distributed to all shareholders in the target company concerning the proposed arrangement.

The purpose of the report is obviously to enable minority shareholders to decide whether or not to vote to support the special resolution proposing the scheme of arrangement.

Section 114(3) outlines the following information, which must be included in the report:

  • Type and class of securities that would be affected and include the prescribed information relevant to the value of those securities, as well as describe the material effects on the rights of the holder, as well as outlining the advantages and disadvantages of the scheme.
  • The effect of the proposed arrangement and the interests of holders of any class of securities.
  • Proof in terms of s 164 to the effect that the holders of securities who voted against the proposal were explained their appraisal rights.

Remedies for dissenting minority shareholders

In terms of ss 163(1)-(3) of the Act, minority shareholders may apply to a court for relief if, inter alia, any act or omission of the acquiring company, or a related person to that company, which has resulted in an oppressive or unfairly prejudicial conduct, or that unfairly disregards interests of minority shareholders. Stretch J in Justpoint Nominees (Pty) Ltd and Others v Sovereign Food Investments Limited and Others (ECP) (unreported case no 878/16, 26-4-2016) (Stretch J) said: ‘Cassim et al in Contemporary Company Law JUTA, Cape Town at 770 opines that it would seem that section 163 has been drafted to include “interests” in order to underline or emphasise the principle that the oppression remedy is not limited to the strict infringement of legal rights, but that it extends also to the protection of the interests of the applicants.’

In the Justpoint Nominees (Pty) Ltd case, it was held that: ‘Sovereign’s conduct and its proposed course of conduct was prejudicial and oppressive of the rights of dissenting and minority shareholders and disregards their interests. It is unfair, in my view, for a board such as Sovereign’s to manipulate and create this type of lock-in situation by not allowing minority/dissenting shareholders to enjoy fair participation in its business.’

Alternatively minority shareholders may invoke the derivate action remedy and thereby take steps in terms of s 165 demanding that the acquiring company institute legal proceedings to protect the interests of the target company.

When the subsidiary company was a regulated company as defined

If a subsidiary company is to fall within a definition of a regulated company, the proposed re-acquisition would have to comply with all the reporting or approval requirement as set out in part B and C of ch 5 and the Takeover Regulation Panel regulations, and can only proceed to give effect to an affected transaction provided the panel has issued a compliance certificate in respect of the transaction or has granted exemption accordingly in terms of s 119(6).

The panel only can exempt an acquiring company from complying with the provisions in the Act regulating affected transactions and the takeover regulations if there is no reasonable potential that the transaction will prejudice the interests of any existing holder of a regulated company’s securities, or the cost of compliance is out of proportion to value of the transaction or it is reasonable and justifiable in the circumstances (s 119(6)).

Mlunghisi Duncan Tlemo LLB (Univen) is a legal adviser  at KPMG Services (Pty) Ltd in Johannesburg.

This article was first published in De Rebus in 2017 (Sep) DR 32.

De Rebus