Let’s unpack, in plain language, the concept of Distributions as a Shareholder in terms of Section 46 of the Companies Act (71 of 2008) (“the Act”) along with a few salient points that derive from it.
What is a Distribution as a Shareholder? A Distribution refers to a benefit to shareholders at the expense of the company. There are three categories of Distributions by a Shareholder:
- Money or property | transferred by the Company to a Shareholder(s)(excluding Shares) e.g. cash dividends;
- Debt or obligation | the Company incurs a debt or obligation on behalf of a Shareholder(s) e.g. suretyship; and
- Waiver of Debt | a debt otherwise owed to the Company by a Shareholder(s) is waived i.e. the Company abandons its right to claim a debt owed to it by a Shareholder(s).
There is no obligation on the Company to declare its Distributions to Shareholders even though there is an expectation by Shareholders to share in the profits of the Company – unless directed other by the Memorandum of Incorporation and/or the Shareholders Agreement. It is important that you consider both documents to see what limits have been placed on Declarations of Distributions as Shareholders.
There is a legislative process to enable a Distribution and thus process is mandatory. The process requires that Major Shareholders participate in decision-making around the Distribution as Shareholders in the first place. Naturally, therefore, the majority of Shareholders will come to know of the Distribution through the compliance process.
Looking specifically at Section 46 of the Act, there are specific requirements which must be met in order for a Distribution as a Shareholder to be lawfully made. If these requirements are not met, then the Distribution as a Shareholder should not be made:
- Authorisation | The Board of Directors has authorised the Distribution by way of a Resolution (unless the Distribution is to satisfy an existing obligation pursuant to a Court Order);
- Company Liquidity Unhampered | The proposed Distribution will not hamper the Company’s Liquidity (see below); and
- Acknowledgment | The Board of Directors have acknowledged in the Resolution that the Company’s Liquidity will not be hampered.
Liquidity and Solvency
In the process of determining the outcome of Company Liquidity, the Board of Directors will need to apply the Liquidity and Solvency Test. This is a two-pronged test which entails two tests being done:
- Commercial Solvency Test | From the Balance Sheet, looking at the fair value of assets, are they equal to or do they exceed the fair value of liabilities?
- Factual Solvency Test | When assessing its Budget for a 12-month period, will the Company still be able to honour its financial commitments if the Distribution is made?
This process has been adopted by the Courts with approval. In this particular exercise, the list of documents a Company must consider is not circumscribed. However, protocol dictates that Accounting Records and Financial Statements are examples of relevant documentation. Notably, all obligations in terms of Distributions as Shareholders lie with the Board of Directors, not the Shareholders.
If the Board of Directors complete the Liquidity and Solvency Test and adheres to the requirements, resolving that the Distribution is to be made, then the Company has 120 days to give effect to the Distribution. If it is not done within that period, the Liquidity and Solvency Test must be redone and the requirements need to be met afresh.
Consequences of Non-Compliance
The global movement towards Piercing of the Corporate Veil, and attributing liability to Directors, has direct consequence here. Unlawful Distributions as Shareholders result in dire consequences, as envisaged in the Act. A Director can be held personally responsible for losses or damages suffered by a Company resulting from Unlawful Distributions as Shareholders. It is not an all-encompassing liability curtain – when is it likely that liability may fall upon Directors?
- If, immediately after fully effecting the Distribution, the Company does not satisfy the Liquidity and Solvency Test; AND
- It was unreasonable to Resolve that the Company would have satisfied the Liquidity and Solvency Test after fully effecting the Distribution.
There are also limits to the amounts claimable against the Directors which can be seen from Section 77 of the Act. Essentially, the amount claimable as damages cannot exceed the difference between the amount by which the Distribution exceeded the amount that it was reasonably able to satisfy in terms of the liquidity and solvency test. Illustrating by way of example, if the Company was factually and reasonably able to Distribute R150,000 but instead Distributed R400,000, the loss in this context is the difference between what was actually Distributed and what the Company was able to Distribute without compromising its liquidity. The Company, in essence, would have exceeded its capacity by R250,000 and this is the amount by which the Company suffered a loss resulting from the Distribution; therefore, this is the amount that is potentially claimable from the Director(s).
If a Director has reason to suspect that a
Claim will be brought against him or her for unlawful Distributions, he or she
is able to apply to Court for relief. The Court may excuse him or her from
liability if it is shown that the Director acted honestly and reasonably
(without any willful misconduct or willful breach of trust).