When the new Companies Act 71 of 2008 (“the Act”) came into effect on 1 May 2011, it placed an administrative burden on the financial management of a company, especially on the smaller, owner-managed companies that, in the course of their business operations in the past, granted loans to related entities and paid directors’ remuneration without too much trouble. The Act restricts this in a manner and now requires much more paperwork to be in place before certain actions can be performed.
You will note, from the discussion that follows, that in terms of Section 4 of the Act, the performance of a solvency and liquidity test is often required although this was not the case in the past.
The solvency and liquidity test
A company satisfies the solvency and liquidity test when, taking into consideration all reasonably foreseeable financial circumstances of the company, and based on the accounting records and financial statements:
- the assets of the company, 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 the business, for a period of 12 months following the date on which the test is carried out.
Now, when performing the tasks detailed below, financial managers and directors should take reasonable care and make sure that they adhere to the provisions of the Act, in order to prevent incurring personal liability.
1. Declaration of dividends to shareholders
Section 46 of the Act deals with the declaration of dividends to the shareholders of a company, and determines that no dividend may be declared unless:
- it reasonably appears that the company will satisfy the solvency and liquidity test immediately after finalizing the proposed distribution, as in terms of Section 4 of the Act;
- the board of the company has acknowledged that it has applied the solvency and liquidity test, and reasonably concluded that the company will satisfy the solvency and liquidity test immediately after completing payment of the dividend; and
- the board of the company has authorised the payment of the dividend by signing a resolution to that effect.
In the event that the correct procedures have not been followed, the financial manager, as a prescribed officer of the company, as well as the directors of the company who participated in making the decision that a dividend should be declared, can be held personally liable for any losses incurred as a consequence of their breach of fiduciary duty regarding the matters of the company.
2. Providing financial assistance to related persons or entities
Financial assistance is defined in Section 1 of the Act as lending money, guaranteeing a loan or other obligation, or securing any debt or obligation by the company, but does not include the lending of money in the ordinary course of business by a company whose primary business is operating in the loan industry.
According to Section 45 of the Act, financial assistance may not be provided to any director, prescribed officer, related or inter-related company, corporation or trust, unless:
- the shareholders, by way of a special resolution adopted within the previous two years, authorise the approval of financial assistance, either to the specific recipient, or generally for a category of potential recipients;
- the board is satisfied that the company will satisfy the solvency and liquidity test immediately after providing the financial assistance;
- the board is satisfied that the terms under which the financial assistance is proposed, are fair and reasonable to the company;
- the board is satisfied that any conditions or restrictions as set out in the company’s Memorandum of Incorporation, have been adhered to; and
- the board subsequently adopts a resolution giving effect to the financial assistance, and provides written notice of such resolution to all the shareholders and to any trade union representing the company’s employees.
Any agreement with respect to the provision of any such assistance (i.e. loan agreements) is void to the extent that the provisions of section 45 have not been met. Directors will incur personal liability for any losses sustained as a consequence of their breach of fiduciary duty.
3. The payment of directors’ remuneration
The payment of directors’ remuneration is also regulated by the Act, in terms of Sections 66(8) and 66(9).
Section 66(8) provides for the payment of remuneration to directors, to the extent that the company’s Memorandum of Incorporation does not provide otherwise.
The Act goes further, and imposes the condition in Section 66(9) that no remuneration may be paid to directors unless a special resolution approving the remuneration payable to the directors, has been passed and approved by the shareholders within the previous two years.
You will agree that these provisions are often just another statutory burden placed on the management of companies, especially the smaller, owner-managed companies. But the effects of non-compliance may be severe!
Should you require assistance in the preparation of any of the solvency and liquidity tests or the adoption of certain resolutions, please do not hesitate to contact Joanie Viviers at our office at (021) 840 1600 or firstname.lastname@example.org .
 Section 46’s scope is wider than just the declaration of dividends and will be applicable to all distributions made by the company. Distributions are not discussed in detail in this article.