With so many CC’s now converting to (Pty) Ltd’s you might be wondering why? This article from one of our business partners Advocate Leigh Hefer who is an esteemed Companies Act expert will shed some light.
Please contact us should you have any further questions, or if you require someone to help you convert from a CC to a (Pty) Ltd. We provide services from start to finish for this process.
Johann C Hamel CA/SA
What are the compelling reasons for a close corporation to convert to a private company?
A. At present, there is no legal or statutory requirement or regulation enforcing a close corporation to convert to a private company, but there at least 15 reasons that close corporations to convert to a private company.
a.i.1.a.i.1. Close Corporations face a double-edged sword
All corporations have to meet the requirements of the Close Corporations Act (69 of 1984), and certain sections of the New Companies Act (Act 71 of 2008). This additional compliance is often not understood nor complied with.
a.i.1.a.i.2. Owner-managed members versus shareholders and directors
Close corporations do not separate the rights and responsibilities of owners and managers where they are both members in the close corporation, with the same risks and liabilities. The New Companies Act clearly distinguishes shareholders from directors and their respective roles, rights and duties and responsibilities and risks.
a.i.1.a.i.3. Corporate constitutional agreement
Close corporations have only one agreement – an Association Agreement which is a hybrid that combines the roles, responsibilities and relationships of all parties – i.e. the close corporation, the member(s) and the accounting officer.
The New Companies Act achieves this with the Memorandum of Incorporation (MOI) which clearly identifies the respective roles and rights of shareholders from directors and supplemented by the shareholders agreement which deals with the rights, responsibilities and relationships of the shareholders.
a.i.1.a.i.4. Authority, responsibility and liability of members
In a close corporation a non-executive members (not a managing member) is equally at risk with a managing member. In the New Companies Act, shareholders liability is distinct from that of directors.
a.i.1.a.i.5. Empowerment transactions
In close corporations, managers are often incentivised with a small interest in the close corporation, whereas the goal is to reward and incentivise them for performance and results. This can be achieved with a company by way of profit share and/or appointment as a director, without giving up equity and ownership but yet sharing control.
a.i.1.a.i.6. Business judgment rule
Sections 76(4) and (5) of the new Companies Act provides for the protecting of directors against personal liability claims where they have acted in good faith and in the best interest of the company based on assessing objectively professional advice and opinions from auditors, attorneys and other business and professional advisors, but the strategic and operational decision resulted in an error of judgement that resulted in a financial loss to the company.
This prospect is reported to the business judgement rule, and does not apply to members in a close corporation.
a.i.1.a.i.7. Close corporations and the solvency and liquidity test
All close corporations must meet the solvency and liquidity test of section 4 of the new Companies Act before conversion. This is a fundamental component to the new capital maintenance rule of companies and close corporations, and has a major benefit of minimising reckless trading and personal liability exposure of directors. Close corporations and the members face the risk of not meeting the solvency and liquidity test although being factually solvent but commercially insolvent.
a.i.1.a.i.8. Good corporate governance and business failure enhancements for companies
The new Companies Act with its enhanced accountability and transparency requirements and enhanced duties of directors instils a new level of corporate governance responsibilities to shareholders and directors which will contribute to reduced corporate failure.
a.i.1.a.i.9. Close corporations and the financial reporting standards
All close corporations who have converted to a company that are owner-managed with a public interest score of less than 100 do not have to comply with any third party financial reporting standards but only the requirements of the new Companies Act i.e. sections 27, 28, 29 and 30 and Companies Regulations 25, 26, 27, 28 and 29.
a.i.1.a.i.10. Close corporations and the annual return
All close corporation have to submit an annual return in terms of section 32 of the new Companies Act.
a.i.1.a.i.11. Close corporations and the public interest score
Close corporations are also subject to the public interest (PI) score under the new Companies Act (sections 27, 28, 29 and 30 and Companies Regulations 25, 26, 27, 28 and 29).
Close corporations are subject to an audit under the following circumstances:
if they have fiduciary assets at any stage in the financial year in excess of R5 million;
if they have a PI score of 350 or greater;
if they have a PI score between 100 and 349 and the financial statements of compiled internally;
If the close corporation has a PI score of greater than 500 it must also have a Social and Ethics Committee.
a.i.1.a.i.12. Personal liability exposures
In a close corporation all the responsibility, risk and liabilities comes back to the members, with a company it falls on the directors subject to the protection of indemnification and the business judgement rule.
a.i.1.a.i.13. Business model
By being a company there is a greater possibility of having a more dynamic business model and improved risk management which results in a higher level of motivation and management in relation to performance goals.
a.i.1.a.i.14. Global and national compliance
Since close corporations are unique to South Africa (and Namibia) many global trading partners or prospective clients find close corporations foreign and apprehensive in doing business with. Furthermore many financiers, regulators and development agencies require an audit.
a.i.1.a.i.15. No more new close corporation registrations
There is no compelling reason or benefit retained in having a close corporation.
COMPILED BY: Advocate Leigh Hefer, Legal Director, OnlineMOI, OnlineBizValuations and Author of Notes on SA Companies Act, and Questions & Answers on SA Companies Act