Trustees as shareholders or directors in a company
May 15th, 2020 11:28
Trusts are used to hold shares in businesses for asset protection and to ensure the continuity of ownership of assets. The trustees owe, both at common law and in terms of statute, a fiduciary duty (a legal obligation of one party to act in the best interests of another) to the trust’s beneficiaries. The trustees are required to administer the trust, including any shares held by the trust in a company, solely for the benefit of the trust’s beneficiaries. Often estate planners and trustees are uncertain about the role trustees have to play in such companies, especially when the trust is not the only shareholder and not all directors are trustees of the trust.
A trust does not have legal personality and can therefore not vote as a shareholder, because it is only an accumulation of assets. Despite its lack of legal personality, a trust has legal capacity and the trustees, on behalf of the trust, may perform juristic acts relating to trust assets, such as managing investments in companies, as long as the trust deed allows for that. The trustees therefore may own shares on behalf of the trust and are able to vote and attend to the trust’s business. They act as shareholders in this capacity and should always act in the best interests of the trust.
A company is managed by its directors and other officers. The directors at all times have to act in the best interests of the company and not a particular shareholder (who may have appointed them). As discussed below, the director has a fiduciary duty towards the company (and not the beneficiaries of the trust he or she may represent as trustee) and may incur personal liability if he or she breaches this duty toward the company. This may cause a conflict if a director is expected to only act in the best interests of a particular shareholder (board of trustees) who appointed him or her and whom he or she is acting as trustee for.
The Memorandum of Incorporation (MOI)
The MOI is an important document in establishing the balance of power between shareholders and directors. Unless a matter is specifically excluded from the authority and powers of the directors by the company’s MOI or the Companies Act, the directors must manage the business and affairs of the company. The shareholders are not involved in the business and affairs of a company, unless the company’s MOI or the Companies Act requires their involvement or approval of a decision of the directors.
Companies frequently set out additional matters, which would have to be effected by means of a special resolution of shareholders, and these have historically been contained in a shareholders agreement. As the principal governing document under the new Companies Act is the company’s MOI, those companies with additional special resolution requirements (for example the changing of the auditors or the incurring of certain types of debt) should transfer these into their MOI’s in order for them to remain effective.
It is therefore important for the board of trustees, who manages the trust assets, to be involved in and apply their minds when the MOI is entered into or amended. When a board of trustees invest in an existing company, they should study the MOI and request changes to the extent of protecting the trust’s investment and minimising the trust’s risks.
The roles of trustees as shareholders and directors
The board of directors and the general meeting of shareholders (such as trustees of the trust) are each organs of a company. The directors exercise the managerial and executive powers of the company, save to the extent that their rights are limited by the company's MOI. The shareholders cannot override these powers of the directors, unless permitted by the company's MOI. They can remove the directors or change the company's MOI, but they cannot otherwise control the management of the company placed in the hands of the directors.
As a trust cannot operate as a person distinct from the trustees it is important to name the trustees, on behalf of the trust, as the registered shareholders in a company share register. This should be done in accordance with the provisions of the trust deed and the required, duly approved, trustee resolutions. The listed trustees therefore have to act as the representative shareholders of the trust. A share register sets out the classes of shares, who all shareholders are, the amounts paid for the shareholding, and the changes in shareholding over time. Every company is obliged to keep and maintain a share register at its registered offices. A share certificate is merely evidence that a person may be a shareholder, but it is the share register that will ultimately provide conclusive proof. In our law, a company can only rely on its share register, which means that the company cannot allow anyone but the person whose name is on the share register to cast a vote. If this person is holding the shares as a nominee for another (such as a trustee), the company cannot be concerned with that fact and question the legality and enforceability of a board of trustees decision. Any breach of agreement between a nominee shareholder (a trustee) and the beneficial shareholder (the trust) is a matter to be decided between them, and the company cannot be party to their dispute and can also not question the validity of decisions taken by the board of trustees. The company can only rely on the share register to ascertain the person who is authorised to act as shareholder and cannot rely on any other evidence to question the validity of the actions of trustees, on behalf of a trust, such as resolutions taken in terms of the trust deed by trustees as reflected on the Master’s Letters of Authority (Blue Square Advisory Services (Pty) Ltd v Pogiso case of 2011).
Shareholders only own shares and do not participate in the day-to-day management of the company. The shares are their property and they have voting rights attached to the shares they hold. In essence the shareholders can do as they please with their shares they own and as such they do not have a fiduciary duty towards the company (ABSA Bank Limited v Eagle Creek Investments 490 (Pty) Ltd case of 2014).
The Companies Act prescribes certain matters that need the shareholders approval and in these circumstances the shareholders will participate in the control of the company. The only limit the Companies Act places on shareholders is that they must not act oppressively (burdensome, harsh and wrongful) towards other shareholders and directors. Other than that they are free to do and vote as they please.
The business and affairs of a company are managed by or under the direction of its board. Section 66 of the Companies Act places a positive duty on the directors to manage the company and states that the business and affairs of a company must be managed by or under the direction of its directors and that the directors have the authority to exercise all of the powers and perform any of the functions of the company, except to the extent that the Companies Act or the MOI of the company provides otherwise. Directors are obliged to act in good faith in the best interests of the company in terms of the Companies Act. They have the power to manage the property and funds of the company; therefore they have fiduciary duties. In order to exercise the duties that they owe the company as required by the Companies Act, directors must be allowed to perform their function in the management of the business and affairs of the company independently, as they could be held personally liable in the event that they are found to have been in breach of their duties. The director of a company, therefore, cannot afford to merely act as a puppet director for a single shareholder or a dominant majority shareholder, without proper consideration of his or her duties and responsibilities owed to the company, as that director bears the consequences of his or her actions and not the shareholder upon whose instructions are being acted. Given the hugely increased exposure to personal liability that the new Companies Act imposes on directors, trustees who act as directors in a trust-held company should inform themselves about how the company is run and what risks it faces.
The Companies Act also codified the business judgment rule, in terms of which a director will not be held liable if he or she took reasonable diligent steps. The director’s judgement as to whether an action or decision is in the best interests of the company is reasonable if the director:
• has taken diligent steps to become informed about the subject matter of the decision;
• either does not have a material personal financial interest in the subject matter of the decision, had no reasonable basis to know that any related person had a personal financial interest in the matter, it is a decision that a reasonable person in a similar position could make in comparable circumstances, and the director has complied with Section 75 of the Companies Act (disclosure of financial interests) discussed below; and
• made a decision or supported the decision of a committee and had a rational basis for believing that the decision was in the best interests of the company.
The shareholders need to evaluate the performance of the board to the extent that they are able to. By exercising their rights to appoint and remove the directors of the company, the shareholders effectively control the board. The Companies Act provides that the company’s MOI may provide for the direct appointment and removal of directors by any person who is named in, or determined in terms of, the company’s MOI, such as the trustees as shareholder representatives. This is advisable in the event that a company has various shareholders. A profit company must allow for shareholders to elect a minimum of 50% of the directors. The board may discharge a director under certain specific circumstances without shareholder approval, including negligence or dereliction of duty. Trustees as shareholder representatives should be mindful of this right, especially in the event that a company has various shareholders.
The shareholders cannot take over the powers, which according to the company's MOI, are vested in the directors, and the directors cannot take over the powers vested by the company's MOI in the general body of shareholders. A shareholder has the right to dividends when declared by the directors, to a return of capital if the company is wound up or reduces its capital, and the right to attend and vote at meetings of shareholders to ensure lawful conduct by those running the company. This right to vote at general meetings of shareholders means that an individual shareholder cannot bring an action to complain about an irregularity (as distinct from an illegality) in the conduct of the company's internal affairs if this can be done by a vote of the company in general meetings. To the extent that a company's MOI vests the management and control of the business of the company in the directors, the courts do not allow a single shareholder to destroy the fundamental rule of company law that a company is an entity separate from its shareholders and that a shareholder has no right to manage the company's business merely because it is a shareholder. If the directors breach their fiduciary duties so that a contract entered into by them on behalf of the company is void, it is the company itself that must extract itself from the contract. The required action needs to be initiated by the board of directors or the shareholders in general meeting in terms of a company's MOI. As the court pointed out, the rules relating to the way companies are to be run are designed to ensure that business is done by these entities in a proper and controlled manner (Letseng Diamonds Ltd v JCI Ltd case of 2008). A shareholder does not have the right to act on behalf of the company or to manage the company’s business or affairs, not even when the shareholder holds all of the shares of the company.
Shareholders’ rights and responsibilities
The first shareholders’ responsibilities concern the appointment of a board of directors. Since the board is responsible for the daily decision making of the company, the shareholders must ensure the board is elected adequately.
The Companies Act reserves certain decisions for the shareholders and consequently the directors require the approval of the shareholders prior to any such decisions being finalised. In some instances the shareholders provide the directors with a general approval for such decisions, which is usually valid until the next annual general meeting, but some decisions need to be voted on individually.
The Companies Act requires approval of the shareholders by special resolution in the following instances:
• Amendment of the company’s MOI - this would include converting ordinary shares into another type of share, changing the main business and objects of the company, etc.;
• Approval for the voluntary winding-up of the company;
• Approval of any proposed fundamental transaction (including the disposal of all or greater part of assets or undertaking, amalgamation, merger or scheme of arrangement);
• Ratification of any action by the company or the directors that is inconsistent with a limit, restriction or qualification in the company’s MOI;
• Approval of an issue of shares or securities to a director, future director, prescribed officer, or any person related or inter-related to the company, or to a director or prescribed officer of the company;
• Approval of financial assistance for subscription of securities (special resolution of the shareholders should be adopted within the preceding two years);
• Approval of loans or other financial assistance to directors as well as related and inter- related companies (special resolution of the shareholders should be adopted within the preceding two years); and
• Approval of the policy or parameters for director remuneration (special resolution of the shareholders should be adopted within the preceding two years).
The Companies Act extends the duties of directors and increases the accountability of directors to the shareholders of the company. It is important for directors to ensure that they are familiar with the provisions of the company’s MOI, especially those provisions that limit or restrict the authority of the board and the directors.
Section 75 of the Companies Act (disclosure of financial interest) deals with personal financial interests, which links quite closely with the common law concept of fiduciary duties. One of the fiduciary duties of a director is to prevent his or her personal interests from clashing with those of the company. The company’s interests must in all circumstances come first, and where there is a direct or indirect clash between the company and the director’s interests, the director is obliged to disclose this fact and its extent to the remaining directors and the shareholders. Where a director realises he or she has a conflict of interest (or knows that a related party has a conflict of interest) in any matter to be raised at a board meeting then he or she is obliged to:
• disclose the interest and its general nature before the matter is considered by the meeting;
• disclose any material information relating to the matter and may disclose any relevant insights or observations;
• leave the meeting immediately after making his disclosure and not take part in any consideration of the matter by the rest of the board; and
• not sign any document in relation to the matter unless specifically authorised to do so by the remainder of the board.
Where a conflict arises (either for the director or a related person) after an agreement has been entered into by the company, the director in question must likewise disclose such conflict of interest to the company detailing the nature and material circumstances of how that conflict arose. Even if a director has a conflict of interest at the time any decision is taken or agreement is entered into, this conflict of interest will not invalidate the decision if it was approved as set out above, or if the shareholders have ratified it and the court may declare the decision or agreement valid on application of any interested party despite the failure of the conflicted director to comply with the provisions of section 75, only if good grounds are shown, and if the interested party and the conflicted director were acting collusively, it is unlikely that the order sought will be granted.
Section 76 of the Companies Act (standards of directors’ conduct) codified those standards of conduct to which all directors must adhere. It addresses the standard of conduct expected from directors and extends it beyond the common law duty of directors. The standard sets the bar very high for directors, with personal liability where the company suffers loss or damage as a result of the director’s conduct not meeting the prescribed standard. This encourages directors to act honestly and to bear responsibility for their actions. In terms of this standard a director must exercise his or her powers and perform his or her functions:
• in good faith and for a proper purpose – use his or her position honestly to upgrade and enrich the company;
• in the best interests of the company;
• with the degree of care, skill and diligence that may reasonably be expected of a person carrying out the same functions and having the general knowledge, skill and experience of that particular director;
• in a way to communicate to the board at the first possible opportunity any information that comes to his or her attention that is material to the company or generally not available to the company, unless the director is bound not to disclose the information by virtue of legal or ethical obligations of confidentiality; and
• with a duty to avoid conflicts of interest.
Section 76 of the Companies Act therefore promotes higher thresholds of transparency, corporate governance and standards of accountability to directors, in line with international best practice. A director should not use any information while acting as a director to gain some personal advantage or an advantage for any other person than the company itself, or any of the company’s subsidiaries.
Directors should act within their powers, and always use these powers for the benefit of the company. Where a director abuses his or her powers, the company might be bound by his or her action, although he or she can be held personally liable for any loss suffered as a result. Director’s duties and related potential liabilities should not prevent directors from taking the necessary bold decisions that are often required to drive growth and success. Business is ultimately all about taking risk in order to gain reward. It is accepted that directors can take decisions that turn out to be wrong or result in financial loss to the business, as long as they have acted in the best interests of the company in terms of the law.
Annual General Meeting (AGM)
AGM’s are not a requirement for private companies. However, those private companies requiring an audit, whether due to the Companies Regulations or their MOI, will have to convene an AGM to appoint an auditor annually. The AGM provides shareholders the opportunity to review their company’s audited financial statements and deal with relating directors’ decisions.
Any decisions made at the AGM are done through either ordinary or special resolutions by the shareholders of the company. Special resolutions are required per the Companies Act or may be required by the company’s MOI. Unless specified, an ordinary resolution will suffice. For a special resolution to be passed, 75% of the voting rights exercised on the resolution must be in favour of the proposal. For an ordinary resolution to be passed, more than 50% of the voting rights exercised on the resolution must be in favour of the proposal. These percentages may be amended through the company’s MOI, subject to the provisions of the Companies Act.
Liability of directors
The need for the new, more stringent liability provisions in the Companies Act were necessitated by the fact that in the past directors have frequently treated companies as their own. A company creates a corporate veil whereby directors hide behind the legal form of a company as a separate legal entity. The company merely serves as a facade concealing the true facts. The principle of piercing of the corporate veil is a well established principle for companies as established in the Airport Cold Storage (Pty) Ltd v Ibrahim case of 2008. This principle holds the directors to be the owners of the property, actually owned by the company, or for the directors to be personally liable for its debts and other liabilities. There must at least be some misuse or abuse of the distinction between the corporate entity and those who control it, which results in an unfair advantage being afforded to the ones controlling it. The Companies Act is aiming at making it easier to prevent and prosecute abuses of the corporate structure.
Directors could be subject to criminal sanctions like fines, jail time, and even disqualification from serving as a director in future, if they have failed to perform their duties. The directors of a company owe their duties to the company and not to the shareholders of such a company. Therefore, if a director follows the instructions of a single shareholder or a dominant majority shareholder, without any consideration for the duties he or she owe the company, the director could be held personally liable for any loss, damages or costs incurred by the company or suffered by an aggrieved third party if his or her actions resulted in a breach of his or her duties as a director.
The principle of a separate legal personality of a company implies that a third party, aggrieved by an action of the company could, generally, not hold the shareholders of the company liable for the actions of the company. Such an aggrieved third party would institute action against the company. In the event that an aggrieved third party can prove that a director acted in contravention of the abovementioned duties, a third party could however hold that director personally liable for any loss, damages or costs incurred by such third party.
Each shareholder has a claim for damages (a personal claim) against any person including a director who intentionally, fraudulently, or due to gross negligence, causes the company to do anything inconsistent with the Companies Act or any limitation, restriction or qualification in terms the MOI (unless the action has been ratified by shareholders) (section 20 of the Companies Act).
A shareholder (and any other stakeholder) can also have a claim against a director in accordance with the principles of the common law relating to breach of a fiduciary duty for any loss, damages or costs sustained by the company as a consequence of any breach by the director of:
• a duty contemplated in section 75 and 76 of the Companies Act;
• any other provision of this Act; or
• any provision of the company’s MOI.
It is important to note that the actions of the director does not need to be fraudulent or carried out with gross negligence for a valid claim (section 218 of the Companies Act).
Where a director has not complied with the standards of conduct contemplated in sections 75 and 76 of the Companies Act, discussed above, which are really a codification of the common law position, and as such are nothing new, the director will attract liability in terms of section 77 of the Companies Act (liability of directors and prescribed officers).
A director will, in terms of section 77 of the Companies Act, be held personally liable for any loss, damages or costs (including costs of court proceedings) sustained by the company as a direct or indirect consequence of the director having:
• acted in the name of the company, signed anything on behalf of the company, or seem to bind the company or authorise the taking of any action by, or on behalf of, the company despite knowing that the director lacked the authority to do so;
• allowed the company to carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose (section 22(1) of the Companies Act);
• been a party to an act or omission by the company despite knowing that the act or omission was calculated to defraud a creditor, employee or shareholder of the company, or had another fraudulent purpose;
• signed, consented to, or authorised, the publication of any financial statements that were false or misleading in a material respect, or a prospectus, or a written statement contemplated in section 101 of the Companies Act (secondary offer of shares to the public);
• been present at a meeting, or participated in the making of a decision in terms of section 74 of the Companies Act (directors acting other than at a meeting), and failed to vote against:
o the issuing of any unauthorised shares despite knowing that those shares had not been authorised in accordance with section 36 of the Companies Act (authorisation of shares);
o the issuing of any authorised securities despite knowing that the issue of those securities was inconsistent with section 41 of the Companies Act (shareholder approval for issuing shares in certain cases); and
o the granting of options or rights to any person contemplated in section 42(4) of the Companies Act despite knowing that it was not authorised in terms of section 36 of the Companies Act (authorisation for shares);
• approved the provision of financial assistance to any person contemplated in section 44 of the Companies Act (financial assistance for subscription of securities) for the acquisition of securities of the company, despite knowing that the provision of financial assistance was inconsistent with section 44 of the Companies Act or the company’s MOI;
• approved the provision of financial assistance to a director contrary to the provisions of section 45 of the Companies Act (loans or other financial assistance to directors) or the company’s MOI;
• approved a resolution for a distribution, where the company has not passed the solvency and liquidity test; and/or
• approved the allotment by the company where such allotment is contrary to any provision of chapter 4 of the Companies Act (public offerings of company securities), where the allotment is declared void.
Directors should note that any inquiry into the conduct of the affairs of a company will always involve an evidential investigation. To the extent that a director has fulfilled his or her fiduciary duties and conducted the affairs of the company in accordance with sound business practices that fall within the parameters of these expectations, the evidence should speak for itself. Compliance with what can be “reasonably” expected of a director when faced with similar circumstances will therefore constitute a defence to any action launched in terms of section 77 of the Companies Act. “Reasonable behaviour” will differ from case to case and will be considered having regard to the specific circumstances of the issues facing a particular director. As in all cases involving negligence, the test in South African law is essentially an objective one, as it assumes the standard of conduct of the “reasonable” director. It is however subjective insofar as the “reasonable” director is seen as conducting himself or herself with the same knowledge and access to financial information as the relevant director would have had in the circumstances.
An offending director can be held personally liable to the company and to any other affected person for any consequential loss suffered by the company or such person. The liability of a director is joint and several with any other person who is, or may be, held liable for the same act, which means that a single director can be held liable for the totality of damages suffered by a third party as a result of the breach of his or her fiduciary duties.
The Companies Act (section 78(2)) provides that any provision of an agreement, the MOI or rules of a company, or a resolution adopted by a company, which directly or indirectly claims to relieve a director of any duty or liability, or negate, limit or restrict any legal consequences arising from an act or omission that constitutes wilful misconduct or wilful breach of trust on the part of the director, is considered invalid and not legally binding. However (and except to the extent that the company’s MOI provides otherwise), a company may, in terms of section 78(5) of the Companies Act, indemnify a director in respect of any liability arising. This is except for liability arising:
• from wilful misconduct or wilful breach of trust on the part of the director; or where a fine has been imposed as a consequence of a director having been convicted of an offence; or
• where a director acted recklessly, or despite knowing he or she lacked authority, or with the intent to defraud creditors, or with any other fraudulent purpose.
Where the board of a company has taken any decision, which contravenes the Companies Act, then the company or any director who has been held liable in terms thereof may apply to a court for an order setting aside that decision and the court may make any order which is equitable in the circumstances, including rectifying the decision or reversing the transaction and requiring the company to indemnify any director who may have been held liable in terms of section 77 of the Companies Act, which would otherwise be joint and several with any other person who may be held liable in terms of the Companies Act.
If a director acts in any manner that amounts to gross negligence, wilful misconduct or breach of trust in relation to the performance of his or her director’s duties, a court may declare him or her to be delinquent. The Companies Act also states that any director that takes personal advantage of information or opportunities contrary to the provisions of the Companies Act, will face the possibility of being declared delinquent. Any declaration of delinquency will exist for the lifetime of the person concerned and may be made subject to any conditions that the court considers appropriate, including conditions limiting the application of the declaration to one or more particular categories of companies.
Although all the conduct and liability provisions in the Companies Act appear to be daunting in their scope, they really are nothing other than a codification of the common law position on fiduciary duties and a more effective means of prosecuting those who offend against these duties, by creating a statutory mechanism for piercing the corporate veil and thereby increasing the transparency and accountability of a company and its directors in accordance with the suggestions put forward by the King Code on Corporate Governance. The intended effect of sections 76 and 77 of the Companies Act is to protect directors who, in carrying on the business of a company, have shown a genuine concern for its prosperity and have made decisions in its best interests. A responsible corporate citizen should have nothing to worry about.
~ Written by Phia van der Spuy ~