Private companies and loans to directors and shareholders

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The shareholders and owners of private companies are often also the directors of these companies as well.  This has led to practice over several years where interest free loans have been provided to these owners/directors by the company without any repayment terms.  With the implementation of the new Company’s Act in 2008, new requirements have been introduced for the provision of loans and other types of financial assistance to directors of all types of companies.  These requirements are contained in section 45 of the Company’s Act 71 of 2008.

Although these new requirements can seem confusing, it is actually very straight forward.  There are several questions that need answering to understand the requirements in this section.  These question are:

  • What is seen as financial assistance?
  • Who are included in the definition of directors in terms of the act?
  • Who decides to on providing the financial assistance?
  • Who can authorize financial assistance?
  • What are the other requirements that needs to be met in order for financial assistance to be legal? and
  • Can directors be held liable for any losses which arising from losses due to financial assistance provided to directors?

Let us look at each of these questions.

What is seen as financial assistance?

Financial assistance is seen as any loan made to a director, guaranteeing a loan or other obligation of a director or securing any debt of a director.  For example, this implies that if a company were to provide security to a financial institution to enable a director to obtain a loan or mortgage bond from that institution, the security that the company provides to the financial institution will be seen as financial assistance to the directors.  A company therefore need to be very careful in providing any such financial assistance where a director benefits beyond his/her capacity as director.  There are, however, also exceptions to what is seen as financial assistance.

These exceptions are seen as normal business expenses and will not be judged under section 45 of the act.  The first exception is the ordinary course of business.  If the ordinary business of a company is to provide financial assistance, for example a bank, any financial assistance provided to directors will be seen as a normal business transaction.  If an accountable advance was provided to a director to either cover legal expenses concerning a legal matter of the company, or to cover anticipated expenses on behalf the company, these expenses are allowed, they are seen as normal business expenses and will not be judged under section 45.  Finally, amounts paid to a director to cover expenses for removal at the company’s request, is also not seen as financial assistance.

Who are included in the definition of directors in terms of the act?

The next question which normally arises, is who is included in the definition of a director in terms of this section 45.  There is a long list of individuals who is involved in this definition and situations can become very difficult to judge.  To keep it simple, the section is applicable on any director or official of the company, his/her immediate family (wife/husband and children or any other person who is removed less than 2 degrees of kinship) and any company, close corporation, trust or business that the director controls directly or indirectly via his/her relationship with immediate family.  It Is therefore important to note that immediate family is included in the definition of a director.  Where the company makes a loan to the wife/husband of the company, section 45 would immediately be applicable.

Who decides to on providing the financial assistance?

If the standard Memorandum of Incorporation (MOI) is used to incorporate a private company, without any adjustment, the Board of Directors are allowed to take the decision to provide any type of financial assistance to a director.  It is however possible to limit this right of directors, by changing the MOI to include special requirements for the issue of financial assistance by directors.

Who can authorize financial assistance?

Even though the board of director can decide to provide financial assistance, it is only allowed to be provided under two cases.  The first case is when the financial assistance is in terms of an employee share scheme, in which case no additional authorization is needed.  If the financial assistance is not for an employee share scheme, then the authorization of the financial assistance lies with the shareholders.  The shareholders then need to authorize the financial assistance by special resolution within the prior two years.  In other words 75% of shareholders present at this meeting can authorize financial assistance to be provided.  It is also possible for shareholders to authorize future transactions at this meeting.  If no financial assistance have been granted within two years after the resolution was passed, a new resolution need be taken.

What are the other requirements that needs to be met in order for financial assistance to be legal?

If the authorization has been received from shareholders, the board of directors can go ahead and grant the financial assistance.  They may, however, only do so if they have considered the solvency and liquidity of the company at the time of the assistance and they need to be sure that the company is solvent and liquid.  These two requirements also need to be minuted.  It is important to note that the liquidity and solvency requirements need to be assessed every time financial assistance is provided.  The board of directors also need to consider the terms and conditions of the loan.  The terms and conditions of the financial assistance need to be fair and reasonable.  This implies that repayment terms need to be included in the financial assistance and a market related interest rate need to be applicable.

Can directors be held liable for any losses which arises due to financial assistance provided to directors?

If the board of directors followed the above steps, it is fairly certain that the financial assistance is legal.  The act however does contain an additional requirement in terms of financial assistance.  If the company were to incur liabilities or losses because of the financial assistance provided to a director, all directors who were present at the meeting where the decision was taken, and who did not vote against the financial assistance, will be held personally liable for the liability or loss incurred.

Although this seems like a lot of hoops for a private company to jump through, it protects the company, its assets and the interest of the shareholders.