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DealMakers - Q1 2022 (released May 2022)



by Brian Jennings and Nikhil Sham

One of the fiendishly difficult aspects of law, which every practitioner (or lawmaker) faces in some form, is the concept of unintended consequences. This can occur in drafting agreements, pleadings or even legislation. Focusing on the latter, unintended consequences commonly rear their (often unwelcome) heads in detailed and complex pieces of legislation, with the net effect predominantly being legislative uncertainty. One of the main culprits in South African law is the Companies Act, No. 71 of 2008 (Companies Act). As the article title indicates, we will be discussing the unintended consequences of certain provisions of the Companies Act and how they impact the concept of control between juristic persons thereunder.  

In building our argument, we first look to section 2 (2) (a) (i) of the Companies Act, which states:

"2 (2) For the purpose of subsection (1), a person controls a juristic person, or its business, if –
(a)    in the case of a juristic person that is a company –
(i)    that juristic person is a subsidiary of that first person, as determined in accordance with section 3 (1) (a); or
(ii)    …" 

Following the direction of section 2 (2) (a) (i) we turn to section 3 (1) (a) of the Companies Act which provides: 

"3 (1) A company is –
(a)    a subsidiary of another juristic person if that juristic person, one or more other subsidiaries of that juristic person, or one or more nominees of that juristic person or any of its subsidiaries, alone or in any combination –
(i)    is or are directly or indirectly able to exercise, or control the exercise of, a majority of the general voting rights associated with issued securities of that company, whether pursuant to a shareholder agreement or otherwise; or
(ii)    …"

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Brian Jennings
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Nikhil Sham

Accordingly, we can summarise the baseline concept of control vis-à-vis juristic persons as the controlled company (Controlled Company) being a subsidiary of the controlling company (Controlling Company). For the Controlled Company to be a subsidiary of the Controlling Company, the Controlling Company must be able to indirectly or directly exercise or control the exercise of the majority of the shares of the Controlled Company (noting that this article assumes that only ordinary shares having a vote each are in issue). While this appears to be a simple assessment, complications arise when the aforegoing is taken in the context of s65(8) of the Companies Act (Threshold Increasing Provision), which deals with the threshold to pass an ordinary resolution (Resolution Threshold) and reads:

"(8) Except for an ordinary resolution for the removal of a director under section 71, a company’s Memorandum of Incorporation may require —
(a)    a higher percentage of voting rights to approve an ordinary resolution; or

(b)    …"

The main consequence of the Threshold Increasing Provision is that a company's Memorandum of Incorporation may provide for the thresholds for ordinary resolutions to be increased. We also draw your attention to the carve-out at the start of the Threshold Increasing Provision, which provides that the threshold to pass a resolution for the removal of a director under s71 of the Companies Act can never be increased above 50% plus one (Removal Resolution).

While there is no doubt that the Threshold Increasing Provision was drafted so as to, inter alia, give stakeholders more flexibility in their dealings, it comes with its own set of unintended consequences. For present purposes, the main unintended consequence of the Threshold Increasing Provision is that the Resolution Threshold may be increased, with the result that (on a textual interpretation) a Controlled Company could be classed as a subsidiary of the Controlling Company, without the ability of the Controlling Company to pass ordinary resolutions of the Controlled Company, which seems absurd, since that is the most basic practical element of control of a company.

Consequently, we posit that in determining if a company is actually a Controlled Company of the Controlling Company (Designated Company), regard must be given to the Resolution Threshold of the Designated Company, such that the Designated Company should only be regarded as a Controlled Company of the Controlling Company if the Controlling Company directly or indirectly  exercises or controls the exercise of sufficient securities in the Designated Company to pass an ordinary resolution of the Designated Company. 

In support of our argument, we refer you to s3(a) of the Companies Act, No. 61 of 1973 (Old Companies Act) which contains the same definition of a subsidiary as the current Companies Act. The Resolution Threshold under the Old Companies Act's dispensation followed the majority rule principle  (refer Foss v Harbottle (1843) 67 ER 189, (1843) 2 Hare 461) of a simple majority. As such, the same mischief we have identified under the current Companies Act could never materialise under the Old Companies Act, as a Controlling Company would always be able to pass an ordinary resolution of a Controlled Company, as the threshold for both control and to pass an ordinary resolution was a simple majority. 

The only ordinary resolution that is always linked to a majority vote is the Removal Resolution. This could be the only basis on which “control” could be said to vest. If the legislature intended this, then it ought to have been specific in the drafting of the control requirement in s3(1)(a) of the Companies Act, but it did not. Our view then is that our argument ought to prevail.

To conclude, we submit that when determining whether or not a Designated Company is a Controlled Company of a Controlling Company, the Resolution Threshold of such Designated Company may need to be taken into consideration, in addition to its shareholding.  

Jennings is a Director and Sham a Senior Associate in the Corporate & Commercial Practice | Cliffe Dekker Hofmeyr.

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