We met with the Commission to understand its approach to the ownership portion of the Generic Codes of Good Practice, given the uncertainty in the market-place. The Commission representatives highlighted the non-binding nature of the discussion – this article is therefore subject to the disclaimer below.

The representatives mentioned that, while general principles can be clarified, each ownership structure would need to be assessed on the merits of that structure, taking into account the full agreements between the parties. As such, no blanket statement can be applied to all structures.

Whatever structure is used, the goal must be to advance the ownership of black people in companies.  The Commission isn’t an organisation that makes laws. It seeks to regulate based on the existing laws as established by the Department of Trade and Industry. These points therefore provide interpretation guidance to implementing these laws.

Modified Flow Through applied to other scorecards (specifically the procurement and ownership scorecards)

The Commission has disallowed the use of the Modified Flow Through (“MFT”) structure for Exempt Micro Enterprises (“EMEs) and Qualifying Small Enterprises (“QSE’s”). Since the legislation was silent on the applicability of the MFT to EMEs and QSEs, the Commission needed to provide guidance on this particular point, which it did with its Practice Note 1 of 2017.

The Commission representatives highlighted that they would apply the law as it is prescribed in applying the MFT to the procurement and the ownership scorecards.

Although not expressly said, the implication of this was that they could allow the use of the Modified Flow Through structure in these contexts, although this would need to be reviewed for each structure.

The use of trusts and the three points allocated to designated groups

While the Commission does not have a problem with trusts generally, it does have significant concerns that trusts have been used to circumvent the goals of the codes. In assessing whether a trust is reasonable the Commission would look at the following:

The trust needs to have directly identifiable beneficiaries. To this end, there needs to be an updated list of beneficiaries kept available and a clear understanding of the economic participation that these beneficiaries are getting.

In looking at economic participation, the Commission would look at what has been paid out up to that date, in terms of dividends to those parties.

1. Beneficiaries must have the ability to vote via their appointed trustees. The Commission has concerns that trusts have often been used to circumvent the voting rights’ provisions in the codes – to maintain voting control by incumbent shareholders.
2. The Commission sees a difference between charitable trusts (such as education trusts, which would usually be treated under Socio Economic Development) and ownership trusts. Charitable trusts typically do not have specified long term beneficiaries. The economic distribution to each participant would be very different to what would be typical of an ordinary shareholder.

Further, in charitable trusts there usually would be limited participation of the beneficiaries in appointing trustees, since beneficiaries would constantly change. Beneficiaries appointed at the discretion of trustees would not reasonably have a say in the voting in of those trustees.

In reviewing these types of transactions, the Commission would apply the substance of the transaction rather than the legal form.

In reviewing these types of transactions, the Commission would apply the substance of the transaction rather than the legal form.

1. The Commission does note that there are broad-based schemes that deal with communities, such as in certain mining transactions. However, these schemes would still need to have directly identifiable beneficiaries who receive dividend payouts. These directly identifiable beneficiaries could be represented by traditional leaders.
2. The Commission highlighted that it would apply a reasonableness test to the nature of the participation of an ordinary shareholder.
3. The Commission would apply the above, within the context of clause 3.12 and Annexe 100 (D) of the ownership codes.

Employee Share Ownership Schemes

The Commission highlighted that the same concerns raised with trusts apply to Employee Share Ownership Plans (“ESOPs”). The Commission would like to see actual participation in voting by participants of ESOPs and actual dividends being paid to participants.

The success of these schemes appears to be dependent on whether the company pays out dividends and ensures that any vendor-funding is paid, together with the voting considerations mentioned above.

Continuing Consequences

The Commission would look to apply the law as it is prescribed for Continuing Consequences (or as they are described in the codes, “recognition of ownership after the sale or loss of shares by black participants”).

Bank-funded vs Vendor-Funded structures

The Commission does not have a preference between bank-funded vs vendor-funded structures.  Each funding structure would be reviewed on its own merits.

Debt vs preference shares

While the Commission does not have an opinion on the type of vendor-funding used (whether debt or preference shares), the application of the substance over form principle would apply and each structure would be reviewed on its own merits.  The Commission highlighted that the interest/coupon rate would need to be reasonable.

The Commission highlighted the need for the funding to be repaid – in other words the company would need to pay dividends on a regular basis to enable the B-BBEE parties to repay their acquisition debt.

Shareholder voting rights vs board voting rights

Typically, in structures, there is a separation between ordinary shareholder voting rights (dealing with shareholder matters) and board voting rights (operational strategy). However, with B-BBEE schemes, the Commission wants to see active participation of B-BBEE parties in the business. They therefore need to have representation on the board.

Lock-in periods and call options

The Commission has concerns with structures that have lock-in periods that end with a parent company call-option – especially if that call-option is established on a preset formula.  Very often these schemes have significant vendor-funding and as a result end up not providing the B-BBEE shareholders with effective economic participation in the company.

Regarding lock-in structures generally, the Commission would assess the merits of each structure separately.

Mandated Investments (competent persons’ report)

The Commission would apply the law as it is prescribed for Mandated Investments.

Obtaining pre-authorisation from the B-BBEE Commission

The Commission highlighted that, should clients wish, they can obtain non-binding pre-approval from the Commission within approximately 30 days. Empower Capital would work with its clients to facilitate this pre-approval.

Read our other articles