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Noteworthy corporate approvals which can trip up transactions and directors

by Steven Stuart-Steer on 10 October 2019


Directors are tasked with the proper management of their company. In doing so, each of them is expected to (and carry the fiduciary duty) to navigate the requirements under applicable legislation and to obtain regulatory clearances where needed when they undertake any actions on behalf for a company for which they serve as a director, including specifically that the company satisfies all necessary corporate approvals.

A failure by the board to obtain required corporate approvals in accordance with and in the manner prescribed by the Companies Act, 2008 (hereinafter referred to as the "Companies Act") and/or the constitutional documents of the company may be fatal to a transaction as well as lead to directors becoming exposed to claims by stakeholders for personal liability where they did not take the necessary steps to ensure compliance. 
 
The purpose of this post is to briefly highlight a few key matters under the Companies Act which, on the writer's reading, entrepreneurs and directors should keep in mind as requiring specific corporate approvals before they can safely proceed to give effect to any such corporate transactions or decisions.  

Subscription and options for shares

Where any subscription for shares crosses 30% of the total voting rights in the company as immediately before such rights issue, the board needs a special resolution of the shareholders before it can give effect thereto. 
 
The contracting parties will need to furthermore dispense with statutory pre-emptive rights of the existing shareholders to be first offered to take up any additional shareholder on a pro rata basis. 

The corporate approval requirements for a subscription will also apply to the granting of any option for shares or other financing transactions which involve an investor taking up shareholding.   

Asset-for-share transactions 

An asset-for-share transaction (also commonly known as a "share swap") can provide a simple method to allow for the exchanging of shares for other shares in the same company group or otherwise to move certain assets, intellectual property (e.g. existing trade marks, software or other technology) or other rights into a business.  If properly handled it can allow for a tax-neutral treatment from a capital gains perspective. 

Such transactions, however, can attract the requirements of a fundamental transaction or other prescribed change in control protections under the Companies Act to be concluded effectively and without comebacks which need to be considered from a corporate perspective in addition to tax structuring issues.  

Share buy-backs

A company may acquire its own shares from a shareholder (known as a "share buy-back") in which case the shareholder will sell all or a portion of his/her/its shareholding back to the issuing company following which the shares are cancelled as authorised but unissued shares in the share capital of the company.  The result is that the remaining shareholders have a proportionately greater stake in the company.

A resolution passed by shareholder holding a special majority of voting rights (the default being 75%) is required where the share buy-back:
  1. is concluded with a shareholder who is also a director (or holds a similar office to that of a director) or is otherwise related to such a director or officer (such as a spouse, family trust or affiliated company); or
  2. considered alone or together with any other transaction, or series of transactions, results in the company concerned acquiring more than 5% of its shares in issue for any particular class.
A company must be factually and commercially solvent upon giving effect to such transaction given that as part of the corporate approvals for the transaction, the board will also need to satisfy the requirements of the solvency and liquidity test under the Companies Act by passing a resolution to this effect. 
 
The use of share buy-back arrangements has also come under recent scrutiny by the tax authorities which also requires careful structuring to ensure an optimal tax treatment.  In particular, the use of a subscription for shares coupled with a share buy-back within 24 months could trigger a deemed capital gains event as the Receiver of Revenue seeks to treat in the same way as a disposal of shares (similar to the anti-avoidance rules on dividend stripping).

Fundamental transactions

The Companies Act lists three types of transactions which attract special approval requirements before a company may give effect thereto:
  1. disposal of all or a greater part of the assets or undertaking of a business (i.e. more than 50% of its gross assets (irrespective of liabilities) and/or the value of its entire undertaking as fairly valued);
  2. statutory mergers between two or more companies, including a holding company and its subsidiary; and
  3. a scheme of arrangement, including an acquisition by a company of its own shares (i.e. share buy-back).
The concept of a scheme of arrangement is broadly defined under the Companies Act and includes amongst other things the conversion or consolidation of share classes, an exchange of shares and share buy-back transactions.  The requirement for a scheme of arrangement may therefore be applicable to a number of financing, buy-out and corporate restructuring transactions (whether involving a new investor or even for certain internal business restructurings).

The legislator has required parties to observe a number of formalities before they can give effect to such transaction as means to protect minority shareholders., or failing which the transaction or series of transactions involved can be left ineffective.
  
In most cases corporate approvals can be dispensed with by means of written round robin resolutions, however, in the case of a fundamental transaction there is special meeting requirement in which shareholders must receive a prescribed circular and at which there are sufficient shareholders to exercise at least 25% of the voting rights.  The circular to shareholders needs to satisfy a number of statutory requirements, including that it must include the relevant transaction agreements or a precise summary of their terms as well extracts from the Companies Act itself which clearly inform shareholders of their appraisal rights. 

The appraisal rights (also known as an "appraisal remedy") entitles dissenting shareholders to be exited from the business at fair value if such rights are properly followed by having actively opposed a proposed fundamental transaction before a shareholders' meeting and then voted against the relevant corporate actions at such meeting.  Furthermore, a significant dissenting minority of at least 15% of the total rights which object to a fundamental transaction may also seek a court interdict to block such corporate transactions.
 
Given it is not always possible or practical to have shareholders present at a meeting at one place and/or time, it is this writer's view that one needs to approach these requirements as pragmatically and expediently as safely possible in each case.  Where for example there is full alignment between contracting parties and the transaction can be concluded on a full consensus basis, from experience we have seen that the use of proxy forms and electronic communication for instance can greatly alleviate logistical challenges and unnecessary administrative work to help close such transactions.

Share capital changes

The board is generally restricted from amending or converting any issued shares and attaching rights and shareholder entitlements without consensus of the shareholders for each particular class of shares concerned. 
Each company has an allotted number of authorised shares from which the board is authorised to give effect to any rights issue.  Where the total authorised shares are insufficient, the board will need to first obtain an increase to the share capital as pre-closing step to such a rights issue. 
 
Such changes require a special resolution by shareholders as well as an application to the Registrar of Companies to increase the authorised share capital together with a filing of an amendment to the company's memorandum of incorporation (abbreviated herein as "MOI").  An amendment to the MOI can take the form of a surgical change or by replacing the MOI in its entirety where needed.  

Remuneration of directors

A company may only pay remuneration or other benefits to its directors if such amount receives prior approval of the shareholders by a special resolution which was passed within the previous two years.  Non-compliance will leave directors exposed to potential claims by stakeholders to repay previous remuneration received.  

Based on the wording in the Companies Act, the approval must be obtained in advance (i.e. ratification may not be able to fully absolve a failed approval).  Even owner-managed businesses should not be lax on these requirements as a future investor for instance could later take issue with historical non-compliance which can place the original founding directors at risk.
 
As remuneration is defined broadly in the Companies Act, this requirement can extend to many incentive schemes for management (whether by way of profit sharing, commission payments or through the acquisition of shareholding in the company concerned).

Conclusion

It is important that corporate approvals for a transaction are handled properly.  Navigating the corporate approvals at play for a corporate transaction should ideally be done as part of the structuring and negotiation phase of an agreement as these requirements are vital to giving effect to corporate transactions and can trip up the transaction and even leave directors exposed to personal liability if they are missed or not fully addressed before closing.  

To promote better governance the Companies Act also contains provisions which may deem the entire board to be complicit in certain non-compliant transactions or decisions unless an individual director concerned objected to such course of action and can show he or she actually voted against the decision in the relevant resolutions.  This is typically the case where the corporate approvals for the transaction involve the need to satisfy and pass the solvency and liquidity test under the Companies Act which requires each director to apply their mind and carefully consider the resolved course of action.  Accordingly, each director is tasked with responsibility in obtaining and when consenting to corporate approvals and so should take advice where needed.



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