By Yaniv Kleitman (Senior Associate)
To be categorised as a private company there must be a provision in the company’s memorandum of incorporation (MOI) which restricts the transferability of the securities of the company and which prohibits the company from offering its securities to the public (s8 of the Companies Act, No 71 of 2008). A common restriction that is found in private companies’ MOIs is that the board of directors of the company may refuse to register a transfer of any securities of the company, and without giving reasons therefor. For example in Table B, Schedule 1 of the previous Companies Act, 1973, which sets out in a standard form articles of association for private companies, there is an article that provides that “The directors shall have power to refuse to register the transfer of any shares without giving reasons therefor.”
A question which often arises in this context is, to what extent does the board have an unfettered discretion to refuse the transfer? Do the directors have to furnish reasons for their refusal, and is such a clause still in line with modern notions of public policy having regard to the general point of departure that a shareholder’s shares are his private property and he may deal with and dispose of same freely? Obviously a concern here is that the board is given very wide powers to approve or decline the entry of a new shareholder to the company, which powers it could potentially use for self-interested purposes. These precise issues arose in the recent unreported Cape Town High Court case of Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd case no. 15854/2013 (19 June 2014).
In the Visser Sitrus case, the MOI of the target company (Goede Hoop Sitrus or GHS) contained a clause that provided that:
“no shareholder may transfer the registered or beneficial ownership of any Ordinary Shares in the Company to any other party without first complying with the requirements for transfer as set out in the Act and in this MOI and obtaining the approval of the board for such transfer. The board may, at any time, decline to register any transfer of Ordinary Shares in the securities register of the Company without giving any reason therefor and the directors shall be deemed to have so declined until they have resolved to register the transfer.”
One of the shareholders of GHS, Visser Sitrus (VS), wished to sell its shares to an entity that was in the process of consolidating control over GHS, and the board was not pleased with this situation. The board accordingly refused the transfer without giving reasons for its decision. Naturally VS challenged this in court, but was unsuccessful. The court made the following points:
- This type of clause, namely that GHS’s board has discretion whether or not to approve a registration of transfer and does not have to provide reasons for refusal, is a common restriction on transfers of shares in the articles/MOI of private companies. Company legislation in South Africa, in keeping with Commonwealth corporate legislation, has always required a private company’s constitution to restrict the transfer of the company’s shares. This requirement has been retained in s8(2)(b)(ii) of the Companies Act (which, notably, refers to ‘securities’ and not ‘shares’ – securities includes shares but also a number of other instruments issued by profit companies such as debentures and bonds).
- To the court’s knowledge, the validity of such a clause has never been challenged, and counsel informed the court they had found no authority to that effect.
- It has always been held that a board’s discretion must be exercised in what the directors bona fide consider to be the best interests of the company, not for an improper or collateral purpose. It is simply inherent in the nature of a fiduciary power. This is in essence an important ‘check-and-balance’ on the exercise of the board’s discretion to refuse registration of the transfer of shares.
- Recent cases in the UK have dealt with this standard power of directors and confirmed its nature and validity.
- There is no general duty on a person holding a fiduciary position to give reasons for his actions to those to whom their duties are owed. The duty of a fiduciary to render an account is a duty to disclose what he has done in the course of his administration, not why he has done it.
- Accordingly, the court did not see anything repugnant about a clause in an MOI stating that the board does not need to give reasons for its decision on a request to register a share transfer. Many powers are typically entrusted by the MOI to the directors, and the administration of corporations would become unwieldy if directors were bound on request to provide reasons for their decisions.
Therefore, despite VS’s counsel’s argument that such a clause is out of step with modern notions of company law, the court held that such a clause is still perfectly valid and enforceable. If a shareholder believes that the board is acting mala fide or with a collateral purpose in refusing to register the transfer (and is therefore breaching its fiduciary duties under s76 of the Companies Act), then a basis needs to be laid out for such an argument, and a court would certainly intervene and grant an appropriate remedy if a breach of fiduciary duty is proven.
Shareholders of private companies should accordingly at all times be fully appreciative of the scope and impact of this commonly occurring clause. In the process of negotiating and drafting MOIs (and shareholders agreements, for that matter) in any given circumstances, it should certainly be considered whether such a clause ought to be modified or watered down in any way. For example, consider whether the board should be required to furnish reasons for its refusal, or set out defined parameters in the MOI within which the board may exercise its discretion, or perhaps do away with the clause completely and rely entirely on other types of restrictions on the transferability of securities. The issue is that a selling shareholder may well jump through all the hoops of an onerous pre-emptive rights clause, for example, and then find itself very much at the mercy of the board of directors when it finally wants to transfer its shares to a third party purchaser.