One of the more fundamental shifts in our corporate law regime since the enactment of the Companies Act, 61 of 1973 ("the Current Act") is the migration from a capital maintenance regime to a solvency and liquidity environment.
Prior to 1999 there was an absolute prohibition on the provision of financial assistance by a company for the purchase or subscription of shares in that company, companies were entirely precluded from purchasing their own shares and a company was not able to make payments to its members, other than by way of dividends (i.e. out of company profits).
The first signs of a dilution to the capital maintenance rule appeared in the Companies Amendment Act, 37 of 1999, which permitted the repurchase by a company of its own shares and payments by the company out of the capital of the company, subject to the solvency and liquidity conditions being met. The movement towards a solvency and liquidity environment was further enhanced by the Corporate Laws Amendment Act, 24 of 2006 which introduced a new exception to the prohibition against the provision of financial assistance by a company for the purchase or subscription of shares in that company, subject to the board being satisfied as to the solvency and liquidity of the company and the shareholders of the company adopting a special resolution approving of the financial assistance.
One of the stated objectives of the new Companies Act, 71 of 2008 ("the New Act") (due to come into operation on 1 April 2011), is the replacement of par value shares and nominal capital with a regime based on solvency and liquidity. The New Act extends the field of application of the solvency and liquidity test beyond the Current Act, by making the test a prerequisite for:
- providing financial assistance in connection with the acquisition of a company's shares (section 44);
- providing a loan or financial assistance to a director (section 45);
- all distributions, including the repurchase by a company of its shares (sections 46 to 48); and
- an amalgamation or merger with another company (section 113).
The New Act, as amended by the Amendment Bill, 2010 (which is still to be finalised), formulates the solvency and liquidity test as follows:
For any purpose of this Act, a company satisfies the solvency and liquidity test at a particular time if, considering all reasonably foreseeable financial circumstances of the company at that time-
- the assets of the company or, in the case of a holding company, the consolidated assets of the company, as fairly valued, equal or exceed the liabilities of the company or, in the case of a holding company, the consolidated liabilities of the company, as fairly valued; and
- it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of-
- 12 months after the date on which the test is considered; or
- in the case of a distribution contemplated in paragraph (a) of the definition of distribution' in section 1, 12 months following that distribution."
The application of the test will predominantly be the prerogative of the directors of the relevant company (except in relation to amalgamation and mergers). In applying the test, the directors will be required to consider "all reasonably foreseeable financial circumstances of the company at that time". This implies a predictive element requiring the directors to consider matters which may not be reflected in the accounting records and financial statements of the company, but are rather based on elements such as how the economy or political circumstances may impact on the financial state of the company in the future.
Some direction is given to directors in that any "financial information" concerning the relevant company and which is to be considered by the directors "must" be based on the accounting records and financial statements that satisfy the requirements of the New Act. Furthermore, the board or any person applying the test "must" consider a fair valuation of the company's assets and liabilities including any reasonably foreseeable contingent assets and liabilities, and "may" consider any other valuation of the company's assets and liabilities that is reasonable in the circumstances.
An important element of the application of the solvency and liquidity test is that the New Act does not require that the company in fact (and objectively speaking) be solvent and liquid. The application of the solvency and liquidity test by the relevant directors differs in regard to the different sections of the New Act. By way of example, if a company wants to provide financial assistance in connection with the acquisition of its shares, the New Act does not require that the company in fact be solvent and liquid, but rather that the board of the company in applying the test be "satisfied" that the company "would" satisfy the solvency and liquidity test. In making a distribution, it must reasonably appear that the company will satisfy the solvency and liquidity test and the board of the company must acknowledge, by resolution, that it has "applied" the solvency and liquidity test and "reasonably concluded" that the company will satisfy the test.
Despite the New Act's welcome extension of the solvency and liquidity regime, it unfortunately does not provide concrete principles to assist directors who are required to apply the solvency and liquidity test. It remains to be seen whether any further changes will be brought about by the proposed amendments to the New Act.