Section 221(1) of the Companies Act, 1973 (the "current Act") provides that in order for the directors of a company to issue shares therein, notwithstanding any provisions contained in the memorandum or articles of association of the company to the contrary, the prior authorisation of the shareholders of that company in general meeting is required for such issue. Such authorisation can either take the form of a general authority, whereby the shareholders of the company conditionally or unconditionally authorise the directors thereof to issue shares in the company as and when such directors deem fit, or it can take the form of a specific authority, whereby the shareholders of the company authorise the directors thereof to make a particular issue of shares in the company. This provision thus prevents the dilution of shareholdings in companies through the unrestricted issuance of shares by directors. It however also has the effect of restricting directors from freely raising capital finance, unless prior authorisation is in place. In practice, shareholders (especially institutional shareholders of listed companies) are often reluctant to put prior authorities in place, so that when funding is required, shareholders must first be approached for specific approval, which exercise has cost and timing implications, especially in the case of listed companies where a circular convening a general meeting would be required.
Section 38(1) of the Companies Act, 2008 (the "new Act") provides that the directors of a company may resolve to issue shares therein as and when they deem fit, so long as such issues are made within the classes and to the extent that the shares in question have been authorised by or in terms of the memorandum of incorporation of the company, in accordance with the provisions of section 36 of the new Act. Section 38(1) of the new Act thus effectively increases the powers of the directors, as it allows them to issue shares, and as such raise capital finance, at their discretion and does not require them to procure the prior consent thereto of the shareholders of the company.
The aforementioned shift in the prerogative will bring South African company law, which originated from the UK, in line with company law prevailing under certain foreign jurisdictions such as Canada and the USA.
Shareholders fearing the untempered dilution of their shareholdings are however not deprived of measures to protect their interests in this respect.
Directors will only be able to issue such shares as have been authorised by the company, effectively the shareholders, in accordance with the provisions of section 36 of the new Act. Section 36 of the new Act provides, inter alia, that the number of authorised shares of each class of shares a company, as set out in its memorandum of incorporation, may be altered by means of an amendment of the memorandum of incorporation by the shareholders thereof. Thus, should a company not have any authorised but unissued shares in its share capital, the directors will not be able to exercise the powers afforded to them in terms of section 38(1) of the new Act. One may therefore in future find that shareholders will not be willing to approve major increases in the authorised capital, as they have been prepared to do under the current Act.
Furthermore, section 39(2) of the new Act affords the shareholders of private companies a statutory pre-emptive right upon the issue of any new shares, to first be offered such percentage of the shares to be issued as is proportionate to their voting rights. Public companies may adopt similar provisions in their memoranda of incorporation and one may even see that this continues to be a requirement of the JSE for listed companies in the new regime. Should such shareholders be in a position to follow their rights in this respect, their shareholdings would be protected from being diluted.
Finally, the provisions of the memorandum and articles of association of certain companies (which will together comprise the memorandum of incorporation of such companies following the implementation of the new Act, should such companies fail to adopt new memoranda of incorporation pursuant to the implementation of the new Act within the time period provided therefor), may already contain certain provisions that adequately protect shareholders from dilution through the exercise by the directors of the rights afforded under section 38(1) of the new Act. One would have to closely examine the provisions of the memorandum and articles of association of these companies, while being mindful of that which the new Act provides, to determine whether they indeed afford such protection to shareholders.
The decision as to whether to adopt these measures may be influenced by the fact that section 40(1)(a) of the new Act places on directors the duty of ensuring that shares are issued for adequate consideration. Furthermore, directors will
have to be mindful of their fiduciary duty to act in the best interests of the company (and therefore its shareholders) when deciding on the matter of issuing new shares.
As is evident from the above, it is clear that while the coming into force of section 38(1) of the new Act will result in directors being statutorily afforded greater powers in deciding when a company’s shares are issued, shareholders are not without means for limiting such powers.
At present it is still unknown what additional requirements or restrictions the JSE will impose in respect of share issues, following the amendment of the Listings Requirements to take account of the new Act.
The question of limiting the power of directors to issue new shares will require a weighing up of shareholder protection versus factors such as the ability of directors to raise capital finance without the potential time delays and cost of referral to shareholders.