When drafting a Memorandum of Incorporation (“MOI”) the question often arises as to which provisions should be dealt with in the MOI and which should be agreed upon in the shareholders’ agreement. Section 8(2)(b)(ii)(bb) of the Companies Act 71 of 2008 (“the Act”) states the following:
A profit company is –
(b) a private company if –
(ii) its Memorandum of Incorporation–
(bb) restricts the transferability of its securities;
This means that in order for a profit company to qualify as a private company, its MOI must restrict the transferability of its securities (“shares” are included in the definition of “securities” in the Act). To achieve this, it is clearly insufficient for an MOI merely to record that the transferability of its securities is restricted. The manner in which these restrictions apply must be set out in the MOI.
A requirement of the previous Companies Act of 1973 was that a private company’s Articles of Association had to restrict the “right to transfer” its shares. Henochsberg points out that the concept of restricting the “right to transfer” shares is a more limited concept than a restriction on the “transferability” of shares (Henochsberg on the Companies Act 71 of 2008 at p 50).
There are a number of ways in which the transferability of securities can be restricted. Examples are the recordal of pre-emptive rights in favour of existing security holders or requiring the directors of a company to approve the transfer of securities. Henochsberg is critical of using the approval of directors as a requirement for the transfer of securities. He argues that this creates uncertainty in that the decision of the directors must be subject to their fiduciary duties (Henochsberg 51).
In many instances, pre-emptive rights provide the only restrictions on the transferability of shares agreed to by the shareholders, in which case these provisions would need to be in the company’s MOI in order for the company to qualify as a private company. Also relevant to this discussion is section 15(7) of the Act. In terms of this section, a shareholders’ agreement must be consistent with the Act and the company’s MOI, and any inconsistency is void to the extent of the inconsistency.
It could be argued that where the Act stipulates that the MOI of a company is to deal with a certain subject matter, then to deal with that subject matter in the MOI and then to supplement it in a shareholders’ agreement potentially renders the shareholders’ agreement inconsistent with the MOI. An example of this would be where an MOI restricts the transferability of shares by requiring director approval, and a shareholders agreement restricts transferability by recording pre-emptive rights in favour of existing shareholders.
The intention of the legislature could be interpreted to be that a third party should be entitled to rely on a company’s MOI as the sole record of all provisions which the Act stipulates should be dealt with in the MOI. If this argument is sound, then in the aforesaid example the pre-emptive rights in the shareholders agreement would be invalid as being inconsistent with the MOI.
There are accordingly two reasons for recording pre-emptive provisions in an MOI and not in a shareholders’ agreement:
- To ensure compliance with the provisions of section 8(2)(b)(ii)(bb);
- To remove any possible argument that dealing with pre-emptive rights in a shareholders’ agreement leads to an inconsistency between the MOI and the shareholders’ agreement, and the resultant invalidity of the pre-emptive rights.
It is arguable that forced sale and come along clauses do not restrict the transferability of shares, but rather that they oblige a shareholder to dispose of its shares under certain circumstances. These types of clauses, however, are usually so intertwined with pre-emptive provisions and tag along clauses that they too should be included in the MOI of a company, and not in a shareholders’ agreement.