The purchase and sale of shares in a private profit company can be disastrous if the parties involved failed to address all the relevant legal implications that may be associated with the concerned sale and purchase of equity shares in a private company. In accordance with the Companies Act, Act 71 of 2008 (hereinafter the “Act”), the transferability of the shares in a private company must be restricted in its Memorandum of Incorporation.
Restrictions imposed on the transferability of shares in a private company are traditionally imposed by way of ‘pre-emptive’ rights and to protect the remaining shareholders in the company. However, the transferability of shares may be restricted by various other agreements concluded by the company and / or shareholders, containing various covenants and undertakings.
In addition to the restrictions to the transferability of shares, there is a plethora of other legal and tax implications to be considered when a shareholder(s) proposes to enter into a sale and purchase of shares.
From a corporate legal advisor perspective, it is always important to address all of the possibilities and anticipate the possible legal ramifications that may be realised by any anticipated transaction.
Pre-emptive rights and restrictions of transferability:
Pre-Emptive Rights are normally considered rights of pre-emption, granting the remaining shareholder(s) in the private company the right to be firstly offered the equity shares that are up for disposal. Only when the remaining shareholder refuse of fail to acquire the shares offered, will the disposing shareholder be allowed to dispose same to a third party.
However, pre-emptive rights may also contain restrictions that reach further than just a simple right of pre-emption. Certain private companies may have other restrictions imposed on the transferability of its shares (and usually also recorded in the ‘pre-emptive’ clause, due to its intricate nature to the pre-emptive rights). For example, the restrictions may prohibit the sale and disposal of shares by a disposing shareholder to a company or person involved or related to a company that is considered a competitor of the company that issued the sale shares to the disposing shareholder.
Restrictions may also be contained in loan finance agreements entered into by the company and in terms whereof the shareholder provided a financial covenant to the lender. In this instance, the lender’s approval may have to be attained to conclude the sale and purchase of share transactions.
Subject Matter and Price:
Normally, when a transaction for sale of shares is negotiated between a willing buyer and willing seller, the purchase price should be arm’s length and market value. However, what is important to consider, is the portion of the purchase price to be attributed to the value of the shares, and (if any) which portion is to be attributed to loan claims.
In many instances a disposing shareholder will not be allowed to dispose of his shares separately and independently from his loan claims against the private company. This is also important when considering the tax implications of the transaction, and the portion attributed to the loan claim will constitute a return of capital, whereas the value attributed to the sale shares may constitute proceeds for capital gains tax purposes (provided the shares were held as a capital asset).
Suspensive Conditions and Regulatory Approvals:
In many instances there may be certain actions or approval required, before the parties can give effect to the proposed sale and purchase of shares. This will be considered a condition suspending the contractual rights and obligations of the parties to the agreement.
Such conditions can range from shareholder approvals, regulatory approvals (such as approval from the Competition Commission and the Takeover Regulation Panel), financial and legal due diligence investigations, or even conditions relating to the financial performance of the concerned private company.
Release from Sureties:
In other instances, especially in private profit companies, shareholders may have been required to sign as surety for the financial obligations of the company. Where a disposing shareholder exits, it is crucial to negotiate and procure the release of such a disposing shareholder from such sureties signed.
If the purchaser cannot effect such a release, then the contract should provide for an indemnity by the purchaser, indemnifying the disposing shareholder against claims that may follow such a surety.
A sale of shares in a private company will constitute a disposal and transfer of a ‘security’ as referenced in the Securities Transfer Tax Act, Act 25 of 2007 (herein the “STTA”). Accordingly, a security transfer tax will be levied at a rate of 0.25% calculated on the value of the shares.
In the event where the company (that issued the shares) is a residential property holding company, transfer duty may be payable on the sale of shares in residential property holding company, calculated on the market value of the property.
As evidence from the above, there are various important legal implications one should consider and address when drafting a Sale of Shares Agreement in respect of the purchase and sale of shares in private profit companies.
Article by Derek Brits | Senior Associate