The issue of shares is a fundamental aspect of company law, serving as the primary mechanism through which ownership interests are created and regulated, while defining the legal relationship between a company and its shareholders. While many share subscriptions are relatively straightforward, others involve more complex payment arrangements that require careful legal regulation. Section 40(5) of the Companies Act 71 of 2008, as amended (“Act”), establishes a legal framework to regulate these subscriptions and to balance the interests of the parties involved. While the Act recognises that share subscriptions may involve future payment, services or other deferred consideration, it ensures that subscribers do not obtain the full benefits of share ownership before providing the agreed value.
Consider the purchase of a motor vehicle on an instalment plan. The buyer receives the vehicle immediately, even though the purchase price will only be paid over several months or years. The buyer is therefore able to use the vehicle before the full purchase price has been paid. Unlike the purchase of a motor vehicle on finance, where the buyer may take possession and ownership before paying the full purchase price, section 40(5) of the Act generally prevents a subscriber from obtaining the benefits and ownership of securities where the agreed subscription consideration will only be provided in the future. This may arise, for example, where the subscription consideration consists of a financial instrument whose value cannot be realised immediately by the company, or where the subscriber undertakes to make payment at a later date.
General rule
The general principle in terms of company law is that no payment or performance means no entitlement to the ownership and benefits derived from owning securities in a company. However, this is not always how the transactions and deals take place in the real world. Thus, mechanisms such as section 40(5) are salient to guide stakeholders when navigating subscription of shares with deferred or delayed payment. It is important to note that this section is only relevant to the issue and subscription of shares, not the disposal of shares by sale, donation or other means from one existing shareholder to another shareholder or third party.
Future payment, deferred value instruments
Section 40(5) refers to consideration in the form of deferred value instruments or future obligations. A deferred value instrument is an instrument from which the company cannot realise value immediately, but which entitles it to receive value at a future date. Examples include promissory notes, future-dated payment instruments, and conditional payment arrangements. Similarly, future obligations refer to undertakings that will be performed or fulfilled at a later stage, such as the provision of future services, the conferral of future benefits, or the making of future payments. These forms of consideration differ from cash or immediately realisable assets, as their value is dependent on future performance or the occurrence of specified events.
The Middleman
Section 40(5) of the Act provides that the company are prohibited from issuing the full number of shares directly to the subscriber. Section 40(5)(b)(ii) is clear that upon receipt of the instrument or entering into an agreement with a subscriber, the company must cause the issued shares to be transferred to a stakeholder. The shares as issued must then be held in trust and only later transferred to the subscriber in accordance with such trust agreement concluded by the parties. The amendments made to the Act in 2024 (with effect from December 2024) define a ‘stakeholder’ as an independent third party who has no interest in the company or the subscribing party, who may be in the form of an attorney, notary public or escrow agent.
The stakeholder agreement is concluded between the company and the stakeholder and governs the terms on which the shares are to be held in trust. While the parties are free to regulate certain aspects of their arrangement, section 40(6) of the Act prescribes the default legal consequences that apply unless the stakeholder agreement provides otherwise.
Limited rights
In terms of section 40(6) of the Act, the subscriber may not exercise the voting rights or appraisal rights attached to the shares while they remain in trust. Likewise, any pre-emptive rights associated with the shares may only be exercised once the company is able to realise the agreed consideration or the subscriber has fulfilled its obligations under the agreement.
The Act further provides that any distributions declared in respect of the shares must be paid or credited to the subscriber only to the extent that the consideration has been realised or the subscriber has performed its obligations. Where appropriate, those distributions may also be credited against any outstanding future services, payments or benefits still owed to the company. As the subscriber progressively fulfils its obligations, the shares may be transferred to the subscriber, with the remaining shares being transferred once the agreed consideration has been fully realised or all obligations under the agreement have been satisfied. The combined effect of sections 40(5) and 40(6) is to create a carefully balanced framework that accommodates commercial realities while protecting the interests of all parties involved. Unless otherwise agreed, the subscriber will therefore be subjected to limited rights about the shares, while held in trust by the stakeholder.
By requiring shares to be held by an independent stakeholder and regulating the rights attached to those shares until the subscriber has fulfilled its obligations, the Act safeguards the integrity of a company's share capital while accommodating commercially practical arrangements. Companies contemplating share subscriptions involving deferred consideration should therefore ensure that the transaction and the accompanying stakeholder agreement are carefully structured to comply with the requirements of the Act. If you require any legal advice or assistance with the practical implications and implementation of section 40, feel free to reach out to our team for guidance.
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