In depth

There has been much debate over the years about issuing shares that have not yet been paid for and this has left companies and investors grappling with inefficiencies and uncertainty. The debate centred on whether shares should be held in formal trusts registered with the office of the Master of the High Court or through a more pragmatic mechanism. A question that undermined confidence and efficiencies in share transactions. New legal amendments resolve this issue by establishing a clear, streamlined framework that promises greater efficiency and security for deferred share issue arrangements.

The Companies Amendment Act No. 16 of 2024 ("Companies Act Amendments") has finally provided certainty and settled an academic debate regarding the regime that will apply to an issue of shares for deferred consideration in terms of Section 40(5) of the Companies Act No. 71 of 2008, as amended ("Companies Act").

General principles regarding the issuing shares

The base principle governing the issue of shares by a South African company is that shares must be issued for adequate consideration and be fully paid up. The discretion remains for the board to determine what constitutes adequate consideration and shareholders are protected from value dilution where, in certain instances, they are required to approve an issue of shares by a 75% approval (namely, where shares are issued to directors and related persons of the company; or where the shares being issued are equal to or exceed 30% of the voting power of the total shares held by shareholders immediately before the transaction). However, there may be various circumstances where the shares being subscribed for cannot be fully paid up on the issue date and to address legacy challenges created by the Companies Act No. 61 of 1973 ("Old Companies Act"), the Companies Act provides an alternative mechanism in terms of which shares can be issued for deferred consideration (in cash or in kind).

If you are the founder of a start-up, an investor with illiquid assets, any party whose circumstances prevent or discourage full payment for shares on the issue date, or if the transaction's most efficient structure requires that shares cannot be fully paid up as at the issue date, section 40(5) of the Companies Act offers a solution. It allows shares to be issued in exchange for an instrument of future value or an agreement to provide future services, benefits or payments. Under these conditions, the company may issue the shares to the subscriber and immediately transfer them to an independent third party to be held in trust until the entire consideration is paid according to a trust agreement. The Companies Act does not define "in trust", so the term is interpreted in its ordinary sense.

Due to the lack of clarity in the previous legislation as to what was intended by "held in trust", two broad schools of thought developed. A more conservative interpretation required a formal trust, in terms of the Trust Property Control Act No. 57 of 1988, which require a trust deed, the appointment of trustees, and a separate trust agreement. This conservative interpretation introduced significant costs and delays, as the trust had to be registered with the office of the Master of the High Court, and letters of authority needed to be issued to the trustees. Additionally, if a trustee resigned before the shares were fully paid up and transferred to the subscribing party, a new trustee would need to be appointed in order to complete the transaction. By contrast, a more liberal and pragmatic interpretation holds that "held in trust" simply means the shares are kept by an independent third party (through a trusted relationship) under an agreement for non-beneficial custody, pending full payment. This alternative structure requires only a trust agreement and eliminates the need for a formal trust deed and obviating the need for involving the office of the Master of the High Court.

The Companies Act Amendments have now clarified the position aligning with the pragmatic interpretation. The amendments stipulate that the issued shares must now, immediately after issue, be transferred to a stakeholder in terms of a stakeholder agreement. A stakeholder is defined as an independent third party with no interest in the company or the subscribing party who may be an attorney, notary public, or escrow agent. Similarly, a stakeholder agreement is defined as a written agreement between the stakeholder and the company. These changes not only clarify the mechanism required when issuing shares for deferred consideration but substantially increase a company and subscriber's ability to utilise this provision of the Companies Act.

Effects on practice

These changes have now become effective (from 27 December 2024). With renewed certainty as to the intention of the existing provisions in the Companies Act, companies and subscribers can take comfort in adopting the pragmatic approach and utilise this section of the Companies Act with certainty moving forward.