APPLYING BEE CODES TO TRUSTS IS A BURNING CONUNDRUM – PRIYESH MODI

Monday, February 04, 2008
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BEE Codes of Good Practice are at odds with preferred trust vehicles. It is an anomaly that requires urgent solution, since BEE has dominated merger and acquisition transactions in South Africa over the past decade and is likely to continue doing so.
 
Considering the time, effort and cost involved in putting together such transactions, the contracting parties invariably want certainty that the deal will render the “new” (measured) entity BEE compliant.
 
Yet the Codes of Good Practice issued in terms of the Broad-Based Black Economic Empowerment Act are not clear where the BEE party uses a trust as its preferred vehicle for holding a stake in the measured entity. 
 
The elements of broad-based BEE are ownership, management control, employment equity, skills development, preferential procurement, enterprise development and socio-economic development. An enterprise’s BEE status is evaluated on the generic scorecard, which defines the weighting accorded to each element.
 
The ownership element, which carries a 20% weighting, measures effective ownership of enterprises by black people. Code 100: Measurement of the Ownership Element of Broad-based BEE contains the mechanisms for measuring and calculating the ownership element.
 
Thus:
 
·        A black person – African, Coloured or Indian who is a citizen of South Africa by birth, descent or naturalisation – may hold shares directly in his name or through a legal entity while retaining control over the shareholding; or
·        A black person may hold an indirect stake through being a participant in a trust or a beneficiary of a broad-based ownership scheme such as a public benefit organisation or of an employee ownership scheme.
 
For a measured entity to recognise black ownership held through a trust, the following qualification criteria apply:
 
·        The trust deed must define the beneficiaries, with a written record of the names of the beneficiaries or a defined class of natural persons;
·        The trust deed must define the proportion of the beneficiaries’ entitlement to receive distributions, with a written record of the fixed percentages of entitlement, or the use of a formula for calculating entitlement;
·        The trustees have no discretion over such criteria;
·        On termination of the trust, the trust deed must provide for all accumulated economic interest to be transferred to the beneficiaries, or any entity representing the interests of the participants or class of beneficiary. 
 
If all such criteria are met, the measured entity is limited to 40% of the ownership points.
 
Be aware that although the qualification criteria for trusts seem relatively straightforward, this is not so.
 
Code 100 is silent on how to differentiate between trusts, broad-based ownership schemes and employee ownership schemes – which poses a problem, since the qualification criteria for each of these instruments are different and broad-based ownership and employee ownership schemes are normally established via a trust.
 
The Interpretative Guide issued by the DTI on 28 June 2007 suggests that the qualification criteria for trusts are limited to family trusts. The general view is that the qualification criteria for trusts apply to family trusts while the qualification criteria for broad-based ownership schemes apply to charitable trusts and schemes that are focused on empowering broad-based groups and public benefit organisations. It is unclear which qualification criteria apply to business trusts.
 
It is also unclear why the qualification criteria for trusts are not similar to those of broad-based ownership schemes. The rule that the management fees of the broad-based ownership scheme must not exceed 15% and at least 50% of the fiduciaries of the broad-based ownership scheme must be black people should apply to trusts as well.  
 
Code 100 refers to “Black Participants in a trust holding rights of ownership in a Measured entity …”.  Participant is defined as a natural person holding rights of ownership in a measured entity. Participants seem to refer to the beneficiaries of a trust, even though a beneficiary of a trust does not hold any rights of ownership in the assets of the trust. Only once the trustees have declared a particular distribution to the beneficiaries do the beneficiaries have a vested right to that distribution.
 
Accordingly, the word “ownership” in the definition of participant is being loosely used and must not be interpreted in the strict sense of the word. 
 
But does “Black Participants” mean that all the beneficiaries must be black people, or will it suffice most beneficiaries are black?
 
Interestingly, Code 100 stipulates that at least 85% of the value of benefits allocated by a broad-based ownership scheme must accrue to black people.
 
What if the beneficiaries include non-governmental organisations (NGOs) or public benefit organisations (PBOs)? Would they qualify as participants considering that they are not natural persons? And what if, for example,  the charity organisation uses the money received for the benefit of both black and white people in equal proportions?
 
It surely should not matter whether or not the beneficiaries of the trust are natural persons; the important thing is that the ultimate beneficiaries of the trust are black natural persons, with non-black beneficiaries excluded from the calculation of ownership points.
 
To qualify for 100% of the ownership points, the trust must, in addition, provide a certificate issued by a competent person that:
 
·        The trust was created for a legitimate commercial reason, which is disclosed on the certificate (for example, estate planning); and
·        The terms of the trust do not circumvent the Act or the Codes.
 
“Competent person” is defined as one who has acquired the knowledge and skills to undertake any task assigned to them under the Codes.
 
I suggest that it would be more appropriate for the founder of the trust to issue the certificate under oath and, in his absence, for a competent person to issue the certificate. 
 
There are clearly gaps in the application of Code 100 to trusts. An interim solution may be to interpret the Code 100 provisions liberally in line with the purpose of the Act and ensure that the trust satisfies the qualification criteria for trusts and broad-based ownership schemes.
 
Similarly, where the beneficiaries of a trust include one or more charity organisations, these organisations should also be required to satisfy the qualification criteria for broad-based ownership schemes.
 
To the extent that the qualification criteria are not satisfied, there may be a need for the Trust Deed and/or the constitution of the charity organisation to be amended in line with Code 100. The more lasting solution would be for the DTI to address these issues in a further interpretation note.
 
Priyesh Modi is an attorney at Bowman Gilfillan