SOUTH AFRICA: PRACTICE NOTE PROVIDES WELCOME CLARITY ON BROAD-BASED BLACK ECONOMIC EMPOWERMENT STRUCTURES
A practice note (Practice Note) recently released by the Minister of Trade, Industry and Competition (Minister) has brought much-needed clarity on various matters relating to the allocation of shareholdings in companies to broad-based black economic empowerment (BBBEE) vehicles.
One of the ways a company (Measured Entity) can score ownership points under the ownership pillar of its BBBEE Scorecard is from shareholdings held in it by broad-based ownership vehicles operating primarily or wholly for the benefit of black people or a sub-class of black people (for example, black women).
Two examples of such broad-based vehicles which are specifically regulated by the BBBBEE sector codes and generic codes are Broad-Based Ownership Schemes (BBOSs) and Employee Share Ownership Programmes (ESOPs). Often structured as trusts administered by trustees, they operate for the benefit of specifically designated groupings (for example, communities or students), or employees of the Measured Entity, respectively.
Points of difference
Over the last few years, differing views have been expressed by the BBBEE Commission (on the one hand) and certain other stakeholders, including many Measured Entities, advisors and BBBEE verification agencies (on the other) on the rights of Measured Entities to attain BBBEE ownership points through broad-based vehicles.
The BBBEE Commission has adopted the view that rights of ownership (particularly the rights to cash flows from shareholdings in Measured Entities, and to vote those shares) must vest in the beneficiaries of the broad-based vehicle, not in the trustees of the broad-based vehicle. Other stakeholders have interpreted the relevant provisions as allowing rights of ownership to vest in the trustees, for practical and other reasons, on the understanding that the vehicle operates for the benefit of those beneficiaries.
As other examples, the BBBEE Commission has:
- held the view that it is not sufficient for the vehicle’s trust deed/constitution to identify the beneficiaries as a class of beneficiaries unless accompanied by a closed list setting out the names of each individual within that class who is a beneficiary;
- objected to provisions in constitutions pursuant to which named beneficiary might cease in the future to be beneficiaries, even where that occurred in fault-related circumstances;
- adopted the position that ownership points cannot be claimed if the beneficiaries are minors;
- been of the view that the constitution must set out the percentage of each distribution by the vehicle to which each beneficiary is entitled, for example, ‘30% of each distribution is to be made to person X, 30% of each distribution is to be made to person Y, and the remaining 40% of each distribution is to be made to person Z’; and
- required that distributions by broad-based vehicles be in the form of cash, and that the cash must be placed in the hands of each beneficiary.
What does the Practice Note provide?
Ownership can vest in the broad-based vehicle itself - the Practice Note recognises that ownership points can be derived from the shareholdings of broad-based vehicles as typically structured in this market, that is, with ownership rights vesting in the broad-based vehicle rather than in the beneficiaries.
Identification of beneficiaries - the Practice Note clarifies that the inclusion of a defined class of persons in the constitution is sufficient (without the need to list each beneficiary), that the Constitution can provide that persons who are members of that class will cease to be beneficiaries should they cease to be members of that class and that ownership points can be claimed if the beneficiaries are minors. Examples of a defined class of beneficiaries are ‘black people living in the Gauteng Province’ or ‘black women studying economics in tertiary educational institutions in South Africa’.
Perpetual structures are acceptable - the Practice Note recognises that ESOPs can operate on a perpetual or evergreen basis. It follows that it is not necessary for there to be an outside date on which an ESOP sells, or can sell, its shareholding. It can continue to operate indefinitely for the benefit of the employees from time to time of the Measured Entity.
Vested entitlements - the Practice Note clarifies that the constitution need not set out the percentage of each distribution to which each beneficiary is entitled. It is sufficient for it to specify what the total percentage is of distributions to be made to black people falling into the defined class (which will be 100% in circumstances where the class is limited to black people).
The form that distributions take - the Practice Note provides that distributions to beneficiaries do not need to take the form of cash placed in the hands of each beneficiary. It states that, for example, moneys can be used by the broad-based vehicle to pay for skills development, education or training on behalf of beneficiaries or to facilitate access to funding or fund social or community interventions or developments for the benefit of the beneficiaries.
Other points to note
The Practice Note states that ‘Challenges with existing schemes (covering their funding mechanisms, fronting practices, inadequate information to intended beneficiaries and governance challenges) will need to be addressed’. The Minister accordingly anticipates that further laws or communications will follow which will focus on the need for greater communication and interaction between the Measured Entity and the beneficiaries.
At this stage, it is merely conjecture as to what is specifically contemplated, and whether this will entail the introduction of additional qualification requirements for a broad-based vehicle to qualify as a BBOS or ESOP. These might require greater education to be provided to beneficiaries on the principles of ownership, or further information disclosures on the Measured Entity and its activities; or that broad-based vehicles or beneficiaries should have representation on the board of directors of Measured Entities.
There remain areas not addressed in the Practice Note where the views of the BBBEE Commission and certain other stakeholders differ. For example, there are differing views on the impact of the inclusion or exclusion of certain terms and conditions in shareholders agreements regulating the relationship between broad-based vehicles and the other shareholders of a Measured Entity. The BBBEE Commission has regularly taken the approach that if certain rights and protections are not afforded to a broad-based vehicle in the shareholders agreement, no real ownership is created, with the result that BBBEE ownership points cannot be awarded.
We welcome the Minister’s statement that increased steps are contemplated to counter fronting.
The Minister should be respectfully commended for addressing critical areas of confusion that have existed up until now. We look forward to the clarifications creating impetus for an increased number of transactions involving BBBEE vehicles.