EXCHANGE CONTROL CONTRAVENTION AND THE FORFEITURE OF ASSETS
The recent news that businessman Mzilikazi Khumalo lost another exchange control battle in the courts and will have to forfeit assets estimated to be worth approximately ZAR1 billion captured people’s attention. This raised the question: What was the contravention which led to such a severe penalty, and what does this mean for business?
Mr Khumalo’s assets were declared forfeited to the State in terms of Exchange Control Regulation 22, which allows the South African Reserve Bank (SARB) to seize both tainted and untainted assets, in connection with an exchange control contravention that has not been regularised. This applies even where the contravention has not been proven in court. Further, our Courts have rejected arguments that this regulation is invalid. Earlier this month, the High Court again demonstrated its reluctance to interfere with orders of attachment and forfeiture in terms of Regulation 22.
On 8 May 2017, the North Gauteng Division of the High Court of South Africa dismissed an application brought by Mr Khumalo against the SARB and various other respondents. In doing so, the High Court confirmed an attachment order against Mr Khumalo and Mawenzi Resources & Finance Company (Pty) Ltd (Mawenzi Resources) in respect of a wide range of assets apparently worth approximately ZAR 1 billion.
Exchange control rules as they apply to residents and non-residents
The SARB imposes exchange controls on South African residents in terms of the Exchange Control Regulations, issued under the Currency and Exchanges Act, 1933 (the Regulations). The purpose of exchange control is, among others, to regulate inflows and outflows of capital from South Africa.
South African residents are not permitted to export capital from South Africa except as provided for in the relevant exchange control rules. No South African resident is thus entitled to enter into any transaction in terms of which capital (in the form of funds or otherwise) or any right to capital is directly or indirectly exported from South Africa without prior approval. That prior approval must either be sought from the SARB or a registered bank in its capacity as an authorised dealer.
Non-residents are not subject to South African exchange controls, but may be impacted indirectly because acquisitions of South African assets and certain transactions with a South African exchange control resident may require exchange control approval.
Implications of a contravention
Contravening the Regulations can lead to criminal sanctions, as well as a severe financial penalty in the form of the attachment and forfeiture of assets. Attachment and forfeiture may be enforced not only in respect of assets linked to the transgression but also of "untainted" assets owned by the “transgressor” or by a third party who benefited from or was enriched by the transgression.
In addition, cross-border transactions which did not receive the necessary exchange control approvals could also, in certain circumstances, be declared void by a Court. This could result in the parties having to unwind such a transaction. However, the absence of exchange control approval will not automatically invalidate the transaction. In fact, our Courts have confirmed the principle that the Regulations were adopted for the public interest and not for the sake of disgruntled or disaffected parties to a contract. A contracting party can therefore not rely only on the lack of consent to avoid a claim by a counterparty. The Supreme Court of Appeal (SCA) has also confirmed that there is nothing preventing the Treasury from consenting to a transaction ex post facto. It is thus worth noting that some contraventions can be regularised on application to the SARB.
Wide powers of enforcement highlighted
The Khumalo judgement did not mention what the exchange control contravention was which led to the attachment and forfeiture of assets. It appears, however, that the issue at hand is a transaction in which Mr Khumalo and/or Mawenzi Resources borrowed ZAR 760 million from Deutsche Bank for a Harmony Gold BEE scheme. He (and presumably also Mawenzi) pledged the shares bought, to Deutsche Bank. It is not clear whether Mr Khumalo ever defaulted on the Deutsche Bank loan and what exactly the exchange control contravention was, but there were some allegations of fraud. There must presumably have been some sort of “export of capital” for SARB to issue a Notice and Order of Forfeiture.
Mr Khumalo apparently never asked the Court to consider whether there was in fact an exchange control contravention. Instead, he first asked the Court to find that Regulation 22C (in terms of which the assets were attached) was invalid but the SCA held against him in 2010. He then asked the Court to review and set aside the decision to forfeit the assets and also to declare certain regulations (including Regulation 22C) unconstitutional. However, the Court never considered the merits of this application as it held (on 8 May 2017) that Mr Khumalo did not have locus standi in the matter. In other words, Mr Khumalo did not have the necessary legal standing to bring the application.
Where does this leave parties to cross-border transactions? Although this case does not provide any guidance as to the structuring of cross-border finance transactions, we do know that Regulation 22 has withstood attack in the Courts. The High Court has now again demonstrated its reluctance to interfere with orders of attachment and forfeiture in terms of Regulation 22.
The case highlights the wide powers of enforcement of the SARB and reinforces the necessity for all clients to ensure the relevant exchange control approvals are obtained timeously when working or dealing with cross-border transactions. Also, in those instances where the parties failed to obtain exchange control approval before entering into the transaction, it is advisable that SARB is approached to regularise any potential transgression as soon as possible.