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The new Companies Act of 2008 and its impact on the business community in South Africa

The Companies Act 2008 - why is it such an important piece of legislation?

The new Companies Act of 2008: why is it such an important piece of legislation?

Parliament is passing legislation (Acts of Parliament) and amending legislation all the time. In 2008 alone, Parliament passed seventy five Acts or amending Acts. Why then is there such intense interest in the Companies Act no 71 of 2008, which was just one out of so many statutes, and which will probably only come into force in the middle of 2010?

The answer is not far to seek.

It has been said that, if you were to list, in order of importance, the various human inventions that have shaped the modern day world, limited liability companies would be close to the top of the list.

Thus, on 18 December 1926, an editorial in The Economist said -

"The economic historian of the future may assign to the nameless inventor of the principle of limited liability, as applied to trading corporations, a place of honour with Watt and Stephenson, and other pioneers of the Industrial Revolution. The genius of these men produced the means by which man's command of natural resources has multiplied many times over - the limited liability company - the means by which huge aggregations of capital required to give effect to their discoveries were collected, organized and efficiently administered."

In short, limited liability companies are the driving force of the world's major economies. The largest companies have economic resources that are greater than those of some small countries. Most of the wealth of developed economies is held by companies. Virtually all investments are channelled through companies into other companies. International trade takes place between companies. Companies provide the majority of jobs in the world economy. A large part of individuals' wealth and financial security is held in pensions and other investments held by companies.

We have seen in the past year, how the world's economic foundations trembled at the prospect of the collapse of a few large companies in the USA, the UK and Europe.

The Companies Act plays a major role in ensuring an efficient, ethical, socially responsible, and well-functioning corporate sector.

The last major overhaul of South Africa's Companies Act was in 1973, and a lot has happened since then. Technological advances have been huge. The world's economies have become more interdependent. Corporate scandals have raised the public ire and spurred calls for tighter corporate governance rules. There have been calls for South Africa to adopt a modern business rescue regime to save ailing companies from bankruptcy.

The defining characteristics of a limited liability company

The characteristics of a limited liability company are easily summarised -

* a company is a legal person, that is to say, a legal entity in its own right, capable of having rights and obligations, owning property, and of suing and being sued in its own name;

* consequently, where the company incurs a debt, the legal liability rests on the company itself, not on the shareholders or directors.

* ownership of the enterprise, and management of the enterprise are split. The enterprise is in effect owned by the shareholders, but it is managed by the directors. In a small business, these may be the same persons.

The phrase "limited liability company" is therefore misleading. The company is fully liable for its debts and other obligations. It is the liability of the shareholders that is limited - in essence, once they have paid for their shares, they have no further liability. If the company goes insolvent, they can walk away, unscathed, having lost only the money they paid for their shares.

Limited liability companies brought about a revolution in the way business is done

When limited liability companies first came on the legal scene in England in the mid 19th century, they brought about a revolution in the way business could be done, and created huge new opportunities for the expansion of the business sector, including international trade.

Inter alia limited liability companies created the following new opportunities -

* A person who wished to invest money in a business no longer had to take on himself the risk of becoming a partner in the enterprise, with unlimited personal liability for the debts of the business; instead, he could invest his money by buying shares in the company. If the company flourished, he would participate in its success via dividends that would be paid to him. If it failed, he would have lost the money he paid for its shares, but he would not be personally liable for its debts.

* The company (if it was a public company) could raise capital to embark on major projects by offering its shares to the public. In this way, massive amounts of money could be raised in a way that was impossible to achieve via any other business structure. The company would then have the capital to, for example, build a transcontinental railway line or develop a mine.

* Individuals and institutions with money to invest, but who did not want to take an active part in running the business, could choose to be passive investors by buying shares in a company, and then just sitting back and waiting for dividends. They could spread the risk that the company would fail by buying shares, not just in one company, but in many, in different sectors of the economy. Consequently, money that cautious investors may otherwise have just put into banks or kept under the mattress, suddenly became available for investment in business projects.

* Individuals with high levels of expertise, but little or no money to invest, could make their expertise available by becoming directors of companies, or of several companies.

The combination of these factors triggered a massive expansion of business and employment, and the creation of wealth.

The downside of the revolution - possibilities of investor fraud and other abuses

The economic revolution that came about when limited liability companies were recognised by law also provided new opportunities for shysters and fraudsters. For example -

* A small-time crook could now try to dupe hundreds or thousands of people at a time, by forming a company, making false and extravagant promises about its future profitability (for example, that it owned and operated a mine in some foreign country), inducing thousands of people to buy shares in the company, and he could then strip the company of the money that had been invested.

* A businessperson could establish a company, arrange for it to borrow large sums of money or buy goods on credit for resale, then pay the borrowed money or the sale proceeds of the goods to himself by way of directors' fees or otherwise, then put the insolvent company into liquidation and walk away, financially unscathed, to do the same thing again and again, leaving swathes of out-of-pocket creditors to lodge futile claims against the liquidated companies.

Establishing checks and balances in company law

Company law therefore needs to strike a difficult balance in a number of respects.

* Company law must be structured in such a way as to encourage entrepreneurship - in other words, to encourage people to start new businesses and expand existing businesses, and to take entrepreneurial risks in this regard, shielded from personal liability for the debts of the business if it fails.

* On the other hand, company law must restrain - and impose sanctions - where a person forms a company and then allows it to carry on business recklessly, to the detriment of the company's creditors and shareholders.

* Company law must encourage people of ability to become directors of companies, and contribute their expertise to the company's business; but company law must also penalise directors who act improperly in managing the company's business.

These are difficult balances for company law to strike. Draw the legal noose too tightly, and budding entrepreneurs will be deterred from forming new companies and expanding existing ones, and the business sector will be strangled. Let the noose be too slack, and all kinds of abuses and sharp practices will flourish in the corporate sector.

[to be continued in the next issue]

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