May 21,2015 / News / Legal Brief

The Department of Trade and Industry caused wide spread uncertainty and confusion in its Notice 396 in the Government Gazette of 5 May 2015 which stated that black participants in broad based and employee share ownership schemes could only contribute a maximum three points (out of the total available 25 BBBEE ownership points) to a firm’s BBBEE score in terms of the Codes of Good Practice (“Codes“) issued under the Broad Based Black Empowerment Act (“BBBEE Act“).  In one stroke the Notice overturned accepted past practice and threatened many existing and planned BBBEE ownership transactions which relied on such schemes.

On 8 May 2015, the Department issued a statement that BBBEE transactions concluded before 1 May 2015 would not be affected and that the Department would appoint a Technical Task Team to explore the “appropriate balance between active (direct) and passive (broad based schemes) ownership” and report to the Minister within thirty days.  On 15 May 2015, the Department issued a further Notice in the Government Gazette which withdrew Notice 396.  It accordingly now appears that the status quo has been restored and that broad based and employee share ownership schemes are again eligible to contribute to all (and not just three) of the 25 available BBBEE ownership points in the Codes.

The lack of prior consultation by the Department on such a fundamental issue is unfortunate.  From a procedural perspective, any change in the number of points contributed by broad based and employee share ownership schemes would require an amendment to the Codes. In terms of the BBBEE Act, the Minister is obliged to publish a draft amendment to the Codes in the Government Gazette and allow at least sixty days for public comment on the draft. The Codes may not be amended by a Notice in the Government Gazette.

It has been argued that broad based and employee share ownership schemes are “passive” without specific black individuals who can drive transformation in the company. This is a generalisation as a minority shareholding in a company by black individuals can also be “passive”. Each case must be assessed on its own facts and circumstances.  Furthermore –

  • the Codes set targets of 25% plus one vote for Black voting rights and 25% for black economic interest in the company. If achieved, the company will score all the available BBBEE ownership points i.e. there is no incentive in the Codes (from a BBBEE ownership scorecard perspective) to have a higher black shareholding.  A minority shareholder (even if it is a black individual or a company owned and controlled by black people) is generally not in a position to materially influence the day to day management and strategies of a company;
  • from a corporate governance and company law perspective, the transformation of a company should be primarily decided and driven by its board of directors and management not its shareholders;
  • these schemes can provide financial benefits to more black people than individual ownership structures and can especially benefit poor and uneducated black people who would not otherwise have an opportunity to participate in a shareholding or other interest in a company; and
  • these schemes can contribute to the stated objective of the BBBEE Act to “increase the broad based and effective participation of black people in the South African economy”. The definition of “broad based black economic empowerment” in the BBBEE Act makes special mention of black women, workers, youth, people with disabilities and rural dwellers.

Furthermore, the Codes have specific requirements for broad based and employee share ownership schemes including that –

  • the constitution of the scheme must define the participants and the proportion of their claim to receive distributions. Participants may be named or referred to as a defined class of natural person and their claim to receive distributions may be in fixed percentages or determined in terms of a formula. The fiduciaries of the scheme (for example the trustees of the trust) have no discretion in this regard;
  • the constitution of the scheme must be available on request to any participant in an official language in which that person is familiar;
  • the fiduciaries of the scheme must present the financial reports of the scheme to participants yearly at an annual general meeting of the scheme; and
  • in order to contribute the maximum number points on the BBBEE ownership scorecard, the scheme must have a track record of operating as a scheme or, if it does not have a track record, “demonstrable evidence of full operational capacity” to operate as a scheme. Such operational capacity must be evidenced by suitably qualified and experienced staff in sufficient number, experienced professional advisers, operating premises and all other necessary requirements for operating a business.

Further rules for broad based ownership schemes are that –

  • at least 50% of the fiduciaries of the scheme must be independent persons having no employment with or direct or indirect beneficial interest in the scheme;
  • at least 50% of the fiduciaries of the scheme must be black people and at least 25% must be black women;
  • at least 85% of the value of benefits allocated by the scheme must accrue to black people (the management fees of the scheme may not exceed 15%);
  • the chairperson of the scheme must be independent; and
  • on winding‑up or termination of the scheme, all accumulated economic interest must be transferred to the beneficiaries or an entity with similar objectives.

Additional rules for employee share ownership programmes are that –

  • black participants must take part in  appointing at least 50% of the fiduciaries of the scheme and in managing the scheme at a level similar to the management role of shareholders in a company having shareholding; and
  • all accumulated economic interest of the scheme is payable to participants at the earlier of a date or event specified in the scheme constitution or on the termination or winding‑up of the scheme.

The above requirements of the Codes go some way in meeting the criticism that broad based and employee share ownership programmes are “passive”. Such generalisations are not helpful and each scheme should be assessed according to its own facts and circumstances. Individual fiduciaries of the schemes can act in the same way as individual black shareholders and participants in the schemes are not without rights or remedies.

Arguments that these schemes may be used for fronting apply equally with regard to individual black shareholding structures. Unlike individual black ownership structures, the above requirements in the Codes for broad based and employee share ownership schemes provide protections against fronting. The BBBEE Act was amended with effect from 24 October 2014 to criminalise fronting practices and the consequences of a contravention are severe including ten year jail terms and a fine not exceeding 10% of the annual turnover of a company.  In addition, the guilty person may not contract or transact any business with any organ of state or public entity for ten years from the date of conviction and will be entered into the register of tender defaulters held by the National Treasury.  These provisions (as well the establishment of a BBBEE Commission which will have wide ranging powers including to subpoena documents and witnesses) create a statutory enforcement mechanism for actively combatting fronting, whether through a broad based ownership scheme, an employee share scheme or an individual black shareholder structure.

Given the great importance of BBBEE in South Africa, it is vital for local and foreign business to have certainty as to how BBBEE is measured. It is hoped that the Department will draw the appropriate lessons from the withdrawal of Notice 396 and that in future there will be more consultation and dialogue between Government and business with regard to BBBEE laws, codes of good practice, rules and policies.