Written by Mzo Tshaka,
There has been confusion among some owners of (largely) small businesses who have not fully grasped the true implications of the new Companies Act, No 78 of 2008 (the Act). Most of these small enterprises are run as close corporations (CCs) and some business owners have been unsure whether they can continue to trade as CCs or if they needed to convert to private companies.
One of the stated objectives of the Act is to simplify the process of forming and maintaining companies. The Act does this, in part, by providing for a single regulatory regime for business enterprises as opposed to the situation that prevailed before the Act came into force. Then, the old Companies Act, No. 61 of 1973 (old Companies Act) as well as the Close Corporations Act, No. 69 of 1984 (CC Act) applied.
Previously, the rationale for having CCs regulated separately from companies was that CCs were meant to be business vehicles, aimed at smaller enterprises, that created flexibility and encouraged simplified and inexpensive incorporation, separate legal existence and limited liability with less onerous financial reporting requirements. However, because the Act is coming into force with the same purpose of simplifying the incorporation and maintenance of companies, the rationale for having CCs regulated separately has been eroded.
In line with the stated purpose of making it easier to maintain companies, the Act provides that existing CCs are permitted to continue indefinitely but no new CCs could be formed from the date on which the Act came into operation, namely 1 May 2011. Similarly, with effect from that date, no companies could be converted to CCs. Existing CCs will continue to exist until and unless the members of the CC determine that it is in their interest to convert to a company.
The Act provides for the concurrent existence of the CC Act and the Act; subject to the amendments that have been made to the CC Act to align CCs with the principles of the Act. This means, for example, that the provisions relating to business rescue, as contained in the Act, are also applicable to CCs. In addition, the requirements of the Act relating to financial statements apply similarly to CCs.
The Act allows, but does not oblige, existing CCs to convert to private companies. All that is required for a conversion is an official notice of conversion, a certified copy of the special resolution to approve the conversion, and a new Memorandum of Incorporation (MOI) along with payment of the necessary fee. Once the CC is converted to a company, the Companies and Intellectual Property Commission (CPIC) will then cancel the registration of that entity under the CC Act.
Once a CC has been converted to a private company in terms of the Act:
• every member of the converted CC is entitled to become a shareholder of the new company formed;
• the new company steps into the shoes of the converted CC and all rights and obligations of the converted CC accrue to the new company; and
• any legal action instituted by or against the converted CC may be continued.
The regulations under the Act provide that every company (including CCs formed under the CC Act) shall calculate its public interest score at the end of each financial year. This score will be used to determine whether the CC is obliged to file audited financial statements and comply with the extended financial standards or not. The formula for calculating the public interest score is set out in Regulation 26(2) and is calculated as the sum of:
(a) the number of points equal to the average number of employees of the CC during the financial year;
(b) one point for every R1 million (or portion thereof) in third-party liabilities of the CC at the financial year end;
(c) one point for every R1 million (or portion thereof) in turnover of the CC during the financial year; and
(d) one point for every individual who, at the end of the financial year, is known by the CC to directly or indirectly have a beneficial interest in the CC.
For those CCs that have not been converted into private companies, the CC Act still requires all CCs to appoint an accounting officer. Section 30 of the Act provides that each company (which includes a CC) needs to have its financial statements either audited or independently reviewed unless it is exempted in terms of the Act.
In terms of Section 30 (2A) a company will be exempted from this requirement “if every person who is a holder of, or has a beneficial interest in, any securities issued by that company is also a director of the company, that company is exempt from the requirements in this section to have its annual financial statements audited or independently reviewed, but this exemption:
(a) does not apply to the company if it falls into a class of company that is required to have its annual financial statement audited in terms of the regulations; and
(b) does not relieve the company of any requirement to have its financial statements audited or reviewed in terms of another law, or in terms of any agreement to which the company is a party.”
Accordingly, all CCs that meet the requirement to be audited under the regulations, in terms of the public interest score or activities engaged in, would require an audit. Should the CC not need an audit in terms of the regulations, then the requirement for an independent review is also not applicable.
The regulations provide for both activity and size criteria to determine whether or not close corporations require audited financial statements. A CC will require an audit if:
• in the ordinary course of its primary activities, it holds assets in a fiduciary capacity for persons who are not related to it, and the aggregate value of such assets held at any time during the financial year exceeds R5 million (activity test);
• its public interest score in that financial year is 350 or more; or at least 100, but less than 350, if its annual financial statements for that year were internally compiled.
Those business owners who conduct their businesses as CCs need not panic as the Act provides for the concurrent application of the CC Act, with the necessary amendments, as well as the provisions of the Act. As a result, there is, strictly speaking, no requirement to convert existing CCs to companies.
However, from an administrative and compliance point of view, it may be prudent to convert to a company and avoid having to be regulated by two pieces of legislation. The benefits that used to be available under the CC Act have now been incorporated into the Act and there is no longer any real benefit from operating as a CC, as there was before the Act came into force.