Most legally savvy business owners (and hopefully all commercial attorneys) know better than to have the governance of a company subject to an out-of-the-box memorandum of incorporation (MOI), courtesy of the Companies and Intellectual Property Commission (CIPC). However, those with unmitigating faith in the ‘default’ position would do well to be mindful of its potential pitfalls.
One such pitfall is concealed within sections 43(2) and (3) of the Companies Act, 2008, which provide as follows:
“…(2) The board of a company-
(a) may authorise the company to issue a secured or unsecured debt instrument at any time, except to the extent provided otherwise by the company’s Memorandum of Incorporation; and
(b) must determine whether each such debt instrument is secured or unsecured.
(3) Except to the extent that a company’s Memorandum of Incorporation provides otherwise, a debt instrument issued by the company may grant special privileges regarding-
(a) attending and voting at general meetings and the appointment of directors; or
(b) allotment of securities, redemption by the company, or substitution of the debt instrument for shares of the company, provided that the securities to be allotted or substituted in terms of any such privilege, are authorised by or in terms of the company’s Memorandum of Incorporation in accordance with section 36.”
Essentially what section 43 does is give the board of a company, except to the extent that the MOI of the Company provides otherwise (which the standard MOI does not), the power to potentially side‑step the shareholders and obtain unbridled control over a company. In theory, a board of directors could achieve this by recruiting persons that it could control, and issuing to those persons debt instruments that give their holders, pursuant to section 43(3)(a), the power to vote at general meetings and to appoint directors. Again, in theory, there appears to be no reason why a rogue board of directors could not exploit the provisions of section 43 to create an army of pseudo (non‑equity) shareholders which could effectively give the board ultimate control over the company to the prejudice of the equity shareholders.
Another pitfall in the standard issue CIPC MOI is nothing short of incredible, especially given the frequency with which small business owners use the standard MOI (CoR 15.1A). The concerning provision is that found in article 3.6(1), which states that:
“(1) For an ordinary resolution to be adopted at a shareholders meeting, it must be supported by the holders of at least 50% of the voting rights exercised on the resolution, as provided in section 65(7).” (my emphasis)
However, section 65(7) of the Companies Act clearly states that in order for an ordinary resolution to be approved by the shareholders, it must be supported by more than 50% of the voting rights exercised on the resolution.
Now, one could make the argument that the error in the standard MOI is of no consequence due to section 15(1)(b), which provides that any provision in a company’s MOI is void to the extent that it contravenes, or is inconsistent with, the Companies Act. However, the problem is one of practical significance. Take, for example, the exceedingly common scenario of the small private company with two directors (both of whom are also the shareholders, each owning 50% of the shares) which company is governed by the standard MOI, perhaps for no other reason than to save on the legal costs of drawing up a unique MOI for the company.
It would be fair to assume in a case like this, that the directors (whether acting in their capacity as directors or shareholders) would govern their company based on the assumption that the MOI made available to them by CIPC, is not only workable but certainly not in conflict with the Companies Act. The practical effect of this misassumption in our example, is that both of the (50%) shareholders each believe that they have the power to pass ordinary resolutions on their own (“at least 50%” requires one shareholder’s vote, whereas “more than 50%” requires both votes) and they act accordingly, oblivious to the fact that their company’s MOI is inconsistent with the Companies Act.
In conclusion, business owners intending to make use of CIPC’s standard MOI would be well advised to ensure that their company’s MOI is amended to make provision for the issues discussed above. On a more general note, the abovementioned demonstrates that business owners and legal practitioners alike would do well not to accept every standard issue CIPC document at face value and to ensure that they are properly informed on the Companies Act and the impacts which it has on the documents which govern companies.