Raisa Shafudah 200729888 Law of Associations Assignment II Due Date: 16th August 2011 Lecturer: Ms K.

Nghiweda With reference to relevant legislation, decided cases and legal literature compare and contrast Close Corporations and Companies in terms of: 1. Essentials 2. Legal nature 3. Fiduciary relationship between members/ directors.

Introduction A close corporation according to the Oxford Dictionary of law a company is an association formed to conduct business or other activities in the name of the association. Most companies are incorporated and therefore have a legal personality distinct from those of their members. A close corporation according to the same source, a close corporation is an association which has a limited number of shareholders. In comparing the differences and similarities of companies and close corporations, one must consider, inter alia, the manner in which they are created their legal limitations and the manner in which they are managed. In the case of both a company and a close corporation, a separate legal entity is created. A close corporation has a limited number of members who can contribute towards the capital of the business. A company, on the other hand, may be structured to have share capital contributed by many shareholders; this enables a greater amount of business capital to be made available. In both cases, the fact that a separate legal entity has been created entails business advantages, and also means that the shareholders (in the case of a company) and the members (in the case of a close corporation) do not always face the risk of sequestration of their personal estates in the event of failure of the undertaking. However, in certain circumstances the shareholders or members will be at risk. This essay seeks to clarify the dissimilarity between close corporations and companies. Formation I. Close Corporation According to section 2 (1) of the Close Corporations Act1, a close corporation comprises one or more persons but never exceeding ten. According to section 2 (4) of the same Act, a close corporation has full legal personality independent of its members/directors/owners and is therefore a juristic person. Section 12 of the Act places several requirements to be adhered to in the creation of a close corporation by way of founding statement. These requirements are: 1. 2. 3. 4. 5. 6. 7. The full name of the corporation. The principal business to be carried out by the corporation. A postal as well as physical address for the corporation. The full name and identity number (alternatively his/her date of birth) of each member. The portion of a members interest in the corporation, expressed as a percentage. The particulars of each members contribution. The date of the end of the corporations fiscal year and the name and postal address of the corporations accountant, who must be qualified for the work.2 Any person or persons intending to form a close corporation must draw up a founding statement in the prescribed form and it must be lodged with the Registrar of the Close Corporations Registration Office in Windhoek, as stated in section 3(1) of the Close Corporation Act. Prior to the founding statement being lodged, a proposed name for the close corporation
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Act No. 26 of 1988 Section 12 (a)-(g) of Close Corporations Act No. 26 of 1988

has to be reserved by application to the Registrar.3 After the founding statement is registered, the Registrar assigns a registration number to the corporation. He will then issue a certificate as proof of registration.4 Every close corporation must display its registered full name and the registration number outside all of its offices or places of business and on all correspondence in the name of the close corporation. The name and registration number should be displayed in a conspicuous and legible manner.5 II. Companies A promoter (or promoters) is the person who wishes to create a company. They form the idea to start a company for a specific purpose and to do whatever is necessary to have the company incorporated. The promoter/s has (have) the power of defining how, when and in what shape the company will take and begin to start acting as a trading corporation6. The promoters prepare the companys memorandum and articles of association7, nominate directors, procure capital, including the issue of a prospectus if a public issue is required, and negotiate for the for the acquisition of any business or property which it is intended that the company should have on registration8. According to the Companies Act no. 28 of 2004 at section 37, in order to form a public company any seven or more persons are required, with no limit thereafter. In the case of a private company, a single individual may be member, and the company can have a maximum of fifty members, according to the same section. Section 68 of the Companies Act deals with the registration of memorandum and articles necessary for a company to be formed and reads as follows: (1) If a memorandum and articles complying with the requirements of this Act together with two certified copies are lodged with the Registrar in the manner prescribed, the Registrar must, on payment of the prescribed fee and any other additional prescribed fee, register that memorandum and articles, impress his or her seal on one copy and endorse the date of registration and the certificate provided for in section 70. (2) Any memorandum and articles lodged for registration must be delivered and uplifted at the Companies Registration Office personally by a subscriber or by a person authorised by the subscriber in writing. (3) On the registration of the memorandum and articles of a company the Registrar must allocate a registration number to the company concerned.

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328 Section 14 (1) of the Close Corporation Act 5 Fouche et al. Legal Principles of Contracts and Commercial Law, p. 330 6 Fouche et al, Legal Principles of Contracts and Commercial Law, p. 300 7 Gibson et al, South African Mercantile and Company Law, p. 275 8 Fouche et al, Legal Principles of Contracts and Commercial Law, p. 300

The company is said to have come into existence, as is the case of a close corporation, when the company is issued this registration number. Essential Characteristics and Comparison Table

Private Company9 Juristic Person Enjoys perpetual succession Can Have A Maximum Of 50 Members Companies can be shareholders Comprised of directors and shareholders Has a memorandum Registered articles of association Compulsory annual return to be lodged Has share capital Has an auditor Convenes an annual general meeting Certificate of incorporation Members hold shares Can acquire its own shares under certain circumstances Directors are responsible for the day to day management of the company Register of members Limited liability Audited financial statements Prohibition on a company to provide financial assistance for the acquisition of its own shares

Close Corporation Juristic Person Enjoys perpetual succession Can have a maximum of 10 members Companies Cannot Hold A Members Interest Comprised members Has a founding statement Articles of associations not required No annual return to be lodged Has members contribution Has an accounting officer Annual General Meeting not required Certificate of incorporation Members hold members interest Can purchase a members interest Members are responsible for the day to day management of the close corporation No register of members Limited liability No financial statements necessary No prohibition on a close corporation to provide financial assistance for the acquisition of a members interest.

Companies Registration and Legal Personality: A company must be registered in accordance with the Companies Act No. 28 of 2004. It is an artificial person created by law. Although it is a purely legal conception, and has no physical existence, a company exists only as in contemplation of the law. A company is a distinct legal entity and distinct from its members.10 In the case of Salomon v Salomon & Co. Ltd11 the learned judge had the following to say:

http://www.intergate-immigration.com/private-company-close-corporation.php Gibson et al, South African Mercantile and Company Law, p. 260 11 [1897]AC 22 (HL) at 30
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it seems to more impossible to dispute that once a company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are. The facts of the case were as follows: S has traded as a sole proprietor for 30 years. He then formed a company in which he and his family bought shares and he was the managing director. He subsequently sold the sole proprietorship to the company. The company paid the purchase price in the form of shares and secured debentures12 issued to S. s pledged the debentures to X, in order to obtain financing for the company. Less than a year later the company was liquidated. At the time of the liquidation the company had $ 6 000 worth of assets, and owed $ 7 000 in debts to unsecured creditors, and a further $ 10 000 to X, who was in possession of the secure debentures. As the primary secured creditor, X was given the $ 6 000 and the unsecured creditors received nothing. These creditors then wanted to sue S in his personal capacity, but the court, by way of the judgment above, reiterated that a company is a separate legal entity from its members. Limited Liability: The liability of the members of a company having share capital is limited to the extent of the nominal value of the shares held by them. Shareholder cannot be called upon to pay more than the unpaid value of his shares, whatever may be the level of indebtedness of the company. In the case of a guarantee company, the liability of members is limited to such amount as the members may undertake to contribute to the assets of the company. The shareholders, however, lose whatever investment they have made in the company.13 A company enjoys perpetual succession because even if there is a change in members, the company continues its business.14 A private company can have a minimum of 1 member and a maximum of 50 members, whereas a public company has no maximum amount of members, but must have a minimum of 7 members. The company is represented by its board of directors, who must manage the company on behalf of all shareholders.15 Close Corporations Similar to a company, a close corporation has a legal personality separate from that of its members. Since the close corporation enjoys a separate legal identity from those of its members it has perpetual succession and is not affected by any change in membership or by the death of any of the members. A close corporation can have a minimum of one member and a maximum of 10 members.16 The members must complete a founding statement in the prescribed form and submit to the Registrar as set out by section 12 of the Close Corporation Act. Each member of the corporation must make a contribution to the corporation and their interest is expressed in percentages.

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A secured debenture is an acknowledgement of debt when a company borrows money. To secure a debenture a bond is take out over the assets of the company to secure the payment of the debt. 13 Fouche et al. Legal Principles of Contracts and Commercial Law p. 293 14 Fouche et al. Legal Principles of Contracts and Commercial Law p. 293 15 Fouche et al. Legal Principles of Contracts and Commercial Law p. 292 16 Fouche et al. Legal Principles of Contracts and Commercial Law p. 334

Fiduciary Relationships Close Corporation Where a corporation has more than one member the members may at any time enter into a written association agreement governing the internal relationship between the members, or the members and the corporation.17 Each member of a close corporation stands in a fiduciary relationship with the close corporation.18 This implies that a member, without prejudice to the generality of the words: a) Must act honestly and in good faith in relation to the corporation19 b) Must avoid any material conflict of his own interests with those of the corporation.20 In particularly describing this conflict of interest the section specifies that a member must a) Not derive any personal economic benefit from the corporation or any other person if he is not entitled to that benefit by reason of his membership or service, in circumstances where the benefit is obtained in conflict with the interests of the corporation.21 b) Notify every other member at the earliest practicable opportunity of any material interest he may have in any contract of the corporation;22 c) Not compete in any way with the corporation in its business activities.23 Provided a member acts in the interests and for the benefit of the corporation, conduct which would otherwise infringe the above rules does not constitute a breach of the fiduciary duty if his conduct was followed by the written approval of all members where all the material facts known to them.24 Where a members act or omission breaches his fiduciary duty, the member is liable to the corporation for any losses suffered as a result and for any economic benefit he derived from it.25

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Close Corporation Act section 44 (1) Aclose corporationording to the Close Corporation Act, section 42 (1) 19 Section 42 (2) (a) 20 Section 42 (2) (b) 21 Section 42 (2) (b) (i) 22 Section 42 (2) (b) (ii) 23 Section 42 (2) (b) (iii) 24 Gibson et al, South African Mercantile and Company Law, p. 248 25 Gibson et al, South African Mercantile and Company Law, p. 430

Companies Duties of Directors Every company must have one or more directors; a public company at least two and a private company at least one.26 The law imposes duties towards agents, trustees and it also imposes the same strict duties towards directors.27 Directors must at all times act in the best in the best interest of the company. A director may not make a secret profit from his dealings with or on behalf of the company and must avoid any personal conflict with the interest of the company. 28The law presumes that the nature of director's business is not far away from driving the company, which is mainly with the companys philosophy; the business of the company will be at risk of maladministration. Thus being said, the director can be considered an agent of the company.29 Section 429 of the Companies Act No. 28 of 2004 deals with the duty of good faith of the directors regarding their management of the companys affairs. Below is a list which indicates the duties of agent (i.e. directors) fiduciary duties towards the company Duty to act in good faith

Directors are anticipated to act honestly towards their company. The subjective test is often used in the matters of companies in that directors need to act based on their principles as they believe what is to be in the best interest of the company. However, if directors fail to act in the best interest of the company, it is considered as they breach their duties and responsibilities towards the company. Honesty, integrity and interdependence with other company stake holders and professional independence must go together regarding the duty of good faith. A director breaches the fiduciary relationship if he makes secret profits, if there is a conflict of interest, if he abuses confidential information and if he delegates the authority granted to him without authorization.30 Duty of Care and Skill31

A director as an agent of the company expected to take the property of the company as his own. On the other hand, a director is appointed to serve his company by his trained skill. Hence, he has the duty to a greater degree of skill as expected from a reasonable person in the same experience and knowledge. For instance, a director cannot be excused by the share holders due to his ignorance of the law. In the case of, Re City Equitable Fire Insurance Co.32 the term care and skill was simplified to mean:

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Fouche et al. Legal Principles of Contracts and Commercial Law, p. 316 http://www.simplylinks.co.za/article955_view.htm 28 Fouche et al. Legal Principles of Contracts and Commercial Law, p. 317 29 The director is considered an agent as he is authorized and usually required by another (the company) to contract or negotiate a contract on the latters behalf with third parties. 30 Fouche et al. Legal Principles of Contracts and Commercial Law p. 238 31 Fouche et al. Legal Principles of Contracts and Commercial Law p. 318 32 [1925] Ch 407

1. A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. A director of a life insurance company, for instance, does not guarantee that he has the skill of an actuary or of a physician 2. A director is not bound to give continuous attention to the affairs of his company. His
duties are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee of the board upon which he happens to be placed. He is not, however, bound to attend all such meetings, though he ought to attend whenever, in the circumstances, he is reasonably able to do so

3. in respect of all duties that, having regard to the exigencies of business, and the articles
of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly

Duty to act in the best interest of the company33

The duties apply to each director separately, while the powers apply to the board jointly. Also, the duties are owed to the company itself, and not to any other entity. This does not mean that directors can never stand in a fiduciary relationship to the individual shareholders; they may well have such a duty in certain circumstances. The director has to expect to avoid the conflict of his rights and duties with that of the rights and duties which is imposed upon him by the company. He has to disclose when such cases happen immediately to the board of directors. A director even has the duty to avoid conflict of interest after he resigns. Avoidance of Conflict of interest means that to use the overall potential of the company to the best interest of the company, therefore, a director who hired or set up his own business cannot use the information he gain while working in original company to the use of the new company. It is a civil breach and can sometimes extend to criminal wrong. 34 Statutory Duties

Section 241 of the Companies Act makes it an offence for a director with inside knowledge of the companys affairs deal with the companys shares or debentures to their own advantage before those shares and debentures are offered to the public. A director is therefore required to refrain from dealing in shares and debentures before they are made available to the public. Any contract in contravention of this duty is void ab initio. Section 240 of the same Act requires directors of public companies with a share capital to enter any material interests they may have in the companys shares or debentures into a register. The final statutory duty of a director is that such director may not in his personal capacity enter into a contract with the company without the approval of the general meeting or the articles of association authorizing it.35

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Re Equitable Fire Insurance Co. [1925] Ch 407 http://www.gt.co.za/Publications/Effective-directors-guide/directors_duties.asp 35 Section 246 (1) of the Companies Act No. 28 of 2004

Conclusion Companies and close corporations are similar in the fact that they are both corporate bodies having juristic personality distinct from their members with their own rights and obligations. Even though the mechanisms of the two kinds of associations are alike, it is clear that corporations are less rigidly operated and they have simplified rules. The intricacies of a companys inner-workings are not easily understood by an ordinary person, without the expertise. However, there are differences between the two kinds of associations, which I hope have been properly illustrated in the conversation above. A corporation may have membership ranging from a single individual to a maximum of 10 members. A private company can have membership ranging from a single individual to a maximum of 50. A public company must have a minimum membership of 7 and unlimited number of members thereafter. A corporation does not have the abbreviation Ltd or (Pty) Ltd, but has the abbreviation CC instead.36 Juristic persons may not be members of a corporation and a corporation cannot be a subsidiary of a company. The corporation can, however, hold shares in a company and could be in the position analogous to that of a holding company37; there is no similar rule in the case of a company. Every member of a corporation is entitled to participate in the carrying on of business and has the equal right of management of, and in the representation of the corporation, whereas in the case of a company the management and representation is undertaken by one director or the board of directors. Registration of a Close Corporation is simpler than that of a company, as there need not be articles of association and a memorandum, but in the case of a company these are pre-requisites to the registration of the company.38

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Or its equivalent in one of the other official languages according to section 12 of the CCA of 1988 A parent corporation that owns enough voting stock in another corporation to control its board of directors (and, therefore, controls its policies and management). 38 See section 12 of the Close Corporations Act and Section 37 of the Companies Act