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Getting out of a BEE deal – navigating the minefield

B-BBEE is a (highly criticised) policy instrument, and the politics can change. With this in mind some businesses have taken the approach of creating BEE structures that can be unwound if needed. More often though, there is a fallout between shareholders (not uncommon) and in this case it may be between BEE and non-BEE shareholders. Getting out of a BEE deal may be something you have do do, but this is a complex area with significant legal and ethical considerations. We’ll cover both legitimate and illegitimate methods, highlighting the risks and potential consequences of the latter.

I. Introduction

Broad-Based Black Economic Empowerment (B-BBEE) ownership deals are intended to be long-term commitments, contributing to lasting economic transformation in South Africa. However, circumstances can change, and parties may seek to exit these arrangements. Exiting a B-BBEE deal is far more complex than entering one, and it’s fraught with potential legal, financial, and reputational pitfalls. This article explores the various ways businesses attempt to exit B-BBEE ownership arrangements, both legitimate and illegitimate, and highlights where things often go wrong.

II. Legitimate Ways to Exit a B-BBEE Deal

Exiting a B-BBEE deal legitimately requires careful planning and adherence to the principles of B-BBEE, the terms of the original agreement, and relevant legislation. Here are the main legitimate approaches:

Sale to Another Qualifying Black Entity/Person:
- Description: The most straightforward and preferred method is for the existing black shareholder(s) to sell their shares to another qualifying black individual, company, or group. This maintains or even enhances the B-BBEE ownership profile of the company.
- Requirements:
  - The buyer must meet the definition of “black people” under the B-BBEE Act and Codes of Good Practice.
  - The transaction must be at fair market value.
  - The sale must comply with any pre-emptive rights or restrictions on transfer in the shareholding agreement or company constitution (MOI).
  - If the original deal involved vendor financing or other specific terms, those may need to be addressed in the sale agreement.
  - If the transaction is a “Major B-BBEE Transaction” (currently, a value of R25 million or more in the ownership element), it must be registered with the B-BBEE Commission.
- Potential Issues:
  - Finding a suitable buyer willing to pay fair market value can be challenging.
  - Disagreements over valuation can arise.
  - The original B-BBEE deal may have lock-in periods restricting sales for a certain time.
Expiry of a Time-Based Ownership Scheme:
- Description: Some B-BBEE ownership schemes, particularly those involving trusts or broad-based ownership plans (like ESOPs), have a defined lifespan. Once the term expires, the shares may vest in the beneficiaries, or the scheme may be wound up according to its rules.
- Requirements:
  - The terms of the scheme must be clearly defined in the founding documents (e.g., trust deed, ESOP rules).
  - The expiry must be in accordance with those terms.
  - Any distribution of shares or proceeds must comply with the B-BBEE Codes.
- Potential Issues:
  - Disputes can arise over the interpretation of the scheme’s rules.
  - Beneficiaries may not be in a position to retain the shares, leading to a sale that could dilute B-BBEE ownership.
Company Buy-Back (with careful consideration):
- Description: The company itself buys back the shares from the black shareholder(s). This is highly sensitive and requires extreme caution. It can easily lead to a reduction in B-BBEE ownership, which is problematic.
- Requirements:
  - The company must comply with the Companies Act requirements for share buy-backs (solvency and liquidity tests, shareholder approval).
  - The buy-back must be at fair market value.
  - The company must immediately find a replacement black shareholder to maintain its B-BBEE ownership level. Simply buying back the shares and holding them in treasury is not a legitimate long-term solution. This is the most likely scenario to be viewed as circumvention.
- Potential Issues:
  - This is often viewed with suspicion by the B-BBEE Commission and could trigger a fronting investigation.
  - Finding a replacement black shareholder quickly can be difficult.
  - The company may not have the financial resources for a buy-back.
  - It may negatively impact the company’s BEE scorecard.
Liquidation or Winding-Up of the Company:
- Description: If the company is liquidated or wound up, the B-BBEE ownership arrangement ends along with the company’s existence. This is obviously a drastic measure and not a strategy for exiting a B-BBEE deal specifically.
- Requirements:
  - The liquidation must be genuine and comply with the Companies Act or Insolvency Act.
- Potential Issues:
  - This is not a way to selectively exit a B-BBEE deal; it terminates the entire business.
Mergers and Acquisitions (with B-BBEE considerations):
- Description: If the company is acquired by or merged with another entity, the B-BBEE ownership structure may change.
- Requirements:
  - The merger or acquisition must comply with the Competition Act (including notification thresholds and public interest considerations, as discussed in previous articles).
  - The impact on B-BBEE ownership must be carefully assessed. The Competition Commission will scrutinize any dilution of B-BBEE ownership.
- Potential Issues:
  - The acquiring entity may not have the same level of B-BBEE ownership, leading to a reduction in the overall score.
  - The Competition Commission may impose conditions to mitigate any negative impact on B-BBEE.
Restructuring (with caution and B-BBEE Commission approval):
- Description: In very limited circumstances, a company might restructure its operations in a way that could involve a change in the B-BBEE ownership structure. This requires extreme caution and is highly likely to be scrutinized.
- Requirements:
  - There must be a genuine commercial rationale for the restructuring, unrelated to avoiding B-BBEE obligations.
  - The restructuring must not result in a significant dilution of B-BBEE ownership.
  - It’s highly advisable to seek pre-approval from the B-BBEE Commission for any restructuring that could affect B-BBEE ownership.
- Potential Issues:
  - This is a high-risk area, and the B-BBEE Commission will likely investigate to ensure it’s not a fronting scheme.

III. Illegitimate Ways to Exit a B-BBEE Deal (Fronting and Circumvention)

These methods are illegal and carry severe consequences. We don’t recommend them, but include them so that the reader will have a greater awareness and understanding of what goes on ‘out there’.

Sham Transactions:
- Description: Creating artificial structures or agreements that appear to comply with B-BBEE requirements but lack genuine economic substance. This is the essence of fronting.
- Examples:
  - Appointing “token” black shareholders who have no real power or economic interest.
  - Using side agreements to secretly transfer benefits back to the original (non-black) owners.
  - Creating complex loan structures that make it impossible for black shareholders to genuinely benefit from their ownership.
  - “Rent-a-black-face” schemes where black individuals are paid to pose as shareholders or directors.
- Consequences:
  - Criminal charges (fines and imprisonment) for all parties involved.
  - Voiding of the B-BBEE transaction.
  - Significant reputational damage.
  - Exclusion from government contracts and licenses.
  - Civil claims by the B-BBEE Commission.
Misrepresentation and Fraud:
- Description: Providing false or misleading information to the B-BBEE Commission, verification agencies, or other stakeholders.
- Examples:
  - Inflating the value of B-BBEE transactions.
  - Falsifying documents (e.g., share certificates, financial statements).
  - Concealing material information about the ownership structure.
- Consequences:
  - Similar to sham transactions: criminal charges, voiding of the transaction, reputational damage, exclusion from government contracts, and civil claims.
Unilateral Termination Without Cause:
- Description: Simply terminating the B-BBEE agreement without a valid legal basis or without following the agreed-upon procedures.
- Consequences:
  - Breach of contract claims by the black shareholder(s).
  - Potential legal challenges to the termination.
  - Negative impact on the company’s B-BBEE rating.
  - Reputational damage.
Constructive Dismissal of Black Shareholders/Directors:
- Description: Creating a hostile or untenable environment that forces black shareholders or directors to resign, effectively removing them from the ownership structure.
- Consequences:
  - Unfair dismissal claims.
  - Potential legal challenges.
  - Scrutiny by the B-BBEE Commission.

IV. Where Things Go Wrong (Even in Legitimate Exits)

Even when attempting a legitimate exit, things can go wrong:

Valuation Disputes: Disagreements over the fair market value of the shares are common and can derail the process. Independent valuations are crucial, but even those can be contested.
Funding Challenges: The black shareholder may struggle to find financing to buy out other shareholders, or the company may lack the funds for a buy-back.
Breach of Contract: The exiting party may inadvertently breach the terms of the original B-BBEE agreement (e.g., failing to offer pre-emptive rights).
Regulatory Hurdles: The transaction may face unexpected scrutiny from the B-BBEE Commission or the Competition Commission.
Tax Implications: There can be significant tax consequences to exiting a B-BBEE deal, which need to be carefully considered. Capital Gains Tax, Dividends Tax, and Securities Transfer Tax can all apply.
Reputational Damage: Even a legitimate exit, if handled poorly, can damage the company’s reputation and relationships with stakeholders.
Unintended Dilution: Even a sale to another black entity could result in a lower overall B-BBEE score if the new entity has a lower B-BBEE rating than the original shareholder.

V. Best Practices for Exiting a B-BBEE Deal (Legitimately)

Plan Ahead: Consider exit strategies from the outset when structuring the initial B-BBEE deal. Include clear provisions in the shareholding agreement regarding termination, transfer of shares, and valuation.
Seek Professional Advice: Engage experienced legal, financial, and B-BBEE consultants before taking any steps to exit.
Be Transparent: Communicate openly and honestly with all stakeholders, including the B-BBEE Commission, verification agencies, and the black shareholder(s).
Document Everything: Maintain meticulous records of all communications, agreements, and transactions.
Prioritize Fair Market Value: Ensure that any sale of shares is at a genuine fair market value, supported by independent valuations.
Comply with All Laws and Regulations: Adhere to the B-BBEE Act, Codes of Good Practice, Companies Act, Competition Act, and any other relevant legislation.
Consider the Spirit of B-BBEE: Remember that the goal of B-BBEE is genuine economic transformation. Any exit strategy should be consistent with this objective.

VI. Conclusion

Exiting a B-BBEE ownership deal is a complex and high-stakes process. There are legitimate ways to do it, but they require careful planning, adherence to legal requirements, and a commitment to the principles of B-BBEE. Attempting to circumvent B-BBEE obligations through illegitimate means carries severe consequences, including criminal charges and significant financial penalties. The best approach is to plan for potential exits from the beginning, seek expert advice, and prioritize transparency and fairness throughout the process. The focus should always be on achieving genuine and sustainable economic transformation, even when circumstances change.

Please contact us for a confidential discussion around your unique BEE ownership needs.