How the NCA sinks vendor-financed deals

This may be one of the more NB articles we’ve written. No kidding. The most common method used to finance BEE might just become spectacularly unstuck thanks to the NCA (National Credit Act) and a whole bunch of money owed to ‘white’ sellers of shares may be unenforceable. Read on, and expect a flurry of legal activity. 

Understanding Vendor finance:

Vendor finance is, very simply, the financing of the buyer by the seller.

You want a BEE partner but they don’t have money (usually the case), so you sell them the shares in the business but lend them the money (i.e. you become a credit provider) to buy the shares. They repay this debt and the interest thereon through dividends over time. You get your money and the BEE points you need; they get the shares and the economic value. As a credit provider, the credit risk is yours but once the shares (or portions thereof) have been transferred they belong to the new (presumably BEE) owners.

Almost half of BEE deals involved Vendor financing: the B-BBEE Commission reported that 39% of all BEE ownership transactions were vendor-financed and that a further 5% involved some combination of funding which included vendor financing.

A real world example: 

To fully understand vendor finance let’s look at what it is with a simple example (in this case, unrelated to BEE but the same principles apply):

Mr. Du Bruyn set up a business in 1984 sealing industrial leaks.  He and his wife knew a young man, Mr. Karsten, who they treated as their son.  Karsten was a law graduate, a university lecturer and a municipal councilor and the Du Bruyns involved him in the business in the early 2000s. They mentored him so that, by 2008, he was the technical director and he became a shareholder.

Eventually, in 2012, they agreed to part ways (the best way to get rid of a shareholder, as we discussed previously, is to buy them out) and they agreed that Karsten would buy out the Du Bruyns for R2.5 million.  They gave Karsten until 31 March 2013 to find the money.  When he couldn’t, they very kindly gave him another six months and when the finance still couldn’t be found, the Du Bruyns offered to buy Karsten out instead – for R1.5 million cash.

Karsten wanted R2 million which the elderly couple didn’t have, so the vendor (Mr. Karsten) agreed to vendor finance – the Du Bruyns would buy Karsten’s shares for R2 million with R500 000 to be paid in cash and the balance payable over five years with interest.

So far so good. The vendor gets the price he wants but to do this has to finance the buyer. Fairly typical. The difference is what happens when the buyer can’t come up with the money.

Enter the Supreme Court:

These (above) are the facts of a recent Supreme Court of Appeal court case Du Bruyn NO and Others v Karsten.

What went wrong: the business started underperforming and the Du Bruyns tried what they could to help it, even selling some personal assets.  Ultimately it made no difference and in the end they stopped paying Karsten and he started legal proceedings to recover the R1.1 million that they still owed him.

However, the Du Bruyns argued that they did not have to pay Karsten back in terms of their loan agreement and the highest court in the land agreed with them.  The court said that the loan agreement was void and unenforceable, which means that all its terms like interest rate, security and the like were not worth the paper they were written on.

The long arms of the National Credit Act:

The court reached its conclusion based on the National Credit Act 34 of 2005 which basically says that a lender needs to be licensed in terms of this Act to be able to enforce a loan agreement.

What is more, the vendor needs to have the licence at the time he makes the loan and it does not matter if he gets it later.  The court said that section 40 was clear and that if one makes any loan (even if it’s a once off or even if one is not in the business of making loans) then one needs a licence.

Implications for vendor-financed deals:

Before 2016 the lender had to be owed over R500 000 on his loans before falling under the NCA, since then the law states that a licence is needed for any loan is where there is an amount in excess of R0.01 that has to be repaid. i.e. every loan is now regulated.

In any vendor-financed situation where the buyer cannot come up with the cash – either because he doesn’t have it, can’t get it, or simply doesn’t want to pay – this is a very important judgment.

Yes, if I owe you any amount and you do not have a licence, you can forget about trying to enforce our loan agreement in any court – until parliament changes that section.  This won’t change fast – we do not have a sitting parliament at the moment (April 2019) and since a parliament seldom changes a law quickly and even less frequently backdates a law, we can expect a few years for this problem to be resolved.

Until then the BEE shareholders to whom you extended the credit to buy shares simply don’t have to worry about the contract, and the shares issued so far are theirs to keep.

Get legal advice:

Some of the reported B-BBEE ownership structures may have been vendor financed by licensed credit providers but there are (per the National Credit Regulator’s latest 2017/8 Report) only 6 191 credit providers. Chances are most of the vendors are at risk here.

All other vendor financiers should seek legal opinion on how they will get their money.

Their lawyers will no doubt point them to rules of unjust enrichment, but whatever without a valid contract no lender will get any interest, will not have their loan secured and can’t withhold instalments from dividends or remuneration.

There may have been far more economic empowerment in these deals than anyone realised…