Ms MA Williams
Secretary to Parliament
Parliament
PO Box 15
Cape Town
8000
Dear Madam: / 07 August 2008
Commentary on the Companies Bill

We thank you for the opportunity for Ernst & Young South Africa to provide comment on the Companies Bill, 2008 (“the Bill”) which was published on 27 June 2008.

We support the Department of Trade and Industry’s efforts to develop a “clear, facilitating, predictable and consistently enforced law to provide a protective and fertile environment for economic activity”, as outlined in the Memorandum on the Objects of the Companies Bill, 2008.

We present our detailed commentary as follows:

–General Commentary

–Detailed commentary on specific sections of the Bill

Should you wish to discuss our comments or require clarity on any of the matters raised please do not hesitate to contact me at Ernst & Young, P.O. Box 656, Cape Town, 8000 or alternatively by way of telephone at (021) 443 0258 or 082 603 0772, or by way of email to .

Yours faithfully,

Michael Bourne

Professional Practice Director

National Assurance Services

General Commentary

The view expressed in the Memorandum on the Objects of the Bill, “that company law should promote the competitiveness and development of the South African economy” is an important one. In performing our review and formulating comments we considered whether the proposals were consistent with the five objectives stated on page 215 of the Bill.

The Bill goes a long way towards simplifying the procedures for forming companies; and to some extent in reducing costs associated with the formalities of forming and administering a company. It is commendable that efforts are being made to remove barriers to conducting business and reducing the costs of operating and maintaining companies.

We welcome for instance the retention of the classification of companies as “private companies”, “public companies” and adding “state-owned entities” as opposed to the classifications originally suggested in the discussion draft of the Companies Bill, 2007. The proposed classifications are less complex, and accordingly welcomed and accordingly should result in greater conformance with the legislation.

We have set out in more detailed a list of comments on the Bill which we would be grateful if you would consider, the more significant of which are as follows:

  1. The Bill currently does not address the process and implication of changing from a “private company” to a “public company” and vice versa. We would recommend that these matters be specifically addressed in the Bill.
  2. We support the removal of Schedule 4 to the Companies Act ,1973 and other detailed accounting and financial reporting requirements from the Act. We believe the standards of financial accounting and disclosures should be left to the Financial Reporting Standards Council ( “FRSC” ) to determine. Presently section 29 of the Bill requires the Minister to gazette such standards after consulting the FRSC. We are of the opinion that the FRSC should be given the power to determine standards in the same way as the Independent Regulatory Board of Auditors (“IRBA”) sets auditing standards in terms of the Auditing Profession Act. This will ensure that ,as and when standards change internationally or where local circumstances demand a standard be published, the FRSC can ensure that changes are made in a timely manner without needing to involve the Minister in the process.
  3. We are supportive of the selective exemption of certain companies to be subjected to a full scope audit by an independent Registered Auditor. We believe however that the IRBA should be given the power to determine the standards of “ independent review” introduced in section 30(4)(b)(ii)(bb) and section 30(10)(b) of the Bill in the same way that they set standards of auditing in terms of the Auditing Profession Act.
  4. We do not, however agree with amendments which will allow certain companies to not maintain proper books of account nor annual financial statements. We have set out our reasons for this on pages 9 and 10 of the attached commentary.
  5. The Bill presently does not allow a company to trade while its assets are exceeded by its liabilities, both fairly valued. We believe that in certain circumstances where adequate creditor protection is in place that such companies should be allowed to trade if there is a reasonable prospect of them returning to a solvent position.
  6. The Bill does not allow for the existence of a “wholly owned subsidiary” in terms of the requirements of section 35(3)(b). This is because the Bill requires at least one share of a company to be held by a person other than a company or juristic person controlled by a group company. In South Africa and internationally there are many wholly owned companies in groups of companies. We are concerned that such a requirement will be unfriendly to foreign investors. We believe that the proposed Bill should continue to allow all the shares of a company to be held by one person or company.
  7. Sections 90(2)(b) and 92 seek to place a greater degree of limitation of circumstances in which a person or firm may act as the Registered Auditor of a company. We are of the opinion that matters relating to the independence or otherwise of auditors should be left to the statutory Ethics Committee of the IRBA to determine as required by the Auditing Profession Act.

Limitation of Liability of Auditors

The auditing profession in many developed and developing countries of the world have for many years had some form of limited liability for independent external auditors in respect of the work they conduct as auditors to express an opinion on the financial information of companies. South Africa is presently out of line with such countries. We recommend that a Task Force be formed to investigate this matter further with a view to considering possible amendments to the Companies Act and Auditing Profession Act in due course.

Detailed Commentary on Specific Sections of the Bill

Pg no / Section / Theme / Comment
Pg 13 / Definitions / Correction of grammatical error / There appears to be a grammatical error in thedefinition of “distribution”. Correction to subsection (c) is required as follows: “… owed to the company by one or more holders of any of the shares …” The word “or” should be added to the sentence as indicated.
Pg14 / Definitions / Juristic Person / Juristic person is defined to “include” foreign companies and trusts. We suggest that local companies and close corporations also be specified.
This will align with the definition of “company” and “close corporation” on page12 of the Bill
Pg 14 / Definitions
S1 and S29 / Definition of financial statements / The definition of “financial statement” makes reference to “interim or preliminary reports” in subparagraph (b). However, the Bill does not require the preparation of “interim or preliminary reports” in any of its sections.
We recommend that the references be removed entirely
Or the new Act would need to deal with Interim and Preliminary Reports.
Pg 14 and Pg 82 / S1 and S92(1) / Meaning of “designated auditor” / There is no definition for “designated auditor”, although section 92 of the Bill refers to it. Section 92(1) of the Bill indicates that the same individual may not serve as the “auditor or designated auditor of a company for more than five consecutive financial years”. It is unclear what the difference between “auditor” and “designated auditor” is. We recommend that the reference to “designated auditor” be removed from Section 92 if there is no difference between “auditor” and “designated auditor”.
Pg 19 / S4(1)(a) / Interpretation of “consolidated” in the application of the solvency and liquidity test / The “solvency and liquidity test” has to be applied using “the assets of the company, or if the company is a member of a group of companies, the consolidated assets of the company…”
The meaning and application of “consolidated assets of the company” is unclear for example, it could be construed as meaning that:
  • If a subsidiary is “insolvent”, but the group as a whole is “solvent”, that the subsidiary would pass the test; or
  • Unless the company is also a parent company, only that company’s assets are considered (i.e. ignoring the assets of that company’s parent company).
Given the various possible interpretations, we recommend that this requirement is clarified.
It is submitted that the intention of the legislation is to require the company’s assets to equal or exceed the company’s liabilities, both fairly valued and therefore reference to the “consolidated” assets and liabilities is superfluous.
This is a problem with the existing Corporate Laws Amendment Act as well.
Pg 19 / S4(2)(b)(i) / Application of “fair valuation” in the solvency and liquidity test / This section of the Bill requires the company to “consider a fair valuation of the company’s assets and liabilities…” when applying the solvency and liquidity test.
The meaning of “fair valuation” is unclear.
We recommend that the terms “fairly valued” and “fair valuation” be specifically defined as “The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.”
This definition is taken from International Financial Reporting Standard 1 ( Appendix A -- Defined Terms )
Alternatively, the manner or process in which fair value should be determined must also be specified in the Bill.
Pg 19 / S4(2)(c) / Sentence construction / The section currently reads as though the “person” is not to be regarded as a liability, whereas it would appear that the amount of a “distribution” should not be regarded as a liability.
Pg23 / S8(3) / Significance of 31 December 1939 / Section 8(3) of the Bill is currently section 31 of the current Companies Act ,1973.
The significance of this section is not apparent to the reader.
We do not understand whether this section needs to be retained in our corporate law. If not then we suggest consideration be given to removing it.
Pg 23 / S10(2)(c) / Referencing error / The references are incorrect. There is no Section 67(9) or (10). It is unclear what the correct reference should be.
Pg 24 / S11(2)(a)(ii) / Criteria for names of companies / In light of the changes proposed to the naming of companies we recommend that consequential amendments are made to the Business Names Act to ensure consistency. For example, the Business Names Act refers to the registrar and deals with the basis of rejection of company names while the equivalent provisions in the Bill refer to a Commissioner and a more simplified basis of rejection.
Pg 25 / S11(3)(b) / Meaning of “RF” and incorrect references / S11(3)(b) of the Bill requires: “if the company’s Memorandum of Incorporation includes any provision contemplated in section 15(2)(b) or (c), the name must be immediately followed by the expression ‘‘(RF)’’…”
It is unclear why this section refers to “section 15(2)(b) or (c)”.There appears to be no correlation with these sections. We recommend that the reference to “section 15(2)(b) or (c)” be removed or, if the reference is incorrect, that the reference be updated to refer to the intended sections of the Bill.
The meaning of “(RF)”, is unclear, as it has not been defined anywhere in the Bill, nor is it used anywhere else in the Bill. We recommend that the reference to “(RF)” be clarified.
If the term “RF” is clearly defined then it may assist with an understanding of section 11(3)(b) and the cross references to section 15.
Pg 26 / Part B – Purpose and application / Changes in company type / The Bill currently does not provide details regarding procedures to be followed whenever a company changes from private company to public company or vice versa. Given the significant impact that this may have on a company, for example having to prepare financial statements, having its financial statements audited and various corporate governance requirements, the Bill should provide the relevant transitional provisions to cater for these changes. These matters are currently dealt with in Sections 22 to 29D of the Companies Act, 1973.
Pages 28 and 68
Pg 83 / S15 (6)(c) (ii) and 72 (2)(a)
S94(4)(a) / Composition of audit committees
Committee member must be a director / These subsections recognize persons who are not directors, acting on the audit committee can be members of such a committee. We question the rationale of having non-directors as members of the committee. To date only directors have been members with a number of other persons attending only by invitation. We would recommend that only directors be allowed to be members of the audit committee.
We also bring to your attention an anomaly in the Act insofar as Section 94(4)(a) requires members to be directors only while S15 and 72 allow persons other than directors to be members.
Pg 32 / S22(1)(b) / Insolvent circumstances / This section does not allow a company to “trade under insolvent circumstances”.
The term “insolvent circumstances” is not defined. To enable compliance we suggest these words be defined.
For instance where a company’s assets are exceeded by its liabilities and it has received a subordination agreement from a creditor which , when taken into account, would mean that the other liabilities of the company are exceeded by its assets would these circumstances be such that the company would have to cease trading ? If so we would submit that many companies in South Africa would have to stop trading.
Furthermore, if a company can not trade in such circumstances it needs to be understood that the company will then have no opportunity to trade out of its predicament.
Pg 35 / S27(6) / Financial year ending on Saturday, Sunday of public holiday deemed to be on the next business day. / According to section 27(6) if: “ in a particular year, the financial year of a company ends on a Saturday, Sunday or public holiday, that financial year will be regarded to have ended on the next following business day.”
It is not clear why this provision of the Bill has been inserted.
Whether a financial year ends on a Saturday, Sunday or public holiday is irrelevant and accordingly we are of the view that this section should be deleted.
Furthermore, it is common knowledge that the retail industry prefers to end its financial reporting period at the end of day on the last Sunday of the last month of each of their financial years. In terms of the proposed section 27(6) these companies will no longer be able to do so.
Pg 36
Pg34 / S28(2)
S25(1) / Accessibility of company records / Section 28(2) currently states that the “company’s records must be kept at, or be accessible from, the registered office of the company.”
Section 25(1) states that the “records” must be accessible at or from the company’s registered office “or another location, or locations, within the Republic.”
To accommodate companies which operate in multiple locations we recommend that Section 28(2) be amended to read similarly to Section 25(1) which allows companies to have their records located in a number of locations across the Republic.
Pg 36 / S29(1)(e)(ii) / First page of financial statement to contain name of person responsible / This section requires the name of “the individual who prepared or supervised the preparation of” the financial statement to be stated on the first page.
Ultimately it is the directors who are responsible for such a process of preparation and supervision.
In many medium to large companies more than one person has the responsibility to prepare and supervise such a process.
Accordingly we suggest that the word “individual” be replaced by “individuals”.
Page 37 / S29 (4) / Timely issuance of Financial Reporting Standards / Section 29(4) tasks the Minister, after consulting the Council, with making regulations prescribing financial reporting standards and the form and content of summaries of financial statements.
We are concerned that there may be delay in the prescribing of regulations regarding IFRS which may lead to a situation where compliance with IFRS may constitute non compliance with the Act in cases where certain accounting standards have not been gazetted.
This , by way of example , may have serious consequences for companies listed on the JSE as the JSE has prescribed the use of IFRS for listed companies in order to attract and satisfy foreign investors. If there was any delay in the Minister gazetting changes to financial reporting standards then JSE listed companies may have to issue two differing sets of financial statements.
Accordingly we recommend that the Act allows the Financial Reporting Standards Council (“FRSC”) to issue new or amended standards as and when it needs to do so rather than requiring the Minister to gazette such standards as and when they frequently change.
This would then be similar to the way in which auditing standards are set and amended. When the Auditing Profession Act was introduced in 2006 the power to determine auditing standards was given to the Independent Regulatory Board for Auditors(“IRBA”). From time to time when international standards are issued the IRBA issues them locally as being effective in South Africa without having to get the Minister to gazette them.
Part C / Issuance of local accounting guidance and interpretations / The current provisions are silent as to the issuance of local accounting guidance and interpretations. We propose that the FRSC be charged with these responsibilities as well.
Pg 37 and pg 58 / S30 (1) and S61(7) / Annual financial statements to be prepared within 6 months and / Section 30(1) of the Bill requires a company to “prepare annual financial statements within 6 months after the end of its financial year…”
Section 61(7) of the Bill requires a public company to convene an annual general meeting “once in every calendar year, but no more than 15 months after the date of the previous annual general meeting…”
Section 179 of the Companies Act, 1973 allows for the AGM (where the annual financial statements have to be approved) to be held 9 months after the year-end, i.e. allowing the company 9 months to prepare the financial statements and present it to the AGM for approval. We recommend that the 9 month period be retained for both the preparation of the financial statements and the time within which the annual general meeting should be held.
Pg 36
Pg 37 / S28(1)
S30 (1) / Certain companies not required to maintain accounting records
nor prepare annual financial statements / In terms of S28(1) a company “must keep…accounting records…-- (a) as necessary to enable the company to satisfy its obligations in terms of this Act … with respect to the preparation of financial statements;” This means that if a company does not have to prepare financial statements as defined then it does not need to keep accounting records.
Secondly, in terms of S30(1) certain companies do not need to prepare “annual financial statements” nor any other type of financial statement if not required by the Act or any other law.
Whilst we can appreciate why an audit and audit committee would not be required for entities given exemption by this section, we question the wisdom of a company not being required to maintain accounting records nor to prepare financial statements.
We believe there should be a requirement for all companies to maintain accounting records and to prepare financial statements, for the following reasons:
a)A number of regulatory returns and statistics are generated from financial statements. For example the submission of tax returns and National Credit Regulatory returns for credit providers. There will be a risk that returns / statistics presented by / prepared from companies not required to prepare annual financial statements may be misstated or manipulated.