Ewald van Heerden discusses the differences between the Companies Act and the Close Corporations Act and weighs up the pros and cons of conversion
Subsequent to the effective date of the Companies Act 71 of 2008 (the Act) and the resultant changes to the Close Corporations Act 69 of 1984 (the CC Act) the differences between these entities and how they are impacted by legislation have been greatly reduced. It is clear from the changes to the Act and the subsequent moratorium on registrations of close corporations (CCs) that it is the intention of government to make the private company a more attractive business entity for smaller businesses and reduce the need for CCs.
Given that CCs still exist and will do so indefinitely, and may even be purchased off-the-shelf to house new businesses (albeit often at exorbitant prices), it is worth considering whether there is a need for converting your CC to a company, or even a compelling reason to do so.
As a first step we need to look at the differences between the Act and the CC Act. In many cases sections of the CC Act were repealed and one has to refer to a specified section of the Act which would then be applicable to CCs. From a broader point of view the impact of the two acts on the entities governed by them is very similar, especially if one was to compare it for two entities of similar size and characteristics.
There are some minor differences, however, and one that could very well impact small businesses is the requirement to have an accounting officer appointed in a CC. An owner-managed company that is small enough and qualifies for section 30(2A) of the Act exemption from independent review could theoretically perform the whole process related to accounting and financial statements in-house without the need for any highly qualified accounting staff or professional advisors, whereas a CC, irrespective of size, still requires the appointment of an accounting officer. The accounting officer has certain duties in relation to the financial statements, as set out in section 62 of the CC Act. This requirement may very well cost money, and in the case of some CCs this could constitute a significant and unwanted cost to the members. It is a serious offence if the members of the CC allow the office of accounting officer to be vacant for six months and the CC could lose the protection of limited liability should this be allowed to happen.
One technical difference that could have a significant impact on the directors or members of the entity in question is that the Act in section 76 provides for what is known as the business judgment rule. Directors of private companies will be able to take advantage of this protection which is not provided for members of a CC by the CC Act. The business judgment rule is designed to protect directors who follow certain steps from being liable to the company and shareholders for making bad business decisions. A director who wishes to take advantage of this protection needs to show that he or she acted in good faith and with proper purpose, in the best interests of the company, and with the necessary skill and diligence. In addition the director would need to satisfy some other very specific requirements which relate to being free of personal financial interests in the matter and in taking appropriate steps to become informed about the matter. While this may seem minor at first, this is a significant difference between the two pieces of legislation and provides protection for diligent directors that will enable them to operate the business in order to achieve maximum return for the shareholders without undue fear of liability.
In general a company does provide more protection to directors. There are a number of simple instances where a CC could lose its protection of limited liability. Take, for example, the fact that this could happen if the name of the CC is used without the CC abbreviation (or equivalent) and the conversion to a company could start to look very attractive.
Apart from the legislative aspects there may be other matters that may cause one to consider converting a CC to a company. One of those may be the future of the business and plans for expansion. Membership in a CC is restricted to natural persons and this would mean that a conversion would be required should one wish to move the entity into a position within a group where shareholding by a juristic person, such as a company, would be required. Even if the members have no intention of moving the CC into a group, the mere fact that membership of a CC is limited to ten people could inhibit the expansion of the business.
Finally, one may consider the trends in the corporate landscape as sufficient reason to convert. Use of a CC for business is by no means an indication of something sinister, but this particular business entity has developed a reputation as the “bad boy” of business because they have been subject to lower levels of regulation and were simpler to create. So, what was created as a simpler means to setting up and running a small business has been abused in some instances and this has contributed to the reasons for the changes we see now. Prior to 2011 no CCs were subject to an audit requirement and this in itself made it attractive for those who did not like to be looked at too closely. This reputation still plagues CCs and we see certain organisations being a bit more careful when it comes to their own due diligence when considering entering into contracts with businesses utilising this form of entity. This will certainly change over time as the market participants come to grips with the varying levels of regulation to which different companies may be subject. At this point you may not be alone if you consider the decision to convert your CC to a company likely to provide you with a friendlier reception within certain circles.
It is worth mentioning that as difficult it may be to find a reason why one should convert your CC to a company, it is just as difficult to find a reason not to. The rules regarding the administration and governance of the entities are now very similar. Consider for example the audit requirement. While an audit was applicable only to companies in the past, it now has exactly the same impact on CCs. If your CC has a public interest score over a certain level an audit is required, and this audit is performed to the exact same standards as applicable to a company.
There is no clear compelling reason for all CCs to convert to companies and many CCs will go about their daily business largely unaffected by the changes, but it may be in the best interests for some business people, especially considering the matters discussed above. It is clear that the opportunity to convert does exist and is more inviting than at any point under the previous Companies Act. ❐
Author: Ewald van Heerden is a director in the Risk Management Department of Mazars
