Lesson 12: Companies Act

Section 2 and section 4

Section 2: Related and interrelated persons, and control

This section is important as there are a number of other sections in the

Companies Act that refer to related parties. It is important for you to be
able to identify a related party so that you as an auditor can identify any
relationships that may transgress legislation when conducting business
transactions. Learn the definition of the terms control, consanguinity
and affinity thoroughly. Remember that directors are required to submit
a declaration of all interests held and related parties (section 12(1)) at
least annually or when any significant change occurs. Directors must also
declare whether they have any conflicts of interest in respect of matters
on the agenda of board or committee meetings. Revise the lesson on
Related parties in TL104 to supplement your understanding.

Section 4: Solvency and liquidity test

This section requires the company’s directors to ensure that a company

should satisfy the solvency and liquidity test when making certain
decisions and/or passing resolutions. The solvency and liquidity test
“refers to the ability of a company at any reasonable point in time to
ensure the assets of the company are fairly valued, equal or exceed the
liabilities of the company, fairly value”. This is a very important section,
and you should be able to apply the solvency and liquidity test in relation
to resolutions passed by a company’s directors to ensure that they have
complied with this section of the Companies Act.
Section 8: Categorisation of companies

Part B – Incorporation and legal status of companies

Revise and study

Section 15 to 16 and 19 to 22 – Incorporation and legal status of

companies

Section 15 and 16

These sections refer to the memorandum of incorporation, which is also

known as the founding document of a company. This document sets out
shareholdrs, directors and others duties, responsibilities and rights. You
have already come across this term within the finance and investment
business process (lesson 9.5). remember, a company is not allowed to
enter loans or capital expenditure that is against its memorandum of
incorporation. This section also allows for the board of a company to
amend or repeal any rules in accordance with the Companies Act.

Section 19 to 22

These sections refer to legal status of companies, the validity of actions in

line with the memorandum of incorporation, the application of pre-
incorporation contracts and the liability thereof as well the prohibition of
reckless trading. It is important to understand what pre-incorporation
contracts and reckless trading are.

- Pre-incorporation contracts are entered into, with, or on behalf

of a company that is not yet incorporated. This section is necessary,
as the company does not exist as a juristic person prior to
incorporation, which implies that it cannot exercise its powers.
- The prohibition of reckless trading is explained as to “a
company must not carry on its business recklessly, with gross
negligence, with intent to defraud any person or for any fraudulent
purpose; or trade under insolvent circumstances”. This section is
important and links directly with the prior lessons on going concern
and possible reportable irregularities (lessons 11.1 and 11.4). It
should be studied in conjunction with Regulation 19 of the act.
Section 22 refers to the prohibition of reckless trading and that the
Commission may require the company to cease carrying on
business, whereas section 77(3) further on in the companies act
provides the directors of a company are liable for losses, damages
or costs incurred as a consequence of carrying on the company’s
business while knowing it is in contravention of Section 22, that is,
trading recklessly.
Section 23 and section 24

A company must register with the Commission within 20 days after it

begins conducting business and must ensure it maintains one office in the
republic. Section 24 further requires companies to keep accurate and
complete accounting records, and other documents set out in this section.
Regulation 23 specifies additional information required for a company’s
record of directors. This is an important section for an auditor within an
assurance engagement. Instances of incomplete accounting records and
documents can initiate non compliance with this section.

Section 27 and section 30

All companies must have a finance year with a dater as set out in the
notice of incorporation. A companys financial year is the annual
accounting period. All companies must keep accurate and complete
accounting records and financial statements as set out in section 28 and
section 29 of the act respectively.

Important to note:

Remember, in section 8 we discussed the need or a company to

determine its category in accordance with the Act. This will determine
whether the company is required to be audited or independently
reviewed. This will also affect the financial reporting standards applicable
to the company.

Revise and study

With this in mind, study Regulations 27 to 29 in auditing notes regarding

the financial reporting standard requirements (for example, use of IFRS)
as well as the audit or review requirements referred to above.
Section 35

Section 35 refers to the legal nature of company shares and requirements

to have shareholders. Share are authorised in the MI and the MOI sets out
the different classes and number of shares. Please note that a company is
not allowed to issue shares to itself (section 35(3)) (not to be confused
with a company buying back its own shares in terms of section 48 of the
act)

Section 36

Section 36 is also an important section and refers to the authorisation for

shares. Should a company want to change the classification, aurhotisation
or number of shares, the MOI must be amended in terms of

- A special resolution of shareholders (section 36(2)(a)); or

- Through the board of the company (unless prohibited by the MOI)
(section 36(2)(b))
- Section 36(3) further allows the board to make the following
changes:
o Change the number of authorized shares
o Reclassify classified shares that are authorised but not issued;
o Classify unclassified shares that are authorised but not issued;
and
o Determine the preferences, rights and limitations of
authorised shares

Section 37

Section 37 refers to preferences, rights, limitations and other share terms.

Section 38 prescribes the issuing of shares. The board of directors has the
power to issue shares (that are authorised in the MOI). It is important to
take note that this section also allows the board to increase the issue of
shares or issue unauthorised shares that are retroactively authorized (by
special resolution) by the shareholders within 60 business days.

Section 39
Section 39 is applicable to the subscription of shares in private companies
unless if provided otherwise in the MOI ( for public or state owned
companies). Section 40 refers to the adequate consideration required for
the issue of authorised shares. Section 41, practice, is relevant to the
public sector and provides that a registered auditor may engage in public
practice. The section does not prohibit the Auditor General from
appointing any person who is not a registered auditor. To carry out on his
behalf, any audit in terms of the Public Audit Act 25 of 2004. Sections 42
and 43 refer to options for securities and securities other than shares.

Section 44:

Section 44 (important section) provides for a company to offer financial

assistance for the subscription of its own/related company’s securities
(such as shares). Financial assistance according to the act may be in the
form of a loan, guarantee, or a provision of security. This section is not
applicable to companies who lend money in the ordinary course of
business except to the extent that the MOI provides otherwise.

The following conditions should be met before authorising any financial

assistance:

- Any conditions set out in the MOI in this regard should be adhered to
- A liquidity/solvency test should be satisfied immediately after the
financial assistance has been granted
- Fair and reasonable terms should apply to the financial assistance
- A special resolution should be obtained (must have been passed
within the previous two years)

Non-adherence to these requirements above (section 44) will result in:

- The transaction being void; and

- The directors may be held liable for losses incurred by the company
is this regard

Section 45

Section 45 (important section) represents loans or other financial

assistance for directors. Exclusions to this section include:

- Lending money in the ordinary course of business

 - Financial assistance to pay for legal expenses for a matter
concerning the company;
- Financial assistance for anticipated expenses to be incurred on
behalf of the company; and
- To defray the personal expenses for removal at the companys
request

The following conditions should be met before providing the assistance:

- Any conditions set out in the MOI in this regard should be adhered to
- A liquidity/solvency test should be satisfied immediately after the
financial assistance has been granted
- The terms should be fair and reasonable
- A special resolutions should be obtained (must have been passed
within the previous two years) except if the financial assistance is
pursuant to the employee share scheme
- Written notice of the meeting and of the intended assistance should
be given to shareholders (unless all shareholders are directors)
- Written notice of the meeting and of the intended assistance should
be given to any trade union that is representing the employees of
the company

If the requirements of section 45 are not adhered to:

- The transaction will be void; and

- The directors may be held liable for losses incurred by the company

Section 46

Section 46 requires a company to not make any proposed distributions

unless it is authorised by the board. It is important to note that
distributions include payments for share buybacks and the payment of
dividends

The requirtemetns to make the distribution include that:

- The distribution is pursuant to an existing legal obligation

- The board of the company by resolution has authorised the
distribution
- The company will satisfy the solvency and liquidity test after
completing the proposed distribution; and
 - The satisfaction of the solvency and liquidity test is acknowledged
by the board

Section 48

Section 48 allows a company to buy back its own shares provided the
requirements are met. These requirements include:

- No more than 10%, in aggregate, of any class of shares is held by or

for the benefit of all the subsidiaries taken together; and
- The voting rights attached to those shares are not exercised

Section 57 to 69 and 71 to 78 – Governance of companies

These sections refer to the governance of companies. This part of the act
focuses on the shareholder. You should revise the definition of
“shareholder” and add to it, “including a person who is entitled to exercise
any voting right in relation to a company, irrespective of the form, title or
nature of the securities to which those voting rights are attached”
(Section 57(1). Section 58 follows and refers to the rights of a
shareholder being represented by a proxy. Remember the proxy must be
in writing, dated and signed by the shareholder. Section 60 allows for
shareholders to vote other than at meetings. Section 61 to 64 refer to
shareholders meetings. Section 62 explains that the notice of meetings
should be done at least 15 business days before a meeting begins for any
other case. Section 64 refers to meeting the quorum and adjournment.

One of the more important sections under the governance of companies is

section 65 which refers to shareholders resolutions. Shareholders
resolutions can be either:

- Ordinary resolutions (must be supported by more than 50% of

voting rights exercised); or
- Special resolutions (must be supported by at least 75% of voting
rights exercised)
- The MOI may require a higher percentage of voting rights for
ordinary resolutions to be approved (except for the removal of a
director under section 71), or one or more higher percentages of
voting rights in order to approve ordinary resolutions on one or more
specific matters (section 65(8)). The percentage required for special
resolutions to be approved may be lower, as provided for the MOI.
- There should be at least a 10% difference between the percentage
approval required for ordinary and special resolutions (section 65(8))
Refer to section 65(11) of the act and auditing notes for a list of instances
where a special resolution is required in terms of the companies act.

Section 66

Section 66 requires companies to be manages by a board of directors.

Study Regulation 38 as well. The board of a company should comprise a
minimum number of directors. These numbers are tabulated below: (the
MOI may specify a higher number)

Type of company Minimum number

of directors
Private company (Pty) Ltd 1
Personal liability company (Inc) 1
Public company (Ltd) 3
Non-profit company (NPC) 3

In addition to the minimum number of directors as prescribed (by the act

or MOI), a company must also satisfy the requirements of Section 72(4) to
appoint an audit committee or a social and ethics committee.

A profit company (other than a state owned company) must allow

shareholders to elect a minimum of 50% of shareholders of the directors
and 50% of alternate directors may be appointed by any other person
stipulated in the MOI.

Directors remuneration for services acting as directors require to be

approved by a special resolution. This special resolution will be valid for
two years.
Section 69 prescribes the ineligibility and disqualification of persons to be
a director or prescribed officer for the company.

Section 70 refers to vacancies on the board and requires the vacancy to

be filled by a new appointment or by a new election at the AGM or in any
other case within six months after the vacancy arose. The company
should also file a notice with the Commission when a person is added or
removed as a director of the company.

Section 71 refers to the removal of directors. In this regard, a director may

be removed by an ordinary resolution adopted at a shareholders meeting.

Section 72 refers to board committee. The act provides that, except

when the MOI provides otherwise, the board of directors may appoint any
number of committes and may delegate any of the authority of the board
to a committee. The board is responsible for performing its duties
properly, and a director or the board cannot use the appointment of a
committee as a shield against their own responsibility. You should study
regulation 43 of the act with regard to the social and ethics committee,
in conjunction with this section.

The following sections mentioned below are very important nd will often
arise while performing an audit. Students should remember to consider
sections 76 and 77 as part of their answers as a consequence of the
transgression of certain of the other sections in the companies act

Section 75: Directors personal financial interest

The act sets out procedures required for a director to disclose a personal
financial interest of that director, or of a person related to that director, in
respect of any matter to be considered by the board. In simple terms, if a
director has a personal financial interest in any contract that will be
concluded, this should be disclosed. Study the definitions of related
persons, directors within this section, and a personal financial interest in
terms of section 1. You will notice aht this section was previously identified
in the lesson on related parties.
Section 76: Standard of directors conduct

For the purpose of this section, directors include prescribed officers and
members of the board committees. This section requires that a director of
a company must exercise the powers and functions of a director in good
faith and in the best interest of the company, and must act within a
certain degree of care, diligence and skill. This section also extends the
duty to apply to a subsidiary.

Section 77: Liability of directors and prescribed officers

This section refers to instances where a director and prescribed officer in

breach of fiduciary duty may be held liable for losses suffered by the
company. These breaches include:

- Acting for the company without authority

- Carrying on business “recklessly” (section 20)
- Being part to an act that defrauds creditors, employees or
shareholders

Please note that members of board committees and audit committees will
have the same liability that directors have under section 77, even if the
members of the board committees are not directors and even though they
have no right to vote on any matters considered by the board committees.

Section Description
84 to 85 Application and general requirements
Sections 84 and 85 refer to the requirements to appoint a company
secretary and an auditor. If the company is a public company or state
owned company, section 84(4) will apply and a company secretary and
auditor must be appointed. This requirement is not applicable if the
auditor general has elected to appoint an external auditor for that year.
However, if the company is not a public company or state owned
company, this requirement does not apply. Please note the exceptions if
the MOI has this as a requirement. Also refer to Regulations 26 to 28.

Section Description
86 to 89 Company secretary

These sections refer to the qualities of the company secretary and the
required knowledge and experience to perform the expected duties. In
addition, the duties of the company secretary are listed (section 88). You
should understand the requirements for the appointment and
resignation/removal of the company secretary.

Regulation 26 and “public interest score”

The public interest score is used to calculate if a company or close

corporation should be externally audited. The underlying decision to be
externally audited is focused on public interest in the entity. As a result,
the companies Act 2008 and its accompanying regulations stipulate that
all companies and close corporations must calculate their public interest
score each financial year.

These are based on factors that determine the level of interest the public
has in the entity. An antity’s public interest score will be the sum of:

- A number of point equal to the average number of employees

during the financial year;
- One point for every R1 million (or portion thereof) of turnover;
- One point for every R1 million (or portion thereof) of third party
liability at year end; and
- One point for every individual who directly or indirectly has a
beneficial interest in any of the companys shares/members interests

The following table summarizes this:

Public interest score in Company Close corporations and
points owner managed
companies
Less than 100 Review No assurance
engagement required
100 to 349 Audit if AFS internally Audit if AFS internally
compiled compiled
Review if AFS No assurance required
externally compiled if AFS externally
compiled

(note: close
corporations and
owner managed
companies have the
same owners and
managers, thus, using
external compiler
increases the level of
credibility of AFS)
350 and above Audit (regardless of Audit (regardless of
who compiles the AFS) who compiles the AFS)

In addition to audit and review requirements arising from public interest

scores, the companies act 2008 and the regulations make it obligatory for
certain other companies to have their annual financial statements
audited, regardless of their public interest score.

These are:

- Public companies and state owned companies; and

- Companies which hold assets (exceeding R5 million) in the ordinary
course of their primary activities in a fiduciary capacity for persons
not related to the company. The reason these specific requirements
is obvious – there is a strong element of public interest.

Refer to auditing notes, chapter 3, for an example of calculating public

interest score
Activity 12.1.2

Your firm was appointed as the auditors of Help you Tax (Pty) Ltd for the
previous three years. The company complies with the requirements of the
companies act. The following matters have come to light during the 20x4
financial year:

1. The companys newly appointed internal audit unit discovered

several personal financial contracts of directors that were not
disclosed. The board of directors dismissed the guilty directors and
issued a letter of termination of services to your audit firm with
reasons linked to negligence in prior audits
2. The board of the company passed an amendment to the
memorandum of incorporation regarding the minimum and
maximum number of directors by decreasing the number to a
minimum of three and a maximum of five directors with an ordinary
resolution
3. The chairman of the board authorized an amount of R20 000 to
assist with speeding up outstanding matters at local revenue
authorities
Required:

1. Discuss in terms of the requirements of the companies act the

validity of the dismissal of the (i) directors; and (ii) your firm as
auditors
2. Discuss the appropriateness of the amendment of the MOI in terms
of the companies act
3. Discuss in terms of the requirements of the Companies act 76 the
actions of the chairman of the board in respect of the R20 000
payment made.

Part 1

(i) Dismissal of directors (Section 71)

The dismissal of directors may be carried out regardless of the
provisions of the memorandum of incorporation, rules or
agreement between the company and the directors
 The dismissal of directors of a company are carried out
through an ordinary resolution
 Directors must be given notice of the meeting and the
proposed resolution, at least the same as what the
shareholders are entitled to receive
 The directors should be afforded the opportunity to
make a presentation at the meeting before the
resolution to remove that is voted on

(ii) Dismissal of auditors (Section 90 to 93)

Section 90 of the companies act states that the auditors of a
company may only be appointed yearly at the annual general
meeting. Therefore, as your firm was re-appointed at the
preceding AGM, the firm will hold office until the next AGM.
Section 90 further iterates that your firm will remain in
appointment until the next AGM unless there is notice given of
the intention to replace your firm as auditors by the members of
the AGM

Hence, your firms dismissal is not valid as the directors do not

have the authority to dismiss the auditors
Part 2

Section 16 of the companies act requires the MOI to be amended under

the following conditions:

- In compliance with a court order

- In accordance with section 36; or
- At any other time with a special resolution when it is proposed by
the board of the company, or the shareholders entitled to at least
10% of the voting rights and is adopted at the shareholders meeting

Hence the ordinary resolution does not meet the requirements and the
resolution is not valid

Part 3

Section 76 requires directors of a company to not knowingly cause harm

to the company. In addition, a director must exercise his power and
perform his functions with good faith, in the interest of the company and
with a degree of care, skill and experience that may be reasonably
expected of such a person in a similar position.