Broad-based black economic empowerment laws create a number of alternative arrangements that can be recognised towards a company’s ownership scorecard – share option arrangements being one of them.
For a share option arrangement to be recognised, there are four criteria that must be fulfilled.
- Criteria 1: the BEE partner must have a written option to acquire the relevant shares at a future date;
- Criteria 2: exercisable voting rights attached to those shares must be transferred to the BEE partner as the option holder;
- Criteria 3: the value of economic interest must be transferred to the BEE partner as the option holder; and
- Criteria 4: the value of the shares must be determined using the standard valuation method for calculating net value.
If the shares are issued shares that are already held by existing shareholders, compliance with these four criteria is relatively simple. The existing shareholder can grant an option over the number of shares required to provide the desired ownership percentage recognition, and the same shareholder can transfer the voting rights and rights to dividends (i.e. economic interest) from those shares to the BEE partner. Therefore, although the BEE partner does not actually hold the shares, they have the rights required for ownership to be recognised for BEE purposes.
It is commonplace to also see these share option arrangements being implemented in relation to shares that are authorised but unissued. This is where compliance with the criteria becomes more difficult.
Criteria 1 now relates to an option to be granted over shares not yet issued. Whilst unusual to refer to this arrangement as an option, this criterion can be complied through an agreement between the underlying company and the BEE partner for the BEE partner to subscribe for shares at a future date.
Compliance with Criteria 2 is where there is a conflict with company law when purporting to implement an option arrangement in relation to unissued shares. Criteria 2 requires that the voting rights attached to the shares that the option is over must be transferred. However, under company law, the rights attached to that share are not exercisable until a share is issued. The rights in relation to unissued shares are not recognised towards a company’s ownership when it is calculated in terms of company law or BEE law. How could there be a transfer of voting rights for purposes of compliance with Criteria 2? We have seen it contended that Criteria 2 is complied with by the voting rights of issued shares being transferred to the BEE partner whilst the option is over unissued shares. However, the wording of Criteria 2 is clear – the voting rights must be those attaching to shares that the option is granted over.
Criteria 3 only requires that the” value” of the economic interest must be transferred. This different wording allows for a contract between the parties to ensure that the BEE partner receives the equivalent value of dividends that the BEE partner would have received if they had held unissued shares, using the standard valuation required by Criteria 4.
All four of the criteria must be complied with in order for an option arrangement to be recognised towards the ownership scorecard of a company. Based on the wording of the BEE laws, there is a distinct difference between compliance with the voting right criteria in the instance of an option over issued shares versus an option over unissued shares. BEE laws cannot override company law. The relevant wording in relation to Criteria 2 would need to be amended to allow for an option arrangement to be recognised in relation to unissued shares.
Share option arrangements over unissued shares do not comply with company and BEE laws. Such arrangements have been approved by BEE consultants and verification agents. So, a word to the wary. The best way to avoid having to correct an existing ownership arrangement and mitigate any potential risks of non-recognition or fronting, is to have the proposed arrangement reviewed by a legal practitioner before implementation to ensure that the arrangement complies with company as well as BEE laws.