Directorship and shareholding

[IzZzy]

The articles weren't clearly defined here by the sounds of things so revert to shareholding. Personally I've never involved myself in any business where a shareholders' agreement does not exist, so I'm not 100% clued up here. You'd absolutely know better than me here.

A company -has- to have an articles of association. So by all sounds of things, they used the standard Table B articles. Therefore there is some ground rules in existence (which aren't necessarily well developed as a shareholders' agreement would be). I suggest pulling this out and having a good read!

Although DJ... it sounds to be to be the opposite: They have a minority equity stake in a company with no board representation i.e. they are screwed. Personally I wouldn't do anything. Though I am not sure what commercial arrangement OP wants to reach? First step...speak to them and find out their intentions.

Also, unless I missed something, I don't see anything pointing that they would be a section 53(b) company?

 

[Cloud]

A company -has- to have an articles of association. So by all sounds of things, they used the standard Table B articles. Therefore there is some ground rules in existence (which aren't necessarily well developed as a shareholders' agreement would be). I suggest pulling this out and having a good read!

Although DJ... it sounds to be to be the opposite: They have a minority equity stake in a company with no board representation i.e. they are screwed. Personally I wouldn't do anything. Though I am not sure what commercial arrangement OP wants to reach? First step...speak to them and find out their intentions.

Also, unless I missed something, I don't see anything pointing that they would be a section 53(b) company?

I have a meeting with the investors this week after which I will have a better idea of whats cooking. Just wanted to know what ground I have to stand on, and ideally I would not want to aggravate them unnecessarily. They have been honest and open with us up until this point.

However business is never personal, so I would like to know where I stand before I go speak to them.

 

[DJ...]

This is not their first rodeo, and they have a personal relationship with the third person, so they do not owe my brother or myself anything.

Shrewd. Sounds to me like you might land up learning a rather expensive lesson. If you are liable for the debt, which as far as I'm concerned you are, Izzy can go into more detail, but it could result in your assets being attached. Izzy will know better here. You are correct though that they don't owe you anything as the business has no revenue and therefore no value...

All I really want out of this is what is fair as I really put a lot into it for the first year. I cannot afford a legal battle, and the last thing I want is to be saddled with paying back the money they invested.

Unfortunately your time and input is not rewarded as a director unless you've agreed to bill the company. That is the risk you take when you start a business - it cannot magically print money without revenue to pay you a severance, and there are certainly no dividends to be paid out. Your income is based on revenue and profitability, of which there exists none as it stands, and there is no value to the company. The likelihood of getting anything whatsoever from them is in my opinion, zilch, to be frank. However should you somehow manage to retain your shares, there might be some future value locked in there, however they could force your hand here by sweetening the pot to preclude you from debt repayment in the event of the company going under...

The product / service is not worthless, in fact it might still go on to do very well. The three of us would never have been able to fully launch it to market with our limited resources. It was always understood that at some point it would be handed over to someone with more marketing / business experience.

If it is a product then I don't understand why you went with the Section 53 registration. What was the rationale behind this? Any company that needs to incur debt for operational purposes should afford its directors liability protection...

I just don't feel comfortable resigning my position in the business without some kind of shareholders agreement.

Perhaps Izzy has some advice here. As far as I'm concerned, this will be an expensive lesson you land up learning, but perhaps there is an out for you here. I don't see it...

 

[DJ...]

A company -has- to have an articles of association. So by all sounds of things, they used the standard Table B articles. Therefore there is some ground rules in existence (which aren't necessarily well developed as a shareholders' agreement would be). I suggest pulling this out and having a good read!

Although DJ... it sounds to be to be the opposite: They have a minority equity stake in a company with no board representation i.e. they are screwed. Personally I wouldn't do anything. Though I am not sure what commercial arrangement OP wants to reach? First step...speak to them and find out their intentions.

Also, unless I missed something, I don't see anything pointing that they would be a section 53(b) company?

My assumption here was that between the third director and the investors, as a group they hold majority control of the board. They're also (inc) which I've always associated with Section 53 companies. Regarding the debt here, assuming they're section 53 registered, is it possible for the company to incur debt and have the shareholders personally sign for some sort of liability protection?

 

[DJ...]

Cloud, you didn't mention how the IP is protected and who owns the IP...

 

[Cloud]

I am not sure if it is a section 53 as you say. Will have to look at the documentation. We agreed and signed documentation that exempted us from paying back the investment if we don not make money.

This was communicated to us in numerous meetings as well. That is why they took equity as well, as it was a high risk investment for them.

I must admit I am royally freaked out now as I have a flat in my name that I am paying off. I am not the only director though, so if they screw me they screw the other two directors too, of which the third person is also a part.

 

[Cloud]

Cloud, you didn't mention how the IP is protected and who owns the IP...

Well, the three of us signed a document with the idea on where we state it belongs to us. It was never transferred to the company. The investors are not aware of this document. It was done at the beginning to insulate us. How valid it would be in court I do not know.

 

[IzZzy]

You need to urgently do your homework and check whether you are a (Pty) Ltd or an Inc. If you are an Inc, well then there isn't really a "separation of liability" between the Company's contractual debts and yours, as a shareholder.

AFAIK unless you are a firm of attorneys, accountants etc - there really isn't any reason for you to ever be an Inc.

Regarding the debt scenario (and assuming it is an Inc.), I would distinguish between debts to third parties and debts to shareholders. I would simply state that whatever assurance you received from the other shareholders means that whilst you are liable to third parties, you wouldn't be liable for your pro rata share to debts incurred to other shareholders.

Look, at the end of the day - until you read all the related company documents: do not sign anything and do not agree (even orally) to anything. At your next meeting, if it starts to take the form of negotiations - tell them that there is no oral agreement unless it is reduced to writing and signed by all parties.

I can't believe that these wouldn't be too far from hand - considering that (1) you are a director and (2) you have outside investors.

I still can't work out the shareholding structure, other than "the investors" have 33%. If you and your brother have control (50% plus one), you are in the pound seat.

What is clear is that if you give up possession of the company (through giving up your board seat), and you remain a minority shareholder - you are royally screwed. The only quid pro quo for that would be a detailed shareholders agreement with numerous minority protections and information sharing provisions.

 

[Cloud]

You need to urgently do your homework and check whether you are a (Pty) Ltd or an Inc. If you are an Inc, well then there isn't really a "separation of liability" between the Company's contractual debts and yours, as a shareholder.

AFAIK unless you are a firm of attorneys, accountants etc - there really isn't any reason for you to ever be an Inc.

Regarding the debt scenario (and assuming it is an Inc.), I would distinguish between debts to third parties and debts to shareholders. I would simply state that whatever assurance you received from the other shareholders means that whilst you are liable to third parties, you wouldn't be liable for your pro rata share to debts incurred to other shareholders.

Look, at the end of the day - until you read all the related company documents: do not sign anything and do not agree (even orally) to anything. At your next meeting, if it starts to take the form of negotiations - tell them that there is no oral agreement unless it is reduced to writing and signed by all parties.

I can't believe that these wouldn't be too far from hand - considering that (1) you are a director and (2) you have outside investors.

I still can't work out the shareholding structure, other than "the investors" have 33%. If you and your brother have control (50% plus one), you are in the pound seat.

What is clear is that if you give up possession of the company (through giving up your board seat), and you remain a minority shareholder - you are royally screwed. The only quid pro quo for that would be a detailed shareholders agreement with numerous minority protections and information sharing provisions.

We are PTY (LTD) as far as I know, sorry about the INC confusion. Almost 100% sure we are not INC. The investors have 33%, and the rest of it is divided equally between me, my brother and the third person. Thus we have about 22% each. My brother and I together hold 44%.

The investors want to add one of their own to the board as a director. What would be the implications of the current board (me, my brother and the third person) stay on and just add one more director? Is this a reasonable proposition to make to the investors?

As it stands they want my brother and I to resign as directors and add one more to the board with the third person staying on as director. Then, as you say IzZzy, we would need an air tight shareholders agreement to ensure we don't lose our shares.

 

[Dracogus]

This is my first post guys so be kind.

Firstly articles of association in old Companies Act, Memorandum of Association is new companies act terms.

Secondly, it seems you have a shareholding in the company. Not majority so you cant do anything, they can kick you off the board though they cannot take away your shareholding %. They cant come for your assets as you did sign an agreement and it was a risk the company did take on when lending you unsecured money. You did give them shares so at the start up of the company one could say that money was share capital invested by them. Your share capital would be your involvement in the company, also the agreement to not pay you a salary could be taken to mean then your salary will go to share capital or a loan to the business as it will be invested further by you in the business. You can then claim that back from the company, you have a valid right to shares given your investment on not getting your salary.

Now I assume you have securities documents that show you hold shares in the company.

I would look at trying to patent the idea you guys have. If you have done a lot of work on the project and are central to the understanding of it then you can quietly go and patent it. Also maybe speak to the other parties in the meantime and try to unsettle them as to how they can go about this project without you and the integral information you have.

For your brother: I assume he has no shares, accordingly all he will be entitled to is a salary if he has been getting one. It is a tough pickle for your bro as he wont be entitled to much given his scenario and predicament and the amount of work performed by him.

At the end of the day: You will get removed from your office and there is little you can do. You can go quietly or loudly. Just tell them that since you didnt take your salary that can be inferred as a loan to the company since it was then re-invested by the company. You do have shares and the right to receive a just amount for them. Look at trying to patent the idea to protect yourself a bit.

Hope this helps

-Giving up possession of your board seat wont screw you, since you and your brother both own 44% together thus you may not be kicked out by them (they may have a majority though the companies act protects minority shareholders quite well, if they do wanna remove you then they have to go through a huge legal process and offer you "fair compensation" for your share and a court will review that to ensure it is fair). It appears to be an unsecured debt/capital for shares so again you cant lose any assets. Memorandum should state the shareholding % so they cant take that away from you and you should have your share certificates. All in all, move on like you starting a new life. Accept the board resignation though they cant take your shares away from you. So hold onto those puppies.

 

[Dracogus]

You shouldnt lose your shares, as long as everyone was under the understanding at inception that the investing company was receiving 33% and the rest split between you all. In court if there is no shareholders agreement they will revert to any correspondences (emails, letters) also they may even look at the contribution of each person to the company and then split it accordingly based upon that. Also the memorandum of incorporation should state the shareholder % firstly.

 

[IzZzy]

Firstly articles of association in old Companies Act, Memorandum of Association is new companies act terms.

Memorandum of incorporation. The only reason to still refer to it as "articles of association" is familiarity, but alas, nothing turns on this.

OP, sounds like you don't have (with your brother) majority control of the shares. Tough situation, but you do have negative control in the sense that they cannot do a whole host of transactions without your consent. Refer s65(11) of the Companies Act.

By adding the other person on as a director (without anyone resigning), means that you are headed to potential deadlock territory as, more than likely, it will be a 2 way split. You would need to factor in a deadlock breaking mechanism here.

 

[Cloud]

Hey Dracogus, thanks for your input, it is appreciated.

The idea is software related, therefore patenting it is not possible (as far as I know in South Africa you cannot patent software).

There is also prior art, our concept is an elaboration of existing services in the market.

So in your opinion, our resignation as directors will have no bearing on our shareholding? What if a potential buyer comes along and they want to sell our shares, will we still have a say even though we are no longer directors?

 

[Cloud]

Memorandum of incorporation. The only reason to still refer to it as "articles of association" is familiarity, but alas, nothing turns on this.

OP, sounds like you don't have (with your brother) majority control of the shares. Tough situation, but you do have negative control in the sense that they cannot do a whole host of transactions without your consent. Refer s65(11) of the Companies Act.

By adding the other person on as a director (without anyone resigning), means that you are headed to potential deadlock territory as, more than likely, it will be a 2 way split. You would need to factor in a deadlock breaking mechanism here.

If my brother and I resign, without a shareholders agreement in place, would they be able to sell our shares without our consent?

 

[IzZzy]

So in your opinion, our resignation as directors will have no bearing on our shareholding? What if a potential buyer comes along and they want to sell our shares, will we still have a say even though we are no longer directors?

Unless you have any contractual documents in place regarding forced sale mechanisms, options, puts etc etc etc or power of attorneys - then no they cannot sell your shares. I would hazard a guess that you have a reciprocal pre-emptive right in the standard articles, but this wouldn't ordinarily go further than merely stating that anyone who desires to sell must first offer their shareholding to the other shareholders.

Don't get it confused with them selling the business out from the company - which would require 75% shareholder approval (which you and your brother can stop).

However, if they are shrewd businessmen, if they take control - plan A would be to dilute your shareholding (by introducing further shareholders, rights offers etc etc etc) to below 25% and therefore, insignificance.

 

[Cloud]

Unless you have any contractual documents in place regarding forced sale mechanisms, options, puts etc etc etc or power of attorneys - then no they cannot sell your shares. I would hazard a guess that you have a reciprocal pre-emptive right in the standard articles, but this wouldn't ordinarily go further than merely stating that anyone who desires to sell must first offer their shareholding to the other shareholders.

Don't get it confused with them selling the business out from the company - which would require 75% shareholder approval (which you and your brother can stop).

However, if they are shrewd businessmen, if they take control - plan A would be to dilute your shareholding (by introducing further shareholders, rights offers etc etc etc) to below 25% and therefore, insignificance.

That is my concern - what can we put in place to prevent them from diluting our shares in the even of us resigning as directors?

 

[IzZzy]

If my brother and I resign, without a shareholders agreement in place, would they be able to sell our shares without our consent?

You need to think long and hard about your demands if you were to concede to resign. By requiring a stringent shareholders agreement, they may similarly require that forced sale mechanisms be included. So by getting significant contractual rights, you'd be giving to them this power. Just something to think about what you can live with, because it is a commercial decision.

That is my concern - what can we put in place to prevent them from diluting our shares in the even of us resigning as directors?

A shareholders' agreement.

 

[Dracogus]

Does the memorandum of incorporation (forgot it was incorporation since had read so many associations, mind fried) state the shareholding % as it should?

If it does then you hold your shares, if there is no shareholders agreement then as long as you have your share certificates per s49, regardless of if they are certified or uncertified. Like I said earlier, you guys will be minority though they cant remove you due to the minority you have is quite large. They wont be able to pass any special resolutions while you and your brother are shareholders since they will need a minimum of 60% (assuming ordinary has stayed at 50%). Now this will be a huge stumbling block for them and quite short sighted thinking on their side. I assume they will just try bully you to give up shares though they cant if you have share certificates and the loan thing cant touch you given it is their share capital investment.

 

[IzZzy]

Well, the three of us signed a document with the idea on where we state it belongs to us. It was never transferred to the company. The investors are not aware of this document. It was done at the beginning to insulate us. How valid it would be in court I do not know.

Underneath all the garbage, this is the biggest elephant in the room. You need to regularise this ASAP. If the investors' did not have knowledge of the fact that the company did not own the IP, you can be certain that they will fight you tooth and nail (because frankly, without the IP, the company is worthless) and you would probably face allegations of 'misrepresentation'.

 

[IzZzy]

Does the memorandum of incorporation (forgot it was incorporation since had read so many associations, mind fried) state the shareholding % as it should?

If it does then you hold your shares

I'm sorry I don't agree. There is no requirement that a MOI state shareholding split. If it is done, it is for convenience only. It is not definitive of your shareholding.

They wont be able to pass any special resolutions while you and your brother are shareholders since they will need a minimum of 60% (assuming ordinary has stayed at 50%).

Again, I don't agree. Unless they have specifically altered the minimum threshold for special resolutions from 75% - I don't think you can make dangerous statements like that without any factual reliance or inference. Precisely because they still refer to it as "articles of association" lends credence to the belief that it is still the old table B articles in terms of the previous Companies Act, and therefore the 75% minimum special resolution stands.