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Journals Collection, Juta's/Acta Juridica (2000 to date)/Acta Juridica/2010/Part I Corporate formation and corporate finance/Articles/The new legal capital regime in
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The new legal capital regime in South Africa

2010 Acta Juridica 131
*
James J Hanks, JR
REMEMBRANCE
Mike Larkin was a sweet and gentle man. I knew him primarily as a teacher and considered him a friend. On my trips to South Africa during the
period of Company Law Reform, he often asked me to teach a class or two in his courses at Wits or UCT, generally followed by dinner with others
and hearty conversation. Unfailingly courteous and constitutionally respectful of others' views, he seemed more interested in what he could learn
than what he could say. In the din of many voices, this grace sometimes obscured, although only briefly, a keen mind operating at a fine pitch. As
the horror of his violent and far too early death recedes, we are left with the warm memories of a wonderful human being, whom all of his friends
were honored to know. This essay is for Mike Larkin.
For nearly two centuries, many countries have addressed, through statutes and case law, the issues of minimum capital for companies and
limiting companies' power to distribute cash and other assets to shareholders. Often company statutes have addressed these issues
conjunctively, although they are not necessarily economically related. Following the lead of the Model Business Corporation Act in the United
States, the new Companies Act 2008 wisely eschews minimum capital requirements, eliminates the artificial concept of par value and nominal
capital and further refines the equity and balance sheet solvency tests for distributions to shareholders and applies it to all forms of distribution.
In some cases, the 2008 Act improves on the Model Act. While these advances should be applauded, further consideration should be given to
whether the balance sheet solvency test has any utility and whether the true concern of company law in limiting distributions should be confined
to the equity solvency test.

I Introduction
Since the early days of corporations, 'legal capital' ­ the rules governing contributions to capital by shareholders and distributions from capital to
shareholders ­ has played a central and often vexed role in the allocation of power and economics among the corporation, shareholders, board
of directors, creditors and others. Most troublesome of all is whether (and, if

2010 Acta Juridica 132

so, how) corporation or company law 1 should try to balance the legitimate main concern of shareholders ­ that they will be able to realise a
current return on their investment ­ with the chief concern of creditors ­ that the board of directors, elected by the shareholders, will,
especially if the directors see the company is in trouble, drain it of funds and other assets, through dividends, share repurchases or otherwise,
leaving insufficient assets to pay the creditors.
In the eighteenth and early nineteenth centuries, when companies were formed episodically ­ in England by a separate Act of Parliament and
in America by separate Acts of the colonial or early state legislatures ­ it appears that almost all financing for companies was provided by equity
investors through initial subscriptions and subsequent capital calls on them. 2 Leveraging capital through borrowing from banks or other sources
appears to have been relatively insignificant. In those times there was a lot of litigation over the shareholders' subscriptions and other pay­in
obligations, including minimum investments, forms of consideration (including promissory notes and future services) and valuation. 3 Most of
these issues have evaporated by now. No state in the United States is known to this author to require any minimum capital to form a
corporation, although minimum capital requirements are still prevalent in the European Union. 4 The Model Business Corporation Act (the Model
Act), 5 Delaware 6 and Maryland 7 all recognise any tangible or intangible property (including promissory notes and contracts for future services)
as valid consideration for the issuance of shares.
In the first half of the nineteenth century, however, with the Industrial Revolution, particularly in England, and with the opening and
exploration of the trans­Appalachian West in the United States, the need for financing in addition to equity capital became significantly greater
and so did the need for companies as the legal structure for the pooling of capital

2010 Acta Juridica 133

and the sharing of risks and rewards. In the still young United States, these developments, accompanied by growing confidence in the federal
government, accelerated the introduction of acts of incorporation in the state legislatures. In Maryland, for example, from 1812 to 1826, the
number of charters granted in each annual session of the legislature fluctuated between 20 and 30. However, between 1825 and 1850, a period
of intense railway construction (beginning with the Baltimore & Ohio Railroad following the enactment of the Act of 1826) that was typical in
other states as well, an explosion in the desire to form corporations confronted the General Assembly of Maryland, culminating in the legislative
sessions of 1837 and 1838, during which the legislature granted 48 charters for business corporations, 8 undoubtedly consuming large amounts
of legislative time and attention. Incorporation of manufacturing companies was increasingly common. Indeed, manufacturing corporation
charters accounted for more than one­fifth of the total number of corporations formed in Maryland prior to 1852. 9 As well, the provisions of
legislative charters varied widely, often reflecting the strenuous efforts of companies to get better terms in their charters (powers, duration,
voting, even taxation) than their competitors were able to achieve. 1 0 Not surprisingly, this competition fueled lobbying, log rolling, bribery and
other scandals. 1 1
In response to similar developments elsewhere, many states enacted general corporation statutes, delegating the power of the state to
grant corporate charters subject to certain requirements and limitations, to a state official, typically the Secretary of State of the state, or to
a state agency. In Maryland (which is today the corporate home of more companies listed on the New York Stock Exchange than any other
state except Delaware), the state Senate in 1845 declared:
In view of the innumerable acts of incorporation which are annually applied for and granted by the legislature, slowing the business of each
session, and lumbering the pages of statute books, and adding largely to the continually increasing expenses of the legislature, the Senate had
supposed some practicable scheme of a general law might be devised to cut off this fruitful source of waste upon the means of State, and the
time of the Legislature. . . . 1 2
During this era of special Acts, an act of incorporation typically specified the maximum amount of capital stock authorised to be issued, the
amount of stock required to be subscribed before the corporation

2010 Acta Juridica 134

could be formed and procedures for the original and subsequent issuances of stock within the statutory limit. An amendment to the charter was
necessary for any reduction in capital stock or alteration in the par value of shares. Any increase in authorised stock required an amendment to
the act of incorporation, 1 3 which meant going back to the legislature.
There is no mention of the liability of stockholders or directors in most of these charters. 1 4 Section 13 of the Act of 1838 of the General
Assembly of Maryland (the Act), although not all a full general corporation statute, provided that if dividends were paid out of capital, the
directors and stockholders of manufacturing and mining companies would be liable to creditors to the extent of the payments in proportion to
their stock in the corporation. Section 14 of the same Act also provided that directors who were present when debts exceeding the actual
assets of the corporation were contracted for and who did not dissent at the time were individually liable in proportion to 'their' stock. Thus, the
'limited liability' accorded to stockholders was not provided to directors. 1 5 When Maryland adopted its first full general corporation statute in
1868, 1 6 s 37 of the Act of 1868 required the certificate of incorporation to state the amount of capital stock, the number of shares and 'the
amount of each share.' Section 62 of the 1868 Act provided for the personal liability of directors for repayment of any dividend paid while the
corporation was insolvent and s 59 for the personal liability of stockholders, jointly and severally, to the creditors for debts and contracts of the
corporation
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Developments in Maryland were fairly typical of developments in other states as well. New York enacted its first general corporation statute
 their stock in the corporation. Section 14 of the same Act also provided that directors who were present when debts exceeding the actual
assets of the corporation were contracted for and who did not dissent at the time were individually liable in proportion to 'their' stock. Thus, the
'limited liability' accorded to stockholders was not provided to directors. 1 5 When Maryland adopted its first full general corporation statute in
1868, 1 6 s 37 of the Act of 1868 required the certificate of incorporation to state the amount of capital stock, the number of shares and 'the
amount of each share.' Section 62 of the 1868 Act provided for the personal liability of directors for repayment of any dividend paid while the
corporation was insolvent and s 59 for the personal liability of stockholders, jointly and severally, to the creditors for debts and contracts of the
corporation 'until the whole amount of the capital stock fixed and limited by the corporation shall have been paid in . . . '.
Developments in Maryland were fairly typical of developments in other states as well. New York enacted its first general corporation statute
in 1811, 1 7 New Jersey in 1896 1 8 and Delaware not until 1899. 1 9 In the United Kingdom, Parliament adopted the first general company law in
1844. 2 0

2010 Acta Juridica 135

II The emergence of 'legal capital'

In the area of legal capital, perhaps the most significant early development was the opinion of the legendary Associate Justice Joseph Story of
the Supreme Court of the United States, sitting as a federal trial court judge in the District of Maine, in 1824 in Wood v Dummer. 2 1 In that
seminal case, the board of directors of a bank caused it to distribute most of its liquid assets to the shareholders at a time when the bank was
already insolvent ­ an almost perfect paradigm of the situation with which creditors are typically concerned. Although the case was poorly
pleaded (the bill in equity did not even allege insolvency, lack of other corporate property or dissolution), 2 2 Justice Story worked through it,
figured out what was going on and ordered the defendant shareholders who had received the funds to pay to the plaintiff creditors a
proportionate share of the debt owed by the bank to the plaintiff creditors. Although not suggested by the plaintiffs in their bill, Justice Story
declared that the capital stock is a trust fund, appropriated by law and the charter to the payment of the debts, and that the surplus only,
after such payment, belongs to the stockholders. 2 3
Justice Story's opinion, characterising the company's capital stock ­ the amount paid by the shareholders to the corporation for their shares
­ as a 'trust fund' for the benefit of creditors, laid the foundation for legal capital in the United States. 2 4 For example, in the first full general
corporation statute in Maryland, the Act of 1868, referred to above, 2 5 the legislature provided in s 62 that the directors of any corporation
that declared and paid a dividend
when the corporation is insolvent, or any dividend, the payment of which would render it insolvent, or would diminish the amount of the capital
stock, . . . shall be jointly and severally liable for all the debts of the corporation then existing, and also for all that shall thereafter be contracted.
and then, just for good measure, the legislature added 'even although the whole amount of the capital of said corporation has been paid in.
Justice Story, writing in 1824, did not use the terms 'par value' or 'stated capital.' Nevertheless, it was clear from his opinion in Wood v
Dummer that

2010 Acta Juridica 136

in referring to 'the capital stock', he was referring to the amount paid by shareholders to the corporation for their shares, a usage picked up in
the term 'amount of capital stock' in later nineteenth century corporation statutes, such as Maryland's, discussed above. When the aggregate
amount paid by shareholders to the corporation for their stock is divided by the number of shares issued, we have the number now known as
'par value per share'. 2 6
In time, par value came to be a number required to be set forth in the charter of the corporation, initially representing the amount per share
of each shareholder's obligation to the corporation to purchase its shares. Obviously, however, 'par value' as a synonym for the price at which a
corporation must sell its shares is unworkable, at least after the initial subscription. A corporation that is successful will want to sell its shares
for more than the par value and a corporation that is unsuccessful may not be able to sell any new shares for as much as par value. So, it
quickly became apparent that par value, divorced as it was from price, had no continuing economic significance and was, therefore, a totally
arbitrary number. It follows that 'stated capital', derived as it is from multiplying par value by the aggregate number of shares issued by the
corporation, is equally meaningless to the economics of the corporation. 2 7 It is easy to imagine that once it was recognised that par value and
stated capital had no economic significance, low par, or even no par, shares made a lot of sense. The corporation could sell its shares for
whatever it could get for them, and would record that part of the purchase price representing the aggregate par value of the shares issued as
'stated capital' and any excess as 'capital surplus' or 'additional paid in capital' or something similar.
The idea persisted, however, that the total amount paid by the shareholders to the corporation for their shares should not be available for
payment to the shareholders, whether by dividend, by share repurchase or redemption or by partial or complete liquidation, until after the
creditors had been paid in full, even though the corporation had more than enough assets to pay its debts and obligations as they became due
in the usual course of its business.
Thus, what began as a sensible remedy, applied retrospectively by Justice Story to a knowing distribution of assets of an insolvent
corporation to its shareholders rather than its creditors, evolved into a doctrine applied prospectively to restrict the power of corporations to
make distributions to their shareholders even when they had more than enough assets to pay

2010 Acta Juridica 137

their debts as they became due. A typical legal capital statute of this era in the United States permitted dividends and other distributions only
to the extent that total assets of the corporation exceeded total liabilities plus stated capital or in some cases capital surplus as well, which in
those latter cases would mean that the full amount of the consideration paid by shareholders to the corporation for the issuance of shares (as
opposed to the price paid by shareholders for shares purchased from other shareholders) was an additional cushion for the creditors on top of
full asset coverage of the liabilities. If the statute was based only on the sum of liabilities and stated capital, it was fairly easy to work around
with low­par (or no­par) stock. A liabilities­plus­low­par­stated­capital statute, of course, made a mockery of the idea that the amounts paid
by the shareholders to the corporation for their shares represented some sort of irreducible core of assets that should be perpetually available
to the creditors.
In the United States, it was Bayless Manning, formerly a professor at Yale Law School and later Dean of Stanford Law School, who identified
and exposed the intellectual emptiness of traditional legal capital statutes in the first two editions of his celebrated book, Legal Capital. Dean
Manning also later served as a member of the Committee on Corporate Laws of the Section of Business Law of the American Bar Association. 2 8
The Corporate Laws Committee first published the Model Business Corporation Act (the Model Act) in 1950 and has the continuing responsibility
for reviewing and revising it. The Model Act has been adopted as the basic corporation statute for 30 of the American states and many other
states have adopted various provisions of the Model Act. The Committee on Corporate Laws consists of a chair, appointed by the chair

2010 Acta Juridica 138

of the Section of Business Law for a three­year term, and 25 members, one of whom is designated as the reporter for the Committee and 24 of
whom serve staggered six­year terms. Committee members have included partners in law firms, corporate general counsel, law and business
school professors, federal and state judges, members and the General Counsel of the Securities and Exchange Commission and a former Director
of Central Intelligence (who is also a former federal judge). 2 9
As a result of Dean Manning's pioneering work, the financial provisions of the Model Act were completely overhauled as part of the 1984
revision of the Act. Jettisoned were the old capital and surplus tests for distributions, as well as any apparition of par value or stated capital. In
lieu, new s 6.40 substituted two new tests for the power of a corporation to make a distribution. 3 0 Section 6.40(c), still unamended after more
than 25 years, prohibits a corporation from making a distribution
if, after giving it effect:
(1) The corporation would not be able to pay its debts as they become due in the usual course of business [the so­called 'equity solvency'
test]; or
(2) The corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise)
the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights
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 if, after giving it effect:
(1) The corporation would not be able to pay its debts as they become due in the usual course of business [the so­called 'equity solvency'
test]; or
(2) The corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise)
the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights
upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution [the so­called 'balance sheet
solvency' test].
The corporation must satisfy both of these tests.
In addition, and very importantly, s 6.40(d) permits a board of directors to base a determination that a distribution is not prohibited under
subsection (c) either on financial statements prepared on the basis of accounting practices and principles that are reasonable in the
circumstances or on a fair valuation or other method that is reasonable in the circumstances.

2010 Acta Juridica 139

This concept was formerly known as 'revaluation surplus', ie, surplus created by reworking the balance sheet on a fair market value basis. In
Delaware, which to this day still has a modified old­style liabilities­plus­stated­capital statute, 3 1 the concept of revaluation surplus has been
adopted by case law. 3 2
Note that the balance sheet solvency test treats liquidation preferences of stock superior to the shares on which the dividend is supposed to
be paid as liabilities unless the charter specifically provides otherwise. Whether to include such an opt­out in the terms of preferred stock is
always an important matter for the corporation, the prospective preferred stock investors and their counsel to consider. On the one hand, the
investors and their counsel may not be inclined to agree to an opt­out, and insist on having their senior liquidation preference treated as a
liability, which will result in a dollar­for­dollar additional block on the corporation's power to make distributions to junior stockholders, thus
increasing the cushion of assets available for payment to creditors and to the preferred stockholders. However, the preferred share investors
also have an interest in the corporation's being able to raise additional common and other junior equity, which will serve as further support for
the corporation's ability to pay the preferred equity dividends and, if necessary, its liquidation preference. Thus, the potential preferred investor
will often agree to the opt­out.
In addition, the 1984 revision to the Model Act eliminated the concept of 'treasury stock'. Previously, issued and outstanding shares that
were reacquired by the corporation, by redemption pursuant to their terms or by negotiated purchase, continued to be treated as issued shares
although they were no longer outstanding. These shares were known as 'treasury shares' and were so noted in the stockholders' equity section
of the balance sheet, with several different possible accounting treatments, some of them tied to the artificial concepts of par value and stated
capital. Significantly, treasury shares were (are, in those jurisdictions where they still exist) just as available for reissuance as ­ and are
otherwise indistinguishable from ­ authorised but never­issued shares. The Committee on Corporate Laws in its 1984 revision wisely concluded
that issued and outstanding shares acquired by the corporation should return to the status of authorised but unissued shares. Thus, the
balance sheet for a corporation organised under the laws of a Model Act jurisdiction will not distinguish between (a) authorised and never issued
shares and (b) authorised,

2010 Acta Juridica 140

formerly issued but now reacquired shares. Nor should it ­ a shareholder acquiring these shares from a corporation should have no interest in, or
care, whether the shares were formerly issued or not. 3 3
Finally, any effective rule must have an effective remedy. Section 8.33(a) of the 1984 revision of the Model Act provides:
Unless he complies with the applicable standards of conduct described in section 8.30, a director who votes for or assents to a distribution made
in violation of this Act or the articles of incorporation is personally liable to the corporation for the amount of the distribution that exceeds what
could have been distributed without violating this Act or the articles of incorporation. 3 4
Personal liability for directors who approve the distribution is an incentive to directors not to approve an excessive distribution. A director's most
likely available defence will be that he complied with the standard of conduct set forth in s 8.30 of the Model Act. 3 5 In addition, s 8.30(f)
permits a director to rely on
officers or employees whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions,
reports or statements provided
and on
legal counsel, public accountants, or other persons retained by the corporation as to matters involving skills or expertise the director reasonably
believes are matters (i) within the particular person's professional or expert competence or (ii) as to which the particular person merits confidence.
...
Thus, a distribution may violate either the equity solvency test or the balance sheet solvency test, or both, of s 6.40 and yet the approving
directors, if each of them acted in good faith, in a manner that he or she reasonably believed to be in the best interests of the corporation and
with the requisite care, will escape liability. 3 6 The Model Act, Delaware and

2010 Acta Juridica 141

Maryland all provide for a right of contribution from other assenting directors and from shareholders. 37

It should be noted, however, that s 2.02(b)(4) of the Model Act provides that a director's violation of s 8.33 of the Model Act may not be
included in a charter provision exculpating directors from monetary liability to the corporation or shareholders. 3 8

III 'Legal capital' under the Companies Act 61 of 1973

South Africa can be justly proud that even before the Company Law Reform process was launched early in the first decade of the twenty­first
century, the existing Companies Act 61 of 1973 (the 1973 Act) had already gone through amendments to its legal capital provisions since its
original enactment and embraced many of the principles of the 1984 revision of the Model Business Corporation Act. Section 90(2) of the 1973
Act prohibited a company from making:
any payment in whatever form to its shareholders if there are reasonable grounds for believing that ­
(a) the company is, or would after the payment be, unable to pay its debts as they become due in the ordinary course of business; or
(b) the consolidated assets of the company fairly valued would after the payment be less than the consolidated liabilities of the company.
Section 90(3) defined 'payment' as including:
any direct or indirect payment or transfer of money or other property to a

2010 Acta Juridica 142

shareholder of the company by virtue of the shareholder's shareholding in the company.
Section 85 contained the same equity and balance sheet solvency tests for an acquisition of shares but s 98 provided that redeemable
preference shares might only be redeemed:
out of profits of the company which would otherwise be available for dividends or out of proceeds of a fresh issue of shares made for the purpose
of redemption. . . .
While it was gratifying to see that, even before the company law reform, South Africa had adopted the sensible equity and balance sheet
solvency tests of the Model Act, permitted revaluation surplus 3 9 and eliminated treasury shares, 4 0 it was surprising, on first encountering the
1973 Act, to discover that it retained par value and the related concept of stated capital throughout, even if only as the basis for determining
the registration fee 4 1 and the share capital increase fee. 4 2 Preserving an economically insignificant and artificial concept such as par value
solely for these purposes does not seem to make sense, especially as the continued existence of par value may mistakenly lead some people to
assume it has economic significance.

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liabilities in determining the power of a company to acquire common shares. Also unclear in ss 85 through 87 was whether a company might
 solvency tests of the Model Act, permitted revaluation surplus and eliminated treasury shares, it was surprising, on first encountering the
1973 Act, to discover that it retained par value and the related concept of stated capital throughout, even if only as the basis for determining
41 42
the registration fee and the share capital increase fee. Preserving an economically insignificant and artificial concept such as par value
solely for these purposes does not seem to make sense, especially as the continued existence of par value may mistakenly lead some people to
assume it has economic significance.
Further, it was unclear under s 85(4)(b) of the 1973 Act whether preferences on liquidation for preference stock would be considered as
liabilities in determining the power of a company to acquire common shares. Also unclear in ss 85 through 87 was whether a company might
acquire shares on a non­pro rata basis from shareholders, as is generally permitted (and often done) in the United States. Finally, in light of the
1999 amendments to former s 90, the continued reliance on 'profits of the company' as a standard for redemption of preference shares was
puzzling, especially given the fact that profits available for dividends had been interpreted as
revenue profits, that is profits earned as a result of trading activities. Divisible profit, on the other hand, can also include capital profit such as
profit earned on the sale of a fixed asset, for example, land. 4 3
As the power of the company to acquire its own shares under s 85 and to pay dividends under s 90 was tied in both cases to the equity and
balance sheet solvency tests, there was no apparent reason to retain a profits­based

2010 Acta Juridica 143

test for redemption of preference shares, especially if 'profits' were limited to revenue profits.
Thus, there was ample room for further improvement to the financial provisions of the 1973 Act.

IV 'Legal capital' under the Companies Act 71 of 2008

The Companies Act 71 of 2008, signed into law by the President in early 2009 after a lengthy and inclusive process, makes several very
worthwhile improvements to the legal capital regime in South Africa.
First, the term 'distribution' is defined in s 1 broadly as:
a direct or indirect . . . transfer by a company of money or other property of the company, other than its own shares, to or for the benefit of one
more [sic] holders of any of the shares of the company . . . whether as a dividend, as consideration for the acquisition by the company of its own
shares or otherwise in respect of any shares of that company. . . .
Also included in the definition of 'distribution' is the 'incurrence of a debt or other obligation by a company for the benefit of one more [sic]
holders of any of the shares of that company' or the 'forgiveness or waiver by a company of a debt or other obligation owed to the company by
one or more holders of any of the shares of that company. . . .' Of course, a 'distribution' does not include payments to shareholders in some
other capacity ­ for example, salary or bonus for a manager who is also a shareholder or compensation to a service provider who is also a
shareholder.
Second, a new 'solvency and liquidity test' in s 4 is applied to all forms of distribution. This makes a lot of sense. Economically, the impact of
a payment to one or more shareholders on the company's financial position, as reflected on its balance sheet and cash flow statement, will be
exactly the same, whether the payment is a dividend to all shareholders, a pro rata purchase or redemption of shares from all shareholders, a
non­pro rata purchase of shares from less than all of the shareholders, a partial liquidation or a reduction in capital. In Europe, there has been
and still is considerable concern that a company's repurchase of its shares may offer the board the opportunity for fraud or abuse. Obviously, a
pro rata acquisition of shares by a company is economically the same as a dividend. Even a non­pro rata share acquisition offers no more
opportunity for misbehavior by the board than approving the purchase of a piece of land or a computer software program from a shareholder.
Third, s 4(1) further refines the solvency and liquidity test by providing that a company satisfies the test

2010 Acta Juridica 144

if, considering all reasonably foreseeable financial circumstances of the company at that time ­
(a) the assets of the company or, if the company is a member of a group of companies, the consolidated assets of the company, as fairly valued,
equal or exceed the liabilities of the company or, if the company is a member of a group of companies, the consolidated liabilities of the
company, as fairly valued; and
(b) it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of ­
(i) 12 months after the date on which the test is considered; or
(ii) in the case of a [dividend or share acquisition or other distribution of money or other property of the company in respect of any of the
shares of the company] 12 months following that distribution (Emphasis added).
The opportunity for the board to consider all reasonably foreseeable financial circumstances of the company is a worthy improvement on s
6.40(c) of the Model Act, which provides no such flexibility. The 'fairly valued' language, carried over from ss 85(4)(b) and 90(2)(b) of the 1973
Act, is also wise as it effectively incorporates the fair valuation provision of s 6.40(d) of the Model Act. Finally, the seemingly innocent two
words 'it appears' emphasise that the focus should be on the apparent likelihood at the time the decision is made rather than on an actual
result that may not be knowable until later.
Note, however, that the 'fairly valued' opportunity applies both to the assets of the company and to its liabilities in s 4(1)(a). Furthermore, s
4(2)(b) requires 'a board or any other person applying the solvency and liquidity test to a company' to 'consider a fair valuation of the
company's assets and liabilities, including any reasonably foreseeable contingent assets and liabilities, irrespective whether as a result of the
proposed distribution, or otherwise; and [to] consider any other valuation of the company's assets and liabilities that is reasonable in the
circumstances. . . .' (Emphasis added.) This is a significant improvement on the Model Act, clarifying that the board may base its action in
considering whether to make a distribution on both a write­up (or write­down) of the company's assets and a write­down (or write­up) of its
liabilities. Further flexibility is provided by permitting the consideration of 'any other valuation . . . that is reasonable in the circumstances. . . .'
Fourth, s 35(1) wisely eliminates par value except for shares of a pre­existing company.
Fifth, s 35(5) provides that not only shares acquired by the company but also shares surrendered to the company in the exercise of appraisal
rights 'have the same status as shares that have been authorised but not issued', thus clarifying that the abolition of treasury shares in the
1973 Act also includes shares surrendered pursuant to the newly enacted shareholders'

2010 Acta Juridica 145

appraisal rights (see s 164) ­ a nice catch, one that should be considered for the Model Act, Delaware and Maryland.
Sixth, the former lengthy and detailed provisions on debentures have been eliminated in a wise recognition that debt instruments of the
company are contracts and that the form and terms of these contracts are best left to situation­specific negotiation and drafting by the
parties.
In addition, the 2008 Act includes other worthwhile legal capital provisions not relating directly to distributions. Among them are:

(a) Blank cheque stock

Section 36(1)(c) allows the Memorandum of Incorporation ('MOI') to authorise 'a stated number' of shares that do not belong to any class but
which may be assigned to a class by the board of directors. Even more boldly, s 36(1) (d) allows the MOI to set out a separate class of shares
'without specifying its preferences, rights, limitations or other terms' that the board may determine before issuance of the shares. Blank cheque
stock was developed in the US over 20 years ago 4 4 and has proven to be extremely useful to companies in rapidly raising capital in time­
sensitive, highly competitive global financial markets without the need for the time­consuming process of obtaining shareholder approval. The
2008 Act and the Delaware and Maryland statutes require a public filing of the board's action in issuing blank cheque stock.

(b) Board power to increase authorised shares

Following the example of Maryland, 4 5 s 36(3)(a) expressly permits the board to 'increase or decrease the number of authorised shares of any
class', unless the MOI 'provides otherwise. . . .' 4 6 Indeed, this provision goes even further than the Maryland statute, which provides the board
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and the Maryland 08 2024require
15:54:39a GMT+0200 (South
public filing Africa
of the Standard Time)
board's
action in increasing or decreasing the number of authorised shares.
 2008 Act and the Delaware and Maryland statutes require a public filing of the board's action in issuing blank cheque stock.

(b) Board power to increase authorised shares

Following the example of Maryland, 4 5 s 36(3)(a) expressly permits the board to 'increase or decrease the number of authorised shares of any
class', unless the MOI 'provides otherwise. . . .' 4 6 Indeed, this provision goes even further than the Maryland statute, which provides the board
with this power, but only if it is set forth in the charter. 4 7 Both the 2008 Act and the Maryland statute require a public filing of the board's
action in increasing or decreasing the number of authorised shares.

(c) Variation of share terms based on external facts

Section 37(6) permits the MOI to
provide for preferences, rights, limitations or other terms of any class of shares of that company to vary in response to any objectively
ascertainable external fact or facts.

2010 Acta Juridica 146

Subsection (7) defines 'external fact or facts' to include

the occurrence of any event, a variation of any fact, benchmark or other point of reference, a determination or action by the company, its board, or
any other person, an agreement to which the company is a party, or any other document,
and requires that 'the manner in which a fact affects' the terms of a class of shares 'must be expressly determined by or in accordance with'
the MOI 'in accordance with section 36', which in sub­s (2)(b) permits the terms of shares to be changed by special resolution of the
shareholders or by the board unless, per sub­s (3), the MOI 'provides otherwise. . . .' This type of provision was developed initially for 'variable
rate preferred stock', the dividend rate for which varies periodically (often weekly) according to a publicly disclosed reference point such as the
London Interbank Offered Rate. It also authorises so­called 'auction rate' stock, the dividend rate for which is periodically reset by referring to
the determination of some named person, often called the 'terms agent.' 4 8 Further, the rights of stock may be made dependent upon contracts
or other documents or obligations, even though not specifically named, in the MOI. 4 9 This means that the rights of stock may change if a
contract upon which those rights are made dependent is amended, even though all of the parties to the contract are not themselves
stockholders. This principle is no more startling than tying the dividend rate for a share of preferred stock to an index over which the
shareholders have no control. The rights of stock may also be made dependent upon a future action or determination by any person, including
the corporation itself or its board or an officer, or upon any other event. 5 0 Under Maryland law, the charter may be amended immediately prior
to a merger or dissolution of the corporation to provide for disparate treatment of holders of stock of the same class so long as the variations in
the terms are 'clearly and expressly set forth . . . '. 5 1
The extrinsic reference concept in the 2008 Act now embraces all terms of the stock. Both Delaware 5 2 and Maryland 5 3 expressly provide for
variable­term stock. The Model Act claims that its s 6.02 provides this authority 5 4 but it is not clear from the text of the statute.

2010 Acta Juridica 147

V The way forward

The people of South Africa, including its government, lawyers, law professors and others involved in the Company Law Reform, can take great
pride in both the careful and thorough process and the substantive results. It is certain that the Act will be looked to by other countries
wanting to improve their basic company legislation for the twenty­first century. The Act not only reflects some of the best thinking in South
Africa and around the world in many of its provisions but has also contributed new ideas and concepts that are likely to be studied carefully,
even in countries with advanced company law legislation and case law.
Still, there is always more work to do. In that spirit, and also in the spirit of a robust exchange of ideas among friends, the following thoughts
are offered:
First, it is fair and probably useful to ask whether creditors (even unsecured creditors) need the protection of company law (in addition to
fraudulent conveyance statutes and privately negotiated contracts) against the paradigmatic distribution, approved by the directors, to
shareholders (who may, of course, include the directors) at or near insolvency and whether the ultimate guarantors of this protection should be
the directors who approved (either by affirmative assent or absence of dissent) the improper distribution. Certainly, it appears that creditors do
not rely heavily on legal capital restraints on distributions. However, assuming these provisions have some continuing utility, then why do we
need both the equity solvency test and the balance sheet solvency test? Why isn't the equity solvency test enough? Consider the following
two balance sheets:
Balance Sheet No. 1
Example of excess of assets over liabilities (balance sheet solvency)
but inability to pay debts in usual course (equity insolvency)

Assets Liabilities

Cash R 100 Accounts Payable R 500

Accounts Receivable 200 Notes Payable (Long­Term) 1 000

Inventory 300 R1 500

Plant and Equipment 600

Real Estate 1 000 Shareholders' Equity

Stated Capital R 100

Capital Surplus 400

Retained Earnings 200

R 700

R2 200 R2 200

In the balance sheet above, how does the balance sheet solvency test help the creditors? It is the company's inability to pay its debts in the
usual course that is the problem.

2010 Acta Juridica 148

Balance Sheet No. 2

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Example of deficit of assets over liabilities (balance sheet insolvency) but ability to pay debts in usual course (equity solvency)
 usual course that is the problem.

2010 Acta Juridica 148

Balance Sheet No. 2

Example of deficit of assets over liabilities (balance sheet insolvency) but ability to pay debts in usual course (equity solvency)

Assets Liabilities

Cash R1 600 Accounts Payable R 300

Real Estate 600 Notes Payable (Long­Term) 2 500

R2 800

Shareholders' Equity

Stated Capital R 100

Capital Surplus 400

Retained Earnings (1 100)

R(600)

R2 200 R2 200

In this balance sheet above, how does the balance sheet solvency test help the creditors? It is the company's ability to pay its debts in the
usual course that matters.
Moreover, the balance sheet solvency test implicitly assumes that all the liabilities are due and payable currently. That is almost never
completely the case. Suppose, for example, that the notes payable in the above examples were not due for five years. Why should they be
treated as if due today?
Of course, the company should clearly be permitted under the 'fairly valued' language of the definition of the 'solvency and liquidity test' in s
4 of the Act to write down its liabilities to what the creditors would accept today in discharge of the debts. But that is not a complete answer
to the conceptual question of how the balance sheet solvency test actually helps creditors. 5 5
Second, if directors are going to be personally liable for excessive distributions, there ought to be some defense available to them based
upon their compliance with the standard of conduct required of them under s 76. As noted above, this is the position taken by the Model Act,
Delaware and Maryland. It is certainly reasonable to expect that directors, as the decision­makers on whether the company should make a
distribution,

2010 Acta Juridica 149

should bear some responsibility in this regard. But it does not seem reasonable for them to bear more responsibility for a distribution decision
than for any other decision. Not giving directors a defense based upon their adherence to the standard of conduct required by s 76 will only
tend to discourage good people from serving as directors.
Third, if the balance sheet solvency test is to be retained at all, it would be helpful for the Act to clarify whether liquidation preferences on
shares senior to the shares on which a distribution is being made count as liabilities in determining compliance with the balance sheet solvency
test. A company should also be able to opt out, wholly or partially, from such a provision in the terms of senior stock.
Fourth, consideration should be given to validating as consideration for the issuance of shares non­negotiable promissory notes and
contracts for future services. As to promissory notes, a company should be able to take the promissory note of Cyril Ramaphosa or Bill Gates as
consideration for the issuance of shares, even though the note is not negotiable (for what may be perfectly good business reasons). Likewise,
why should a contract for future services entered into by a talented senior manager or other performer of personal services with an unblemished
record for prompt and full performance not be valid consideration for the issuance of shares? Is this any different from a signing bonus? These
are simply questions of valuation that should be left to the board of directors. More broadly, as the board already has virtually unfettered power
to finance the company through the issuance of unlimited debt, all of which will be senior to all of the shares, and if we are willing to trust the
board to exercise its business judgment in this regard, then why should we be unwilling to trust the board in valuing consideration offered for
the issuance of shares?

VI Conclusion
For more than two centuries, there has been a steady progression in corporation statutes toward enabling and flexibility. Democratic
governments in free­market economies have realised that they can permit the creation of separate legal personalities on terms largely written
by the entities and investors and that the interests of governments in the formation and governance of these entities are minimal. Indeed, the
increasing flexibility of successive new forms of doing business in many countries ­ the limited partnership, the limited liability company, the
limited liability partnership, among others ­ emphasises this trend.
South Africa has positioned itself squarely in the middle of this progression. Many of the restrictions and limitations of the 1973 Act have
been swept away and it is likely that, as in other countries, more will be loosened or eliminated in the future. Default rules, private ordering and

2010 Acta Juridica 150

transparency are likely to be the core defining principles of workable business entity statutes.
The Companies Act of 2008 is a valuable contribution to the formation, financing and operation of companies in South Africa and contains
many cutting­edge provisions that are likely to be studied and adopted in other countries. For those of us who were privileged to assist in the
Company Law Reform, it was a profoundly challenging and rewarding experience that left this author with a sense not only of participation and
contribution in an important joint enterprise but also of learning and appreciation for a beautiful country and a wonderful people — like Mike
Larkin.

* AB (Princeton University) LLB (University of Maryland) LLM (Harvard University). Partner, Venable LLP, Baltimore, Maryland, and Washington, DC. Adjunct
Professor of Law, Cornell and Northwestern Law Schools; Visiting Senior Lecturer, Cornell Business School. Author, Maryland Corporation Law (Aspen Publishers
Supp 2009); and co­author (with Bayless Manning), Legal Capital (Foundation Press 1990).
1 As is well known, what in US practice is referred to as a corporation and as corporation (or corporate) law is known in South Africa (and England, among other
places) as a company and company law, respectively ­ conventions that I am happy to follow in this article as appropriate.
© 2018 2JutaButler 'Nineteenth
and Company Century
(Pty) Ltd. Jurisdictional Competition in the Granting of Corporate Privileges' (1985)
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15:54:39 at 139 n 30.(South Africa Standard Time)
3 B Manning with JJ Hanks Jr Legal Capital 3 ed (1990) 44­61 (hereinafter 'Manning/Hanks').
4 See European Union, Second Council Directive, Art 6. Article 6(1) requires a 'minimum capital' of at least 25 000 'European units of account' (defined to mean
 * AB (Princeton University) LLB (University of Maryland) LLM (Harvard University). Partner, Venable LLP, Baltimore, Maryland, and Washington, DC. Adjunct
Professor of Law, Cornell and Northwestern Law Schools; Visiting Senior Lecturer, Cornell Business School. Author, Maryland Corporation Law (Aspen Publishers
Supp 2009); and co­author (with Bayless Manning), Legal Capital (Foundation Press 1990).
1 As is well known, what in US practice is referred to as a corporation and as corporation (or corporate) law is known in South Africa (and England, among other
places) as a company and company law, respectively ­ conventions that I am happy to follow in this article as appropriate.
2 Butler 'Nineteenth Century Jurisdictional Competition in the Granting of Corporate Privileges' (1985) 14 J Legal Studies 129 at 139 n 30.
3 B Manning with JJ Hanks Jr Legal Capital 3 ed (1990) 44­61 (hereinafter 'Manning/Hanks').
4 See European Union, Second Council Directive, Art 6. Article 6(1) requires a 'minimum capital' of at least 25 000 'European units of account' (defined to mean
euros). This requirement applies only to joint­stock companies, which, in general, are larger corporations, and the requirement may be increased by the national
law of EU member states. In France, for example, the minimum capital for a joint­stock company (société anonyme, a form of corporation with at least seven
stockholders) is |n*37 000 and if the company is listed, |n*225 000. Indeed, the concept of a minimum capital is so ingrained in France that the traditional, well­
accepted expression is 'Le capital social est le gage des créanciers' ('the minimum capital is the pledge for the creditors').
5 Model Corporation Business Act s 6.21(b).
6 Delaware General Corporation Law s 152.
7 Maryland General Corporation Law s 2­206(a), (b).
8 JG Blandi Maryland Business Corporations, 1783­1852 (1934) 11.
9 Op cit 28.
10 Butler (n 2) 140 n 34.
11 Op cit 141 n 37.
12 Journal of Proceedings of the Senate of Maryland 1845 at 183.
13 JJ Hanks Jr Maryland Corporation Law (Supp 2008) 6 (hereinafter 'Hanks').
14 Ibid. This is an apparent result of the general belief that individual members of corporations were, because of the separate legal personality of the entity, at
risk only for their investment in it. 'Limited liability arose in American corporation law as an almost incidental by­product of corporateness. . . .' Manning/Hanks (n
3) 26. Indeed, 'limited liability' may be viewed as a misnomer since the corporation has complete liability for its own debts and obligations and the shareholders
have no liability for them.
15 Ibid. Typical of early corporation statutes, s 5 of the Act of 1838 required directors to be stockholders.
16 1868 Md Laws ch 471.
17 1811 NY Laws ch 67.
18 Ballantine Corporations (1927) 39.
19 Drexler, Black and Sparks Delaware Corporation Law and Practice (Supp 2008) vol 1 1­4.
20 Joint Stock Companies Act 1844 (c 110). See also Limited Liability Act 1855 (c 133) and Joint Stock Companies Act 1856 (c 47).
21 3 Mason 308, 30 F Cas. 435 (No. 17,944) (CCD Me 1824). In those early days, justices of the Supreme Court, in addition to their appellate duties, 'rode
circuit', hearing cases in the Circuit Courts, as the federal trial courts were then known. The United States Courts of Appeals were not established until much
later in the nineteenth century.
22 Justice Story even generously offered up a justification for these omissions, noting that equity proceedings were not familiar to the bar of the District of Maine.
30 F Cas. 435 at 437­8.
23 Ibid.
24 Henry Butler also claims that until Wood v Dummer it 'was not clear whether a corporation necessarily included limited liability under the common law when
the charter was silent with respect to shareholders' obligations to creditors.' Butler (n 2) 139 n 30.
25 1868 Md Laws (n 16).
26 'Par value' first appeared in the Maryland general corporation statute, without definition, in 1870. 1870 Md Laws ch 310.
27 In more than 40 years of representing companies, this author cannot recall ever being asked by counsel for a debt or equity financing source, 'What is the par
value of your client's shares?'
28 Bayless Manning is one of the most original thinkers and writers on American law in the twentieth century. His influence on corporation law in the United States
can be favourably compared to that of Justice Story in the nineteenth century. As a practising lawyer, teacher, writer, lecturer, director of several publicly held
corporations, legislative drafter, advisor to The New York Stock Exchange, active member of the American Law Institute and the ABA's Committee on Corporate
Laws, Bay Manning has had an unsurpassed influence on the evolution of the law of corporations in the United States and elsewhere. His impact can be found in
the legal capital provisions of the Model Business Corporation Act; in the Model Act's director conflicting interest provisions, for which he was the principal
drafter; in the American Law Institute's Principles of Corporate Governance; and in the overgrown field of appraisal rights, where his seminal article, 'The
Stockholder's Appraisal Remedy: An Essay for Frank Coker' (1962) 72 Yale LJ at 223, is still the most influential single statement on that neglected subject.
After graduating from Yale at 19, Dean Manning helped to decrypt the supposedly unbreakable Japanese 'purple' code, graduated from Yale Law School (where
he was Editor­in­Chief of the Yale Law Journal), clerked for Justice Stanley Reed of the Supreme Court of the United States, practised law in Cleveland with
Jones, Day, Reavis & Pogue, taught at Yale Law School, worked in the State Department, served for seven years as Dean of Stanford Law School and then
became President of the Council on Foreign Relations and thereafter a partner at Paul, Weiss, Rifkind, Wharton & Garrison. He speaks Japanese, Norwegian,
Spanish and native Hawaiian and generally writes in English.

29 For a more detailed discussion of the origin and history of the Model Act and the role and influence of the Committee on Corporate Laws, see Model Business
Corporation Act, Introduction (2007). The author of this article served as a member of the Committee from 1984 to 1990 and from 1996 to 2002, after which he
served as a liaison to the Committee.
30 Section 1.40 of the Act defines a 'distribution' as 'a direct or indirect transfer of money or other property (except its own shares) or incurrence of indebtedness
by a corporation to or for the benefit of its shareholders in respect of any of its shares. A distribution may be in the form of a declaration or payment of a
dividend; a purchase, redemption, or other acquisition of shares; a distribution of indebtedness; or otherwise.' Thus, fundamental to the unitary treatment of
distributions by the Act is the recognition that the economic effect of a transfer of cash or other assets or the incurrence of debt by the corporation to or for the
benefit of the shareholders has the same economic effect, on the corporation and on the shareholders, no matter what the distribution is called.
31 See Delaware General Corporation Law s 170.
32 Morris v Standard Gas & Electric 31 Del Ch 20 63 A2d 577 (1949) (holding that directors of a Delaware corporation are under a duty to evaluate the assets on
the basis of acceptable data and by standards that they are entitled to believe reasonably reflect present 'values' and must be given reasonable latitude in this
regard).
33 Manning/Hanks (n 3) 190­2.
34 See also Delaware General Corporation Law s 174 and Maryland General Corporation Law s 2­312(a).
35 Section 8.30(a) of the Model Act currently provides: 'Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good
faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation.' In addition, s 8.30(b) requires directors to 'discharge
their duties with the care that a person in a like position would use under similar circumstances.'
36 It is good practice to have the chief financial officer or other responsible financial officer execute a certificate, to be provided to the directors, that after giving
effect to the proposed distribution, the corporation will be able to pay its debts in the usual course and the corporation's assets will exceed its liabilities.
37 Model Act s 8.33(b); Delaware General Corporation Law s 174(b), (c); Maryland General Corporation Law s 2­312(b).
38 Although beyond the scope of this article, the author is moved to pause for a moment and lament that the Companies Act 71 of 2008 does not include a
provision permitting the Memorandum of Incorporation to include, either in the original memorandum or by amendment approved by the shareholders, a
provision exculpating directors from monetary liability in suits by the corporation, by a shareholder or by a shareholder suing derivatively in the right of the
corporation. As noted in the text above, the Model Act contains such a provision and the corporation statutes of Delaware, Maryland and many other American
states have adopted such a provision as well. See Delaware General Corporation Law s 102(b)(7); Maryland General Corporation Law s 2­405.2. NB: 1. Unlike
the Model Act or Delaware, the Maryland charter exculpation statute applies to both directors and officers. 2. Unlike the Model Act or Delaware, Maryland does
not have an exception for improper dividends. Charter exculpation provisions have been applied by the courts without, to this author's knowledge, any surprising
results. See eg In re Walt Disney Derivative Litigation 906 A2d 27 (Del 2006); Grill v Hoblitzell 771 F Supp 709, 712 (D Md 1991); and Hayes v Crown Central
Petroleum No 02­122­A, slip op at 16 (ED Va 2002), aff'd, 78 Fed Appx 857 (4th Cir 2003). It is important to note that under the American federal system charter
exculpation provisions adopted under these state statutes can only exculpate for violations of the law of the state of incorporation, not federal law or the law of
another jurisdiction. For a history of charter exculpation statutes, see Hanks 'Evaluating Recent State Legislation on Director and Officer Liability Limitation and
Indemnification' (1988) 43 Bus Law 1207.
39 See 'fairly valued' in s 90(2)(b) above.
40 See s 85(8) of the 1973 Act.
41 See s 63(2).
42 See s 75(3).
43 Cilliers and Benade Corporate Law 3 ed (2000) 21.05.
44 See, eg, Model Act s 6.02; Delaware General Corporation Law s 151(a), (g); Maryland General Corporation Law s 2­208.
45 Maryland General Corporation Law s 2­105(a)(12). Maryland is believed to be the only state in the US with this type of provision.
46 Of course, a board could not use this provision to decrease the number of shares of a class below the number of issued and outstanding shares.
47 Ibid.
48 Hanks (n 13) 52.
49 For a case interpreting this type of provision under Delaware law, see In re Bicoastal Corp 600 A2d 343, 349­51 (Del. 1991).
50 Compare Maryland General Corporation Law s 2­105(b)(1).
51 Hanks (n 13) 52.
52 Delaware General Corporation Law s 151(a).
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 48 Hanks (n 13) 52.
49 For a case interpreting this type of provision under Delaware law, see In re Bicoastal Corp 600 A2d 343, 349­51 (Del. 1991).
50 Compare Maryland General Corporation Law s 2­105(b)(1).
51 Hanks (n 13) 52.
52 Delaware General Corporation Law s 151(a).
53 Maryland General Corporation Law s 2­105(b). Unlike Delaware, Maryland permits the terms of a class of shares to vary among the holders of the class.
54 See Model Act s 6.02 Official Comment.
55 Moreover, the balance sheet solvency test can lead to unintended or distortive results. For example, because of significantly lower share prices beginning in
the second half of 2008, many US companies (and maybe others) found that their defined­benefit pension plans were substantially underfunded because of the
decrease in the value of the plans' assets, resulting in often severe reductions in shareholders' equity, thus threatening compliance with the balance sheet
solvency test, even though these companies were generating significant revenue, earnings and cash flow. Accordingly, Maryland addressed this problem by
providing an exception to the balance sheet solvency test for Maryland corporations with net earnings in the current fiscal year, in the previous fiscal year or in
the previous eight fiscal quarters. 2009 Md. Laws ch 295.

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