Background
Private equity funds are collective investment schemes registered under Section 12J of the Income Tax Act 58 of 1962. These funds provide opportunities for individuals to invest in specific sectors through venture capital companies, which are non-trading special purpose vehicles (SPVs) created exclusively for investment purposes.
The Legal Issue
A major concern is the potential risk exposure that private equity funds face concerning agreements concluded by the companies in which they have invested.
Legal Position of Private Equity Funds
Legal Personality
Companies, as separate legal entities, exist independently from their shareholders, as outlined in Section 19(1)(b) of the Companies Act 71 of 2008. This separation grants shareholders limited liability. However, this limited liability is not absolute. Courts can, under certain circumstances, disregard a company’s separate legal personality, a process known as “piercing the corporate veil.”
Power of the Court to Pierce the Corporate Veil
Both common law and legislation provide the courts with the power to pierce the corporate veil, with legislative provisions offering a less onerous path and wider judicial discretion. Section 20(9) of the Companies Act allows an interested party to apply to pierce the corporate veil when a company’s actions constitute an unconscionable abuse of its juristic personality.
Courts’ Interpretation of “Unconscionable Abuse”
In the case of Ex Parte: Gore NO and Others [2013] All SA 437 (WCC), the Court sought to disregard the separate legal personalities of the King Group due to allegations that business was conducted solely through the holding company, with no distinguishable corporate identity among the various subsidiary and related companies. The Court ruled in favour of the Applicant, concluding that the King Group was a sham, and thus ordering that the group be treated as a single entity.
Requirements for Piercing the Corporate Veil
In Knoop N.O and Others v Birkenstock Properties (Pty) Ltd and Others (7095/2008) [2009] ZAFSCH 67, the Court stated that the corporate veil might be pierced where there is evidence of fraud or dishonesty in the establishment or conduct of the company’s affairs. The case highlighted that transactions must be part of a “device, stratagem, cloak or a sham” to justify piercing the veil. This position was recently reaffirmed in Centaur Mining South Africa (Pty) Ltd v Cloete Murray N.O. and Others (1334/2022) [2024] ZACC 34, emphasizing that misuse of a company to perpetuate fraud or improper purposes warrants disregarding its separate legal personality.
To successfully pierce the corporate veil, an applicant must primarily prove that the private equity fund exercised control over the invested company, established it as a sham, or misused it to perpetuate fraud or dishonesty.
The Position of Private Equity Funds
Private equity funds, often part of a group of companies, may be argued to qualify as holding companies. The Companies Act defines a “group of companies” as a holding company and all its subsidiaries. A holding company controls a subsidiary through the majority of voting rights or the ability to appoint directors who control the board.
For venture capital companies to be approved under Section 12J, the Commissioner must be satisfied that their sole objective is managing investments in qualifying companies. Additionally, these private equity companies must be licensed as Financial Services Providers (FSPs) under Section 8(5) of the Financial Advisory and Intermediary Services Act 57 of 2002.
Conclusion and Recommendations
Given the strict requirements for registering as a Section 12J company, it is arguable that a private equity fund, even if deemed a holding company, may not exercise direct or indirect control over its investments. The fund’s legislative object is merely the management of investments, making it a financial vehicle rather than a controlling entity.
Due to stringent legislative requirements, it is unlikely that compliant private equity funds could be held liable for the debts of the companies they invest in. Naturally, shareholders risk losing their investments but are generally protected from further liabilities. It is advisable for private equity funds to ensure their mandates comply with legislative requirements and clearly outline the shareholders’ positions regarding control over invested companies. Any decision imposing liability on private equity funds could set an undesirable precedent, potentially undermining their role in economic development.
If you have any questions or concerns, please feel free to contact us:
info@gumedeandwarburton.com | Andrew Warburton: samantha@gumedeandwarburton.com | Michele Neveling: michele.n@gumedeandwarburton.com
