Section 40 of the Act deals with the consideration receivable by the company when it issues its shares to an investor. Two key areas must be understood:

1. Section 40(1): A company may only issue shares for adequate consideration to the company (as determined by the board).
2. Section 40(4): Subject to subsections 5 and 7, upon receipt of such consideration by a company for the shares, such shares would be fully paid up and the company would issue the shares to the subscriber and update its securities register. Subsection 5 then deals with deferred or future considerations, i.e. where the subscriber receives a lot of shares upfront but only has to pay later, whether in cash or in kind. The principal requirement is that the shares must go into a trust arrangement and only be released once the shares are fully paid up.

Adequate consideration v fully paid-up shares

The determination of the adequacy of the consideration payable and, indeed, whether such meets the (rather low) threshold for “consideration” as defined in section 1 of the Act in the first place (which essentially requires something of economic value) should be considered separately from the determination of the timing of receipt of such consideration by the company. The conflation of these two issues has sometimes led to an understanding in practice that, because the company receives a contractual undertaking or security on the closing date for consideration that will only materialise in the future, it is not a case of future consideration and, therefore, section 40(5) would not apply. However, one may potentially be confusing adequate consideration with adequate future consideration. That being said, grey areas do rear their head.

The first hurdle of adequate consideration is typically dealt with as a commercial point of discussion and negotiation between the subscriber and the board of the company. One would essentially have to determine what would be an objectively sufficient price to be paid or rendered for the shares.

The next, and separate, question is whether the consideration, once determined by the board, is payable or realised upfront (i.e. is received by a company on the same day and against the issuance of the shares) or, as contemplated under section 40(5), will be payable or realised only at a later date following the issuance of the shares because such consideration takes the form of:

“[E]ither an instrument such that the value of the consideration cannot be realised by the company until a date after the time the shares are to be issued, or an agreement for future services, future benefits or future payment by the subscribing party.”

For example, if the company issues shares to the subscriber pursuant to an agreement for future services, the consideration payable by the subscriber to the company would only be realised at a future date (i.e. when the services have been provided). As such, the consideration would be deemed to be a future consideration, and section 40(5) of the Act would be fully applicable.

Future consideration and earn-out (agterskot) provisions

Once it has been determined that the timing of receipt of the consideration by the company will be at a future date, the provisions of section 40(5) would apply. An interesting but little studied area in M&A that arises regarding future consideration is the earn-out (agterskot) construct. Careful consideration must be given to the payment mechanism to determine whether or not section 40(5) would be applicable.

If, in the agterskot structure, the company issues the full agreed and fixed number of shares to the subscriber on the closing date for a base sum with an earn-out amount being payable at a later date, subject to the fulfilment of certain conditions or milestones, then questions arise as to whether i) those issued shares were fully paid up on the closing date against receipt by the company of the base sum and the earn-out undertaking (which amount neither party knows with certainty, as there are milestones that might or might not be achieved, or it may even be the case that the company ends up having to refund a portion of the base sum to the subscriber); or ii) the issued shares were contingently fully paid up (although phrases like that are unhelpful). Being a test case for this question is probably not worthwhile for any of the parties. In the circumstances, one would rather regard the agterskot amount as future consideration and prepare the required trust agreement as contemplated under section 40(5) of the Act (which has become standard over the years and does not necessarily add a substantial layer of complexity).

Shares to be held in trust

Under section 40(5), the company must immediately issue the shares to the subscriber and transfer the issued shares to a third party to be held in trust for the subscriber, in accordance with the provisions in the trust agreement. In this regard, section 40(5)(b) provides that:

“(b) upon receiving the instrument or entering into the agreement, the company must:

(i)    issue the shares immediately; and

(ii)    cause the issued shares to be transferred to a third party, to be held in trust and later transferred to the subscribing party in accordance with a trust agreement.”

Although the section provides that the shares must be held “in trust”, the conventional view is that the Act does not require the establishment or use of a trust as contemplated in the Trust Property Control Act 57 of 1988 (TPCA). Some interpretations have likened the trust construct under section 40(5) to a debenture trust, which has been held in case law to not be registrable under the TPCA (Conze v Masterbond Participation Trust Managers (Pty) Ltd [1996] (3) SA 786 (C)). Essentially, section 40(5)(b)(ii) of the Act requires nothing more than that the shares be transferred to a third party, other than the company or the subscriber, and the words “held in trust” are simply used to describe the nature of the holding of the shares in escrow.

The pending Companies Amendment Act, 2024 will change the current references to “trustee”, to “stakeholder” and such stakeholder will have to be an independent party, such as an attorney or escrow agent. As a word of advice in this regard, in order to avoid unchartered legal territory such as the insolvency risk of an escrow agent, parties should ensure that the stakeholder is a financial institution, trust company or attorneys’ firm that is regulated by laws that expressly state that trust property is excluded from their personal estates.