What are subordination agreements?

Most commonly, when a financier provides debt funding to a company, the financier will require all existing creditors to give priority to the financier’s claims against that company. In doing so, the existing creditors assist the company in obtaining additional funds from the financier, which funds may assist the company in a number of ways, such as relieving the company’s cash flow constraints or expanding the company’s operations. Such assistance is termed a “subordination of debt”, and the existing creditors and the financier will agree to this by entering into a “subordination agreement”, wherein the existing creditors undertake to subordinate their claims against the company in favour of the financier’s claims. In effect, there is a rearrangement in the ranking of claims among creditors.

How wide is the scope of “financial assistance”?

Section 45(1)(a) of the Companies Act provides that financial assistance “includes lending money, guaranteeing a loan or other obligation, and securing any debt or obligation”. Since the Companies Act came into effect, it has been understood by legal practitioners, scholars and the courts that the forms of assistance defined in this provision are non-exhaustive. For example, in Van Den Heerden NO v Van Tonder (A5076/2018; 407461/2015) [2021] ZAGOJHC 486 (20 April 2021), the High Court held that:

“[T]he use of the word ‘includes’ in section 45(1)(a) is wide-ranging and indicates that the types of transactions referred are not an exhaustive list of what constitutes financial assistance. If the list was intended to be exhaustive, the legislature would have said so.”

However, the Supreme Court of Appeal (SCA) took a different approach. In the case of Constantia Insurance Company Limited v The Master of the High Court, Johannesburg and Others [2023] (5) SA 88 (SCA) (13 December 2022), the SCA considered section 45(1) anew. The SCA acknowledged that, when used in a definition, the word “includes” generally denotes a term of extension in the case where (i) the primary meaning of the term that is defined is well-known, and (ii) the word “includes” introduces a meaning or meanings that go beyond that primary meaning. The SCA then, however, argued that this does not appear to be the case in section 45(1). According to the SCA, all the matters included by section 45(1)(a) (and excluded by section 45(1)(b)), fall within the primary meaning of financial assistance, which indicates an intention to determine the ambit of the term with certainty. Moreover, the intention to provide a precise definition is, in the view of the court, even clearer where, as in this case, the excluded matters would also fall within the primary meaning of the term. The SCA thus concluded that the matters listed in section 45(1)(a) are exhaustive of the meaning of “financial assistance”.

Are subordination agreements recognised as “financial assistance”?

In light of the SCA’s judgment in the Constantia Insurance case, subordination agreements, which are not expressly listed in section 45(1)(a), are not regarded as constituting “financial assistance”.

However, given that rearranging the ranking of claims by way of a subordination agreement could impact the financial condition of the entity subordinating its claims – for example, an existing loan that provides for monthly repayments to an existing creditor will, as a result of a subsequently concluded subordination agreement with another creditor, only be repaid after the debtor has fulfilled its obligations to that other creditor – it is difficult to comprehend how a subordination agreement would fall outside the scope of section 45.

What is the best way to tackle subordination agreements?

It is no surprise that many legal practitioners and scholars disagree with the Constantia Insurance case and maintain that the SCA erred in its conclusion. Olivier critiques the SCA’s judgment in his assertion that:

“[T]he method through which the Supreme Court of Appeal arrived at an interpretation of ‘includes’ in section 45 of the Companies Act is highly questionable. The court’s reasoning would have been more persuasive if it had set out what was the accepted ‘primary meaning’ of financial assistance in company law.”¹

The foremost risk in non-compliance with section 45 is that the relevant subordination agreement would be void, according to section 45(6), and this cannot be remedied after the fact. 

Accordingly, notwithstanding the Constantia Insurance case, the prudent approach would be to ensure that the necessary requirements of section 45 are fulfilled prior to a creditor entering into a subordination agreement. That being the case, thanks to the recent amendments to the Companies Act – which, among others, carve out the provision of financial assistance by a company for the benefit of its subsidiaries from section 45 – a company that intends to subordinate its claims against a subsidiary no longer needs to comply with the section 45 requirements, which should ease the administrative burden on that company.

It must be noted, however, that the recent amendment to section 45 does not find application in the event that a holding company gives financial assistance to or for the benefit of a foreign subsidiary. Notwithstanding the Constantia Insurance case, it would be advisable for a holding company to pass a financial assistance resolution if it subordinates its claims against a foreign subsidiary. It is also important to note that the carve-out of the provision of financial assistance by a company for the benefit of its subsidiaries does not apply to section 44.

¹¹ Olivier “The meaning of ‘financial assistance’ in terms of section 45 of the Companies Act 71 of 2008” 2024 Stell LR 40.