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Explanatory notes Close corporations Study unit 1 Introduction to Close Corporations and Membership and Member's interestf

(Business Law Chapter 30 – 33)
Study Unit 1
Introduction to Close Corporations & Membership and Member’s Interest
PRESCRIBED READING – Chapter 30 & 31
Nagel p 393 – 401
Study Objectives
After studying this section you should be able to:
1. Identify and distinguish a close corporation (‘CC’) from a company by way of its
2. Explain the relevance of CCs under the Companies Act of 2008.
3. Explain the procedure for the conversion of a CC to a company.
4. Discuss pre-incorporation contracts made on behalf of a CC.
5. Discuss the membership of a CC and the nature of a member’s interest.
6. Discuss the requirements for a natural person to qualify as a member of a CC.
7. Explain how a member’s interest in a CC is acquired.
8. Explain how a member’s interest in a CC is transferred.
9. How security by means of member’s interest can occur
10. Apply the theory to a set of facts to solve unfamiliar but relevant problems.
Explanatory notes
1-3 Close corporation (“CC”) as a business venture, characteristics of the
CC, relevance of the CCs under the Companies Act of 2008 and conversion
of CCs to companies
In the past during the period of the Companies Act 61 of 1973 (‘Old Act’), companies
were known for being complex because they were regulated by complicated rules.
Consequently, many entrepreneurs especially those who wanted to start smaller
businesses were not able to easily incorporate companies. There was a need for a
simpler vehicle to run business. Therefore, legislators enacted the Close
Corporations Act 69 of 1984 (‘CC Act’). This Act provided the simpler entity that is
similar to companies in many respects.
However, since the coming into effect of the Companies Act 71 of 2008, it is no
longer possible to incorporate new close corporations or convert companies into
close corporations as the current Act is known for its simplicity and makes it easy for
entrepreneurs to incorporate companies. However, close corporations that are in
existence can exist indefinitely or they can be converted into companies.
Close corporations (‘CC’) as business vehicles share a number of similarities with
CCs have the following characteristics or attributes:
Like companies, CCs have the separate legal personality (Juristic
personality) and enjoy all the benefits of the separate legal
CCs like companies, their capacity is unlimited and it is comparable
to that of a natural human being. This means they can conclude any
contract provided it is legal.
It is easy and less costly to form CCs and they are subjected to
simple legal formalities.
It cannot have more than 10 members and members must be
natural persons. Unlike in companies, juristic persons cannot be
members in the CC.
Capital maintenance (stringent rules on how to use CCs money)
rules have been simplified. Like in companies, solvency and liquidity
test is applied. E.g. in Distributions of profits.
To protect third parties who may conclude contracts with the CC,
members of the CC may be held personally liable for failing to
comply with the prescribed requirements when concluding contracts
with third parties.
CCs structure is flexible to cater for specific needs of members in the
Common law rules that regulate the relationships between the CC,
members, and third parties have been enacted in the CC Act to
ensure that members have easy access to the law and know the
rules that regulate them.
CCs are required to provide financial statements and balance sheets,
however, the financial officer of the CC need not be a qualified
auditor. Even one of the members of the CC can be appointed as
the financial officer provided all members provide written consents.
These attributes clearly show that a CC is a simple structure that is regulated by
simple regulations. This had the effect of allowing entrepreneurs to start small and
simpler entities to participate in the commercial world. The existing CCs contribute a
lot in the development of our economy as they allow small enterprises to participate
in the commercial world. Small enterprises are regarded as important economic
drivers in South Africa.
Conversion of a CC
CCs can be converted to companies in the following manner:
The CC files the notice of conversion from CC to a company.
The prescribed fee should be paid.
The conversion should be supported by members holding an
aggregate of 75% or more of the members’ interest. (Note that this
resembles the special resolution found in Companies)
The notice of conversion must also contain the written consent by
members indicating that members holding 75% members interest
have approved the conversion. (signed by all members.)
The notice of conversion must also be accompanied by the
Memorandum of Incorporation (MOI) of the company. Going
forward the new company will be regulated by the Companies Act
71 of 2008 and the MOI as the constitutive document of the
The CIPC will cancel the registration of the CC and give notice of
conversion in the Government Gazette. (This will ensure that those
wo have an interest such as creditors of the CC have the knowledge
of conversion)
Every member of the CC will become the shareholder of the
company and shares that each member will hold need not be equal
to the member’s interest that was held in the CC.
The assets, liabilities, rights and obligations of the CC will now be
held by the company. Any legal proceedings or debts that are
pending against the CC will be instituted or claimed against the
company as if conversion never took place. This will ensure fairness
to third parties.
Pre-incorporation contract
In terms of common law, no agent can represent a principal that does not exist.
However, for the sake of efficacy (to avoid a situation where a CC that is not yet
incorporated would lose a lucrative deal), section 53 of the Close Corporations Act
provides an exception.
An agent purporting to act on behalf of a close corporation that is not yet
incorporated can conclude a pre-incorporation contract on behalf of the close
The following requirements must be met:
The agent must claim to act on behalf of a CC that is not yet incorporated.
The contract must be in writing.
After incorporation, the CC must adopt or ratify the contract.
In the event that the CC does not adopt or ratify the contract:
The CC will not be liable.
The agent will also not be liable unless the agent guaranteed the performance
by the CC or assumed responsibility in the event that the CC is not
In the event that the CC adopts or ratifies the contract it will then be liable. In other
words, the CC will be a party to the contract.
Membership of a CC and the nature of member’s interest;
In a CC we do not have shares. When a member makes a contribution to the CC or
acquires another member’s interest, the member holds the member interest.
➢ The member’s interest will be in percentage e.g. Samson holds
10% member’s interest at TTT CC.
Like with shares, the member is entitled to:
Share in the profits made
Partake in decision making by voting.
Partake in management or control of the CC.
To share in the remainder of assets of the CC when the CC is
Membership and member’s interest
CCs can only have no more than 10 members.
The total aggregate of members’ interest should always be 100%.
Member’s interest represents the single interest held by a member.
It is represented by percentage. E.g Samson holds 10% member’s
➢ Two or more persons cannot be joint holders of the same member’s
interest in the CC.
Requirements for a natural person to qualify as a member of a CC;
Natural persons qualify as members provided:
How a member’s interest in a CC is acquired;
A natural person is entitled to a member’s interest. E.g Sam dies and
bequeaths his member’s interest to Lucy his daughter. (From a
deceased estate)
A trustee of testamentary trust in his official capacity and no juristic
person is a beneficiary of such a trust (through a will).
In his official capacity as trustee, administrator, executor of an
insolvent estate, deceased estate, estate of a mentally disabled
member, or member who cannot manage their affairs or a duly
appointed or authorised legal representative.
Note in paragraph 31.05 that a juristic person can only be a member of
of a CC only in his official capacity as a trustee, administrator,
executor or curator and provided that none of the
beneficiaries is directly or indirectly controlling the juristic
When a new member acquires member’s interest an amended
founding statement must be filed or lodged.
A certificate of membership signed by all members indicating new
member’s interest must be issued to each member.
How a member’s interest in a CC is transferred;
Member’s interest can be transferred in four ways:
Admission as new member
A person can be added in the CC provided that the she contributes money
or property in the CC and the new member will granted member’s interest
in terms of percentage. Services are not regarded as contribution.
Since member’s interest of the CC must always be 100% (ALWAYS
DURING THE EXISTENCE OF THE CC), the new member’s interest will
have to be granted by adjusting the existing members’ interests.
E.g. The CC has 2 members who hold 50% member’s interest each.
When the third member comes into the CC and contributes money and
members agree that his contribution is equivalent to 30% member’s
interest. This means that the existing members’ interest will be adjusted
to 35% each to accommodate the new member. The total will still be
100%. This must be done in terms of the agreement between the existing
members and the new member.
Acquisition of member’s interest from an existing member
o A new member can acquire a member’s interest from another
member through donation, purchase or exchange. The same
arrangement provided under admission as new member is
applicable. The amended founding statement must be lodged.
o However, the disposition of the member’s interest must be done in
accordance with the association agreement which is an internal
document that regulates relations within the CC. Usually the
association agreement will contain a pre-emptive right which
grants the existing members the right to first purchase the
member’s interest before it can made available to outsiders.
o If there is no pre-emptive right in the association agreement, all
members of the CC must consent to the transfer of member’s
interest to the outsider.
• Acquisition from an insolvent estate
o The trustee of the insolvent estate must sell the insolvent
member’s interest to the CC provided there are other members
other than the insolvent member.
o Or to the existing members in pro rata (in proportion) their
member’s interest.
o Or to an outsider who qualifies to be a member.
o The adjustment process as provided above must also be
complied with and the amended founding statement must be
• Acquisition from a deceased estate
This executor must deal with the member’s interest in accordance with
the association agreement. If the association agreement does not
prescribe any directive, then the executor must do the following:
o The executor should transfer the member’s interest to the
legatee or the heir of the deceased provided that other
members consent.
o If they fail to consent, then the executor will sell the interest to
the CC, existing members or an outsider in the same terms as in
Transfer of member’s interest
Membership of a member commences on the date of registration of
the amended founding statement.
The CCs Act provides the procedure to transfer member’s interest.
However, the association agreement may provide the process.
Since member’s interest is a personal right, it is transferred by cession
which is the transfer of rights of member’s interest.
It is safe to provide the certificate as proof of transfer of member’s
But the transferor is still liable for what he or she owes to the CC.
How security by means of member’s interest can occur;
Member’s interest is incorporeal thing which means we cannot
Certificate of membership evidencing member’s interest on the
other hand is corporeal (we can touch) and movable property.
Like a share in the company it can be used as security.
A security is any property provided by the debtor to the
creditor as a guarantee that the debtor will fulfil his obligation to
the creditor. When the debtor fails to fulfil the obligation she will
forfeit the property to the creditor. Security protects the
interests of the creditor.
Personal rights as pledge
The personal rights of the member can be used as security for
the debt owed by the member and if the debtor fails to pay, the
member’s interest can be sold to satisfy the debt owed to the
The member remains the owner of the member’s interest and
the creditor acquires a real right to the member’s interest.
The member’s interest forms part of the insolvent member’s
estate in the event that the member becomes insolvent.
Cession in securitatem debiti (also known as security cession)
This is where the debtor transfers her member’s interest rights
to the creditor and the two agree that the creditor will cede
back the member’s interest upon payment of the money owed
to the creditor.
This cedent who is the debtor has the personal right against the
creditor who is the cessionary to cede back the interest in terms
of pactum fiduciae.
The member’s interest does not form part of the insolvent
estate of the cedent.
End of the notes
Self-assessment question
Question 1
Sam who was a member at VT CC has passed on and is only survived by his son
Themba. Sam held 15% member’s interest in the CC. Themba who is the only heir
of his father’s estate wants to know what will happen to his father’s interest in CC.
Explain fully to Themba.