There has been panic around the legality of the use of trusts in BEE ownership structures due to recent articles which have been written questioning the use of trusts for purposes of BEE. This results in hesitation from auditors and clients alike who ask whether “trusts are legal” when we suggest using a trust in a potential ownership structure.
To add to this, Rob Davies, Minister of Trade and Industry, stated that around 50% of trusts are not BEE compliant. He was especially critical of so-called education and community trusts, which have been the preferred vehicles of corporate SA. Notwithstanding the negative sentiment, excluding trusts from your thinking when seeking a solution to your ownership needs would be a missed opportunity.
The short answer to the question “are trusts are legal” is that trusts are an ownership vehicle recognised and catered for in the Broad-based Black Economic Empowerment Codes of Good Practice (“Codes”), specifically at clauses 3.1.1.4 and 3.12.
In order for a trust to qualify for the allocation of ownership points under the Codes, it must meet the criteria set out in annexure 100(D) of the Codes. If you meet the basic criteria you qualify for up to 40% of the total points:
The basic criteria are quite simple to understand and implement:
- Define the beneficiaries and their entitlement to share in the benefits;
- A written record of the names of beneficiaries or a class of natural persons;
- A written record of the percentage of the benefit they are entitled to or a formula to determine each beneficiaries benefit;
- The trustee’s must have no discretion as to the above;
- On termination of the trust the economic benefit must be transferred to the beneficiaries or an entity for their benefit.
The rationale for these criteria are quite obvious. If trustees had a discretion as to who benefitted and how, the trust structure would be open to abuse as black beneficiaries could be used for their ownership credentials but the trustees could choose not to give them a real economic benefit.
The lack of clear definition of beneficiaries is the criticism levelled at community trusts with no defined beneficiaries and economic benefit being channelled towards community projects rather than individual benefits as a result of share ownership.
The last criteria also prevents the setting up and then termination of a trust to whom a dividend has been made before a benefit is paid out to the beneficiaries – thus channelling the funds elsewhere after getting the benefit of the ownership points.
To obtain the full points additional criteria must be met which requires that a competent person must issue a letter stating that:
- The trust was established for a valid commercial reason;
- The trust does not seek to circumvent the Codes.
This additional criteria requires the attorney or strategist putting the structure together to put their head on the block as to its legitimacy.
As you can see the criticism around trusts and ownership is not as a result of a defect in the trust form itself or its applicability in the context of the Codes, but as a result of the establishment of trusts on terms which don’t comply with the requirements of Annexure (100D) of the Codes or seek to circumvent the intentions of the Codes.
An example I have recently come across is a trust where the beneficiaries were the black employees of a business and the function of the trust was to fund the education of such beneficiaries. The dividends paid to the trust by the company were loaned back to the company to fund its skills development spend. Although funding for educational programs is technically an economic benefit this is clearly circumvention of the intention of the act. The economic benefit being used to fund the skills development obligations of the company for all employees and not just the beneficiaries cannot be countenanced.
The benefits of using trusts as BEE ownership vehicles are:
- Benefit your employees or stakeholders that have helped you grow the business and are people you are familiar with;
- This can be a quicker solution to implement as you are not courting investors, conducting DD’s and negotiating the structure of the deal with third parties and the inevitable bevy of attorneys;
- Fluidity of ownership: as you can list a class of beneficiaries you can name all employees of the business as beneficiaries and this gives you continuity of ownership. New employees are automatically beneficiaries and those who leave immediately cease to be. There is no continuous issuing and cancellation of share certificates.
Draw backs:
- Beneficiaries have certain information rights. It is therefore a good idea to corporatise your business and put good governance principals in place when deciding on a structure like this;
- Loss of control: Like any disposal of equity you, as the business owner, are no longer owner of the shares. It is important to understand that a trust is not a vehicle for the former owner of those shares to rule from beyond in the capacity of trustee. As a trustee you must act in the best interests of the beneficiaries and courts have pierced the trust form when it was found to be fictional.
- Additional administrative functions: trusts require trustee meetings, record keeping, and training for trustees (as this is a position of responsibility with also carries potential liability) and communication and training for the beneficiaries on what the trust entails. This isn’t insurmountable with the right support.
A trust could be the best solution for you and it isn’t hard to obtain the majority of the points available under this score card element through a trust structure while meaningfully giving effect to the Codes.
If you require assistance with a gap analysis to find the right solution for you. Get in touch on admin@aaryalegal.com
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