Transcripts
Welcome to Perspectives.
::Fasken's legal voices on business.
::Welcome to Fasken podcast on the competition
and B-BBEE aspects to consider regarding
::employee share ownership plans, otherwise
known as ESOPs.
::My name is Lesley Morphet and I head up the
competition team at Fasken.
::So not surprisingly, I shall be looking at
the topic from a competition law perspective.
::My name is Daphney Willem.
::I am a partner in our Labour and Employment
Department which houses our B-BBEE practice
::group. I will provide insight on the B-BBEE
aspects of ESOPs imposed by the Competition
::Commission.
::Welcome, Daphney.
::I look forward to your insights.
::Maybe I can start with giving some
background on the topic, from a competition
::law perspective.
::The purpose of the South African Competition
Act is set out in section two and includes
::provisions such as promoting the efficiency
of the South African economy and providing
::consumers with competitive prices and
product choices.
::But the act also aims to correct the wrongs
of the past and therefore has public interest
::aspects. In 2018, the act was amended, with
the amendments coming into force in February
::2019, and one of the provisions, as it now
reads, is to promote a greater spread of
::ownership, in particular to increase the
ownership stakes of historically
::disadvantaged persons.
::The act in general focuses both on
competition and public interest aspects, and
::this dual focus is particularly notable with
respect to the merger provisions, where, when
::determining whether a proposed transaction
should be approved or not, the Commission has
::to weigh up both competition and public
interest aspects in determining whether to
::approve a merger or not, and if it does
approve the merger, whether the approval
::should be subject to conditions or not.
::Since the amendments came into force.
::The Commission has been exceptionally active
from a public interest perspective in its
::assessment of a merger.
::Section 1283 requires a consideration of the
effect that a merger will have on, amongst
::others, the promotion of a greater spread of
ownership, in particular to increase the
::levels of ownership by historically
disadvantaged persons and workers in firms in
::the market. The Commission sees these
provisions as placing a positive obligation
::on parties to mergers, to ensure that there
is a positive effect on ownership by
::historically disadvantaged persons and
workers.
::Therefore, there are regular requirements
that merging parties either introduce an ESOP
::or increase the ownership levels of the
ESOP.
::Daphney, can you perhaps provide background
to ESOPs from your perspective, what are they
::and how do they work?
::So an ESOP is an employee share ownership
scheme, which is established to enable
::employees to enjoy the benefits associated
with indirect ownership.
::The scheme is housed in a vehicle either in
the form of a company or a trust, which buys
::or has shares donated to it in a measured
entity.
::In the competition case, the measured entity
would be the merged entity and the shares are
::held for the benefit of the beneficiaries of
the scheme.
::In essence, the employees would be
considered indirect shareholders of the
::measured entity by virtue of either being
shareholders of an intermediary company or
::beneficiaries of a trust, depending on the
entity that the employer, or in this case,
::the merged entity uses as an intermediary.
::From a B-BBEE perspective, black people are
allowed to hold shares in a measured entity
::through a recognised business entity,
provided that they do so using a recognised
::business entity that meets the prescribed
qualification criteria.
::An ESOP is one of the recognised business
entities, and it can hold shares and
::contribute to a measured entity's black
shareholding, provided that it meets a
::qualification criteria for such recognition.
::In that case, an ESOP would be regarded as
any other shareholder, and it will have
::voting rights and share in the measured
entity's dividends in proportion to the
::shares that it holds in such a measured
entity.
::Super. Thanks very much, Daphney.
::Now that we understand in general what an
ESOP is, let's look more closely at what the
::Commission requires in this respect.
::It's noteworthy that the previous Minister
of Trade, Industry and Competition, Ebrahim
::Patel, was very in favour of ESOPs, which is
why I think they hold such prominence in the
::public interest guidelines.
::In fact, he held a conference on them
shortly before the elections earlier this
::year to showcase all the successful ESOPs
that had been put in place to buy parties to
::mergers. President Ramaphosa was the keynote
speaker at that conference, and he
::highlighted the value of ESOPs as an
instrument to broaden ownership and with
::time, to enable greater control of the
economy by previously disadvantaged groups,
::especially women and black South Africans.
::He also stated that the schemes allowed
workers a seat at the table where strategic
::corporate decisions were made, so it can
clearly be seen why the government considers
::them such a valuable instrument to rectify
the wrongs of the past.
::And the DTIC has used ESOPs in this way in
its competition legislation.
::Turning back to mergers and ESOPs in
mergers, the Commission has sought to provide
::guidance to merging parties as to how they
will deal with the application of the law
::regarding public interest, including putting
in place ESOPs through issuing guidelines.
::Although these guidelines are not binding on
the Commission, they do give guidance on how
::they are likely to tackle the public
interest aspects of a merger before them.
::In draft guidelines issued late last year,
the Commission included detailed provisions
::regarding the requirements for the ESOP.
::In March this year, final revised public
interest guidelines came into effect.
::The point of departure is that a merger must
promote a greater spread of ownership.
::They will look at pre-merger ownership
levels by workers and historically
::disadvantaged people, where a merger does
not promote a greater spread of ownership.
::In this way, they will look at ownership
remedies, in particular ESOPs in relation to
::workers. There is far less detail regarding
the requirements for ESOPs than there was in
::the draft guidelines.
::The final guidelines simply say an ESOP
concluded in accordance with the design
::principles articulated in case precedent and
refined by the competition authorities from
::time to time.
::The ESOP must hold a minimum range of 5 to
10% of the equity of a merging party or the
::merged entity and must represent a broad
base of workers as opposed to a few highly
::skilled workers.
::However, the comment that it should be in
accordance with the design principles
::articulated in case precedent does lead one
back to the more detailed provisions that we
::have seen in past mergers.
::Daphney, perhaps you can take us through
these.
::Thanks, Lesley.
::And as you have already said, the the final
guideline does not set out these design
::principles that the Commission will use.
::However, if we look at the draft guidelines,
as well as past mergers that the Competition
::Commission has approved.
::They indicate the type of design principles
that the Commission may impose.
::So I'll deal with some of these design
principles.
::The first theme I will start with is the
structure of the SOP.
::The Commission has indicated that it prefers
a unitised employee share ownership trust.
::And this obviously is as opposed to a
company that can also be used to house an
::employee share ownership scheme.
::A Unitised trust presents challenges and
complicates the trust provisions.
::Units presents the risk of being regarded as
equity instruments that present tax
::challenges and may require complex
structuring in order to avoid the vesting of
::the units and tax liabilities for the
beneficiaries due to the units vesting in
::them. Units also add an unnecessary layer of
complexity and administration for the trust,
::as a register of units must be kept
regulating the issuing and cancellation of
::units given the resignation and employment
of new beneficiaries, this will require
::administration that often leaves the
trustees with no choice but to outsource the
::administration of the trust.
::This will increase the expenses that the
trust will incur, and consequently reduce the
::benefits that may be shared by the
beneficiaries.
::An alternative and simple way to deal with
the distribution of benefits to beneficiaries
::would be to use a formula.
::Formulas are easily applied by the trustees
when benefits are paid to the trust, and
::would not be subject to any manipulation, as
the trustees would not have any discretion
::when it comes to the distribution of the
benefits.
::This approach is very simple and only
requires keeping of a register of
::beneficiaries, which can easily be
reconciled by the employer with the
::employee's information.
::The use of formulas is an approach that is
also recognised by the triple B codes.
::The second item under the theme structure is
whether an SPV may be interposed between the
::ESOP and the measured entity.
::There isn't a commercial reason for
interposing a company between the ESOP and
::the measured entity, but this may be
appropriate if the intention is for the ESOP
::to eventually hold shares in other entities.
::The SPV may be considered an investment
holding company that will hold shares in
::multiple companies for the benefit of the
ESOP.
::Remembering that we are looking here at how
the Commission has dealt with aspects of
::ESOPs in the past, and not at what they have
put in their final guidelines.
::What are their views as to whether employees
must pay to participate in an ESOP?
::The Commission has in the past noted that
workers are not required to pay to
::participate in the ESOP.
::This view is consistent with how ESOPs are
operating in the B arena and is welcome.
::The third theme is governance of the ESOP.
::The Competition Commission has noted that
the Board of Trustees must comprise of three
::trustees one appointed by the workers, one
appointed by the founder of the ESOP, and a
::third being an independent trustee to be
recommended and appointed by the workers,
::provided that that person is acceptable to
the measured entity.
::It is impractical to get all workers to
participate in the appointment of the
::independent trustee.
::Think about a situation where the measured
entity employs thousands of employees.
::It will be impractical for all of them to
vote on the appointment of one independent
::trustee. This will present great
difficulties if the appointment of the
::independent trustee is a requirement for the
ESOP to be established.
::Furthermore, the Commission does not define
what constitutes independent, nor does it
::prescribe a qualification criteria for the
independent trustee.
::So quite frankly, Daphney, it might never get
established.
::Yes, a possible way around this impulse and
to ensure that the ESOP is registered is for
::an independent trustee to be appointed by
the measured entity for registration
::purposes. Was. Thereafter, an independent
trustee may be appointed by the trustees
::jointly. The initial independent trustee
will only be for purposes of registration and
::will resign simultaneously with the
appointment of the independent Trustee by all
::the trustees together.
::The trustee appointed by the merged entity
will assist with compiling a list of
::independent trustees from which the two
trustees can choose, subject to an agreed
::qualification criteria.
::We have found that this alternative works in
resolving the impulse between the employees
::as well as the employer and ensures that the
ESOP is registered timelessly.
::The fourth theme is the duration of the
ESOP.
::The Commission approves an evergreen ESOP
for purposes of catering to the ever-changing
::workplace. This, in our view, is appropriate
given the ever-changing number of employees
::in a specific workplace.
::The last theme is participation benefits.
::Here, the Commission recognises that the
ESOP will not be given shares in the merged
::entity for free and approves the use of a
vendor financing loan, which will be an
::interest free loan to be given to the ESOP
for purposes of acquiring the shares.
::In addition to that, the Commission has
highlighted a dividend policy, which includes
::the payment of a typical dividend to the
ESOP for as long as the vendor financing loan
::remains outstanding, the dividend will be
used to pay off the loan and still provide
::benefits to the beneficiaries, Series at a
ratio of 35 and 65.
::35% of the dividends will flow to the
beneficiaries, and at most 65% of the
::dividends will be used to service the vendor
financing loan.
::While the vendor financing loan is an
acceptable way to introduce an ESOP in a
::measured entity shareholding, the use of a
loan may have B-BBEE consequences on the
::measured entity.
::As such, a loan will be considered
acquisition debt and and may affect the
::measured entity's net value points.
::A trickle dividend is normal practice, but
the ratio recommended and seen from past
::merger approved transactions may not be
sufficient to address the requirements of net
::value and the repayment of the loan.
::Thank you. Daphney, What do you think of the
interest free aspect that I can remember them
::imposing in past matters?
::Is that not perhaps onerous on the merging
entities?
::Yes. We had said it shouldn't be interest
free.
::It should be at a rate less than prime.
::Because that's how much?
::Oh, no. That. So this is what we said.
::If the ESOP would go to a a bank, they would
have to pay interest.
::So why is the commission looking at us and
saying we shouldn't get we shouldn't impose
::interest. We are also understand that the
ESOP.
::Well, what the commission is trying to do is
facilitate the introduction of the ESOP,
::making it easy for them.
::So if the Commission doesn't want to impose
interest at the rate that is charged at the
::banks, rather reduce the rate, but still
impose the interest because it is a third
::party transaction.
::So the ownership element under the B-BBEE
codes, and B-BBEE sector codes comprises of
::three sub elements.
::Economic interest, exercisable voting rights
and net value.
::Net value looks at the loan that black
people are given to acquire their shares in
::the merged entity, and the repayment of that
loan is subject to a time graduation factor,
::which sets out the percentage that needs to
be repaid of the loan on an annual basis for
::a period of ten years.
::So if a measured entity is black, shareholder
has an acquisition debt, that acquisition
::date needs to be repaid in accordance with
the time graduation factor, failing which the
::entity will not receive any point under the
third sub element of the ownership element
::being the net value element.
::Importantly, the net value element is also a
priority element, meaning that in addition to
::complying with the time graduation factor, a
measured entity to be able to get points
::under that sub element needs to meet 40% of
the points available.
::Failure to do so will result in that
measured entity being discounted by one
::contributor status level.
::So for example, if a measured entity gets
undergoes a B-BBEE verification, they get a
::level five contributor status level.
::However, the acquisition loan was not paid
in accordance with the time graduation
::factor, and they don't get 40% of the points
available in that sub element.
::They will be discounted by A level so they
will no longer be considered a level five B
::contributor, but will now be a level six
B-BBEE contributor.
::Moving one level down so that sub element is
is crucial for for measured entities that
::actually have acquisition debt.
::That's quite a big impact that it might have
on them.
::So perhaps the competition guidelines need
to take this into account.
::Or the Commission, in its imposition of
ESOPs as a condition of mergers, needs to
::understand these dynamics and apply them
more carefully.
::Definitely, Leslie, and the Commission needs
to take this into consideration, especially
::when considering the ratio that they impose
as part of the dividend policy, because
::currently that ratio is not subject to any
movement.
::It is what the Commission has prescribed.
::It says at most 65%.
::So entities are not allowed to go past or
pay more than 65% of the dividends towards
::the repayment of the loan.
::We must be careful here because those were
the draft guidelines that set out all these
::details that we've been unpacking, but we do
think that that is how they look at matters
::based on case precedent.
::Perhaps the flexibility that they've brought
in in the final guidelines gives us an
::opportunity to negotiate more with the
commission on these points.
::Definitely.
::Thanks very much for these insights.
::Do the requirements of the Commission
dovetail broadly with the provisions of the
::triple B, double E codes?
::It sounds as if they do.
::But there are some differences.
::Yes. So there is there is an overlap between
what the commission seeks to achieve and what
::the B-BBEE codes regulate.
::For example, I've mentioned that the an SOP
is one of the recognised entities that can be
::used to contribute to one's black
shareholding.
::However, the requirements or the design
principles that the Commission seeks to
::impose may have adverse consequences on the
recognition of the ESOP from a B-BBEE
::perspective. So to mitigate against any
adverse B-BBEE consequences that may be
::suffered by the measured entity that has
adhered to the directions or conditions
::imposed by the Commission, and the
Commission should, from now on, consider
::aligning its requirements and possibly using
the same principles set out in the B-BBEE
::code when imposing the ESOPs.
::Because this will make the ESOP more
attractive to a measured entity, because they
::can get recognition under the B-BBEE code,
as well as comply with the conditions that
::are imposed by the Competition Commission.
::If there is a gap, there may be a lot more
pushback from measured entities in adhering
::to the conditions imposed by the by the
Commission because of the consequences that
::the conditions may have on there be
recognition.
::So to to kill two birds with one stone
alignment is crucial in these instances to
::ensure that um measured entities are not
adversely affected.
::Thanks very much, Daphney.
::It's these have been an important factor in
our merger clearances, and certainly parties
::need to think very carefully about how they
will deal with this provision.
::Should it be something that the Commission
is looking to impose in future mergers and
::make sure that they get proper advice from
somebody knowledgeable in the codes?
::Thanks very much for this insight.
::It's been a very interesting chat for me.
::I hope you, our listeners, have found it
useful and informative.
