The Draft Codes of Good Practice on Broad-Based Black Economic Empowerment

Article by Lance Fleiser and Sam Gumede of Werksmans attorneys

The draft Codes of Good Practice on Broad-Based Black Economic Empowerment (“Codes”) were published by the Department of Trade & Industry in December 2004 for comment. In this article we set out some of the principles and requirements of the Codes.

Introduction

The Broad-Based Black Economic Empowerment Act No 53 of 2003 (“Act”) came into effect on 21 April 2004. Section 9 of the Act authorises the Minister of Trade and Industry (“Minister”), by notice in the Government Gazette, to issue Codes of Good Practice on Black Economic Empowerment (“Codes”).

Certain sections of the Codes have now been released in draft form for comment.

Statement 040 of the Codes defines “black people” as “Africans, Coloureds and Indians” (the definition contained in the Act), but then limits the term to South African citizens.

The three core components of the broad-based black economic empowerment (“BBBEE”) scorecard contained in the Codes (“Scorecard”) are –

The Codes include statements relating to ownership and management. However, the draft statements relating to employment equity, skills development, preferential procurement, enterprise development and the residual element are still to be released.

Status of the Codes

Section 10 of the Act requires every organ of state and public entity to take into account and, as far as reasonably possible, apply the Codes.

The Codes require the private sector to take into account the principles and guidance contained in the Codes.

The Codes provide that they apply to all existing and future BBBEE charters.

Consistency between BBBEE charters and the Codes

The Codes require that BBBEE charters be, as between themselves, capable of comparison- in particular in respect of the indicators, the targets and the weightings, so as to facilitate the assessment and comparison of progress made by different sectors.

Only in certain limited circumstances may the indicators in a particular BBBEE charter scorecard differ from those in the Scorecard.

Adequate justification is required if a target contained in a BBBEE charter scorecard differs significantly from that in the Scorecard.

Deviations in excess of 10% from the weightings contained in the Scorecard are not permitted. Further, any deviation from the scorecard weightings requires adequate justification.

Section 12 of the Act requires the Minister to publish a BBBEE charter in the Government Gazette if he is satisfied that the charter has been developed by major stakeholders in the sector and advances the objectives of the Act. It appears that the Minister is required to publish such a charter for general information purposes even if it does not meet the principles and requirements contained in the Codes (in which event, notwithstanding publication, it will be overridden by the Codes to the extent that it fails to reflect such principles and requirements). If a BBBEE charter does meet such principles and requirements, the Minister can elect to publish the BBBEE charter in the Government Gazette as a “Code of Good Practice” in terms of section 9 of the Act.

On publication as a “Code of Good Practice”, enterprises subject to the BBBEE charter will be assessed based on that BBBEE charter scorecard. Organs of state and public entities are then required to use that BBBEE charter scorecard for purposes of determining the BBBEE status of enterprises.

If a BBBEE charter is not published in the Government Gazette or is so published, but not as a “Code of Good Practice”, organs of state and public entities are required to use the measurement criteria contained in the Codes, and not those contained in that BBBEE charter.

The Codes encourage all companies to develop their own economic empowerment plans, setting out the manner in which they intend to achieve the objectives of the Act and the Codes. A company is required to adopt the scorecard contained in a BBBEE charter which is relevant to it and which has been published as a “Code of Good Practice” in the Government Gazette or, if there is no such scorecard, to adopt the Scorecard.

Ownership

“Ownership” is defined as the entitlement of black people to both voting rights and to an economic interest associated with an equity holding –

The fundamental focus is on the effective economic interest or voting rights of black natural persons. Accordingly, where black natural people hold interests in a company indirectly through various other companies, the effective voting rights or economic interests of those black natural persons at the top of the chain is what matters. This is referred to in the Codes as the “flow-through principle”. For example, if black natural people hold 52% of the shares (where there is only one class of shares) in company A which, in turn, holds 52% of the shares (where there is only one class of shares) in company B, the effective economic interest of black people in company B (for purposes of the Codes) will be 27% (ie, 52% of 52%). While this principle is logical in measuring the effective economic entitlement of black natural persons, it is questionable whether it is appropriate in calculating voting rights in a pyramid/control structure. Voting is largely about control and the flow-through principle ignores the actual level of control which black natural people have over company B in the example above.

Once the effective voting rights or the effective economic interest to which black people are entitled is determined, the next question is whether the voting rights or economic interest is subject to any restrictions. Restrictions include pledges, arrangements in terms of which the benefits of the voting rights or economic interest are reserved to some other person, arrangements which withhold, defer or restrict the exercise of the voting rights or the receipt of the economic interest, arrangements restricting the ability of members to elect a number of directors proportionate to their shareholding and undertakings in terms of which a person may be compelled to part with his voting rights or economic interest. It should be noted that any “lock-in” arrangement in terms of which a person undertakes not to sell his shares for a certain period of time is not regarded as a “restriction”.

A

n economic interest is also regarded as being subject to restriction if the acquisition of the equity interest concerned was financed in whole or in part by a loan or similar financing arrangement or if the equity interest was purchased on credit.

The Scorecard sets a target of 25% plus one vote of all the voting rights, and a target of 25% of the aggregate economic interest, in the hands of black people (in an unrestricted form). It allocates a weighting of 20% to ownership which, in turn, is allocated as follows –

Management

“Management control” is defined as the effective control of economic activities and resources and the power to determine policies as well as the direction of economic activities and resources. The exercise of such management control is normally to be measured at two levels, namely –

The focus is on those individuals involved in the determination of the strategy of the enterprise as well as the operational implementation of such strategy.

A substance over form approach is applied in determining whether a representative on the governing body actively participates in the strategic and operational aspects of the enterprise. Accordingly, provisions in agreements (such as management agreements) limiting the decision-making capabilities of representatives on the governing body are taken account of in determining management control. Appointed alternates on the governing body are not recognised in the determination of management control as such individuals are regarded as only able to operate when the nominator does not act personally.

The Scorecard sets a target of black persons comprising 40% of management and allocates a weighting of 10% to management control.

The Codes recognise the difference in operational decision-making capabilities of non-executive and executive representatives on the governing body as well as the operational decision-making influence of such representatives by awarding different weightings for purposes of determining management control, and also awards black women a 50% higher allocation, as follows –

Other Indicators

As mentioned above, the draft statements relating to employment equity, skills development, preferential procurement, enterprise development and the residual element are still to be released.

The Scorecard assigns the following weightings to the other indicators –

The Codes provide that the government will use the total score under the Scorecard to rank enterprises according to their progress in achieving BBBEE, as follows –

The Scorecard also uses the distinction between procurement from excellent contributors, good contributors and satisfactory contributors as the basis to score enterprises for their progress in achieving BBBEE in regard to preferential procurement (ie in regard to their selection of procurement partners).

The rationale underpinning such ranking of enterprises is to distinguish between what is described in the Codes as “narrow-based BEE”, which focuses solely on ownership and management (which according to the Codes, may result in “fronting”) and BBBEE which covers all the elements of the Scorecard. BBBEE is described as the broadening of the beneficiary base to include all black investors, management, employees, suppliers and communities.

Nothing in this publication should be construed as legal advice from any lawyer or this firm. The articles published are general summaries of developments or principles of interest, and may not apply directly to any specific circumstances. Professional advice should therefore be sought before action based on any article is taken.

Specific Questions relating to this article should be addressed directly to the author.