There have been many questions raised recently regarding the correct application of the principles of B-BBEE to ownership by trusts.

The generic Codes of Good Practice published on 11 October 2013 (“the Generic Codes”) in terms of section 9 of the Broad-Based Black Economic Empowerment Act 53 of 2003, states, in statement 100 which deals with Ownership, that:

“Black people may hold their rights of ownership in a measured entity as direct participants or as participants through some form of entity such as: a company…a Trust…

As a general principle, when measuring the rights of ownership of any category of Black people in a Measured Entity, only rights held by natural persons are relevant.  If the rights of ownership of Black people pass through a juristic person, then the rights of ownership of Black people in that juristic person are measurable. This principle applies across every tier of ownership in a multi-tiered chain of ownership until that chain ends with a Black person holding rights of ownership.”

“Rights of Ownership” is defined as a collective term for the right to economic interest and the right to exercisable voting rights.

“Economic Interest” is defined as a claim against an entity representing a return on ownership of the entity similar in nature to a dividend right, measured using the flow-through principle and, where applicable, the modified flow-through principle.  The modified flow through principle may be applied once in a chain of ownership where black people have at least 51% ownership rights, using the flow-through principle, to deem that entity to have 100% black-held rights of ownership.
In my view, this term “economic interest” refers to the right to receive a dividend or other distribution when one is declared by the entity; and the right to receive a capital return on the ownership instrument when it is sold or otherwise disposed of by the holder.

“Exercisable Voting Rights” is defined as voting rights of a participant that is not subject to any limit.  “Participant” is defined as “a natural person holding rights of ownership in a measured entity”.  Hence, in my view, this is a reference to shareholder/owner voting rights.  It is important to note that this does not refer to board of director / management voting rights.

It is also important to note that neither of these terms refers to ownership of the actual share or other ownership instrument itself.

Statement 100 of the Generic Codes states that:
“Black participants in a Trust holdings rights of ownership in a measured entity may contribute:

• a maximum of 40% of the total points on the ownership scorecard of the measured entity if the trust meets the qualification criteria in Annexe 100(0);
• 100% of the total points on the ownership scorecard of the measured entity if the trust meets the additional qualification criteria in Annexe 100(0).”

The basic criteria for trusts to meet is that the trust deed must define the beneficiaries and the proportion of their entitlement to receive distributions and in this regard:

• a written record of the name of the beneficiaries or the use of a defined class of natural persons satisfies the requirement for identification; and
• a written record of fixed percentages of entitlement of the use of a formula for calculation of entitlement satisfies the need for defining proportion of benefit;
• the trustees must have no discretion on this;
• on winding-up of the trust, all accumulated economic interest must be transferred to the beneficiaries of to an entity representing the interest of the participants of class of beneficiaries.

The additional criterion for trusts is that the Trust must obtain certificate from a competent person to the effect that the Trust was created for a legitimate commercial reason, which has been disclosed, and the terms of the trust do not directly or indirectly seek to circumvent the provisions of the Codes and the Act.

So, the question is, how does one apply the concepts of “rights of ownership”, “economic interest” and “exercisable voting rights” to a Trust?

My view is that the economic interest definition can be applied equally to vested and discretionary trusts, provided that the discretionary trust is one where the nature of the discretion given to the trustees is:

• in relation to the timing of when the benefit can be conferred; or
• in relation to what form the benefit can take; or
• in relation to the extent of the total distribution of benefits; but
• not in relation to the proportion of the distribution; and
• not in relation to the identity of the beneficiaries nor the class of the beneficiaries.

This is so, because the economic element that is being tested does not require the participant to have a vested right to the actual share or other unit of ownership but only that certain people or a class of people must have a right to receive income and capital flows in a defined ratio. In addition, this is for all practical purposes identical to the rights of shareholders in a holding company who do not have an immediate or automatic right to receive any dividends that flow into the holding company, but only a right to receive their proportionate share of a dividend from the holding company if and when and to the extent that the directors may resolve to declare a dividend.

This leads us to the question of whether a class of people and the formula for calculation of entitlement to benefits can be as broadly defined as say “black female South African citizens are entitled to 100% of the benefits from the Trust”?

In my view, that may well qualify, strictly B-BBEE-speaking, as a class and a formula, however, from a trust administration perspective, it would be impossible to implement without giving the trustees or some other person a discretion as to which black female South Africans should benefit and to what extent. That, in turn, would result in a circumvention (or indirect circumvention) of the B-BBEE requirement that the trustees may not have a discretion.

However, where a class of beneficiaries is used rather than named beneficiaries, the trustees, by necessary implication, will have to have an element of discretion in selecting members from among that class to benefit. This is a contentious issue for the B-BBEE Commissioner who disagrees with this view. However, provided the trustees select from within the named class, this satisfies the requirements of the Generic Codes.

Turning to the application of the exercisable voting rights definition to trusts, to align this concept with that of shareholders in a holding company, it is clear that the voting rights must be exercisable by the beneficiaries of the trust and not the trustees, as we are assessing the voting rights of “participants”, i.e. natural persons holding rights of ownership, which presumably must refer to the rights that a beneficial owner has (including the right to vote) and not the bare dominium form of ownership that trustees of a discretionary trust are vested with.

My view is that the exercisable voting rights definition can also be applied equally to vested and discretionary trusts, provided the trust holds meetings of its beneficiaries at which the beneficiaries are empowered to vote on the same or some of the issues that shareholders are entitled to vote on (and this list may not be suitable for all trusts), namely:

• the election and removal of trustees (other than trustees directly appointed by a member or any other person);
• the amendment of the Trust Deed;
• the approval of the admission of new beneficiaries (perhaps only in circumstances where the voting power of the new beneficiaries will equal or exceed 30% of all voting power).

However, certain other rights that are afforded to shareholders, as a general rule, should not be afforded to beneficiaries of a trust, such as the approval of a voluntary winding-up of the Trust, the approval of financial assistance to a related party, the approval of the remuneration of the trustees and the approval of fundamental transactions; as this would probably violate the fundamental principle upon which a trust is based, namely the separation between the control of the trust’s assets, which resides with the trustees, and the enjoyment and benefit of those assets, which resides with the beneficiaries.  However, each trust will need to be assessed individually.

Again, as with shareholders, the actual voting power in respect of these decisions is effectively taken by those beneficiaries who actually show up to a meeting and cast a vote (provided the meeting is quorate, which could be constituted by as low a percentage of total beneficiaries as say 25% of the votes of beneficiaries). Going back to the concept of a class of beneficiaries, one can see how a vague class of beneficiaries would cause difficulties in this regard.

Each trust will have its own peculiarities and these issues will need to be individually assessed to ensure that the trust holds “rights of ownership” in the measured entity.