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Lending and borrowing

Are there any restrictions on lending and borrowing?

South Africa

South Africa

Lending

Unless exempted, lenders are required to be registered as credit providers and financial service providers with the applicable regulatory bodies.

Lending to individuals and/or juristic entities which fall within the scope of the National Credit Act (due to their lower level of annual turnover and asset value) is subject to greater regulatory scrutiny as the information that is required to be provided to those borrowers prior to entering into a credit is more extensive. The agreements also need to follow a prescribed format and must include certain prescribed information. There is a heavy onus on lenders in these circumstances to ensure that a borrower will not be over-indebted as a result of the credit made available by the lender to that borrower. A court may declare a contract which does not comply with the prescribed format unlawful and a lender will therefore not be able to enforce its rights thereunder.

All financial institutions are required to complete the necessary 'know-your-client' procedures in terms of the Financial Intelligence Centre Act before providing finance to a borrower. In relation to companies, these procedures involve the collection of information regarding the directors and shareholders of that company, ensuring that the company is duly registered in its jurisdiction of incorporation and that the company has filed the necessary tax returns for the preceding tax years.

Lending to state-owned enterprises and other government agencies is subject to a separate legislative regime. State-owned enterprises are created by statute and the provision of finance to those state-owned entities will need to comply with the provisions of the legislation which governs that entity as read together with the Public Finance Management Act.

Borrowing

Borrowers are generally not restricted by legislation from borrowing. There may, however, be restrictions contained in the particular borrower's constitutional documents with regards to the incurral of financial indebtedness. A detailed review of the borrower's constitutional documents should always be a prerequisite to providing financing.

Also, in relation to the provision of financial assistance, see Giving and taking guarantees and security

Last modified 5 Dec 2019

Are there any restrictions on lending and borrowing?

Lending

Unless exempted, lenders are required to be registered as credit providers and financial service providers with the applicable regulatory bodies.

Lending to individuals and/or juristic entities which fall within the scope of the National Credit Act (due to their lower level of annual turnover and asset value) is subject to greater regulatory scrutiny as the information that is required to be provided to those borrowers prior to entering into a credit is more extensive. The agreements also need to follow a prescribed format and must include certain prescribed information. There is a heavy onus on lenders in these circumstances to ensure that a borrower will not be over-indebted as a result of the credit made available by the lender to that borrower. A court may declare a contract which does not comply with the prescribed format unlawful and a lender will therefore not be able to enforce its rights thereunder.

All financial institutions are required to complete the necessary 'know-your-client' procedures in terms of the Financial Intelligence Centre Act before providing finance to a borrower. In relation to companies, these procedures involve the collection of information regarding the directors and shareholders of that company, ensuring that the company is duly registered in its jurisdiction of incorporation and that the company has filed the necessary tax returns for the preceding tax years.

Lending to state-owned enterprises and other government agencies is subject to a separate legislative regime. State-owned enterprises are created by statute and the provision of finance to those state-owned entities will need to comply with the provisions of the legislation which governs that entity as read together with the Public Finance Management Act.

Borrowing

Borrowers are generally not restricted by legislation from borrowing. There may, however, be restrictions contained in the particular borrower's constitutional documents with regards to the incurral of financial indebtedness. A detailed review of the borrower's constitutional documents should always be a prerequisite to providing financing.

Also, in relation to the provision of financial assistance, see Giving and taking guarantees and security

What are common lending structures?

Loans

Other than pursuant to the provisions of the National Credit Act, as contemplated above, there is no prescribed structure for lending transactions and such transactions may be tailored to suit the commercial requirements of the parties.

A loan may be provided on a bilateral basis (a single lender providing the entire facility) or on a syndicated basis (multiple lenders providing portions of the overall facility) to one or multiple borrowers.

Loan durations

The duration of the loan is subject to negotiation between the parties. Generally, the duration of loans varies between:

  • bridging loans – short-term loans, normally for up to three to six months (there are generally tighter operational restrictions placed on the borrower and the margin is higher than longer-term loans);
  • term loans – provided for an agreed period of time and is made available for a specific purpose (the availability period of such loans ends once the borrower has utilized the loan for the applicable purpose);
  • revolving loans – provided for an agreed period of time and may be redrawn if repaid; and
  • working capital facilities – made available to the borrower for a period of 365 days and is repayable on demand (these types of loans are ordinarily utilized by the borrower to fund its general working capital requirements and may be redrawn if repaid).

Loan security

Loans may be secured or unsecured. For more information, see Giving and taking guarantees and security

Loan commitment

Loans may be committed or uncommitted. It is common, in relation to committed facilities, for the lender to charge a commitment fee for the duration of the availability period of the particular commitment. In order for a loan to qualify as being uncommitted, the provision of that loan must be subject to conditions which are in the lender's discretion (eg credit committee approval).

Loan repayment

Loan repayments vary according the commercial capabilities of the borrower and the purpose for which the transaction was implemented. Repayments vary between:

  • capital bullet – the full amount of capital is repaid on the maturity date with interest being paid in arrears on each interest payment date (normally monthly or quarterly);
  • equal payments – equal payments comprising capital and interest payable at set intervals during the term of the loan;
  • equal capital payments – equal payments of capital plus accrued interest payable at set intervals during the term of the loan;
  • sculpted profile – instalments vary according to the borrower's projected income during the term of the loan; and
  • on demand – capital is repayable on demand with interest having been paid at set intervals during the term of the loan.

Preference shares

An alternative basis on which to provide financing is by way of subscribing for preference shares in the borrower. The advantage of using this type of funding is that the dividends that a preference shareholder receives (ie akin to the interest it would have received on a loan) is exempt from tax under South African tax legislation. In order to benefit from the exemption on dividends, the provision of finance by way of preference shares does, however, need to comply with the requirements set out in the Income Tax Act as to the purpose of such financing and the security provided for such financing. Failure to comply with the provisions of the Income Tax Act for preference share funding has the consequence that the dividends received on account of the preference shares are deemed to be interest (which is taxable) and, accordingly, the tax benefit of such preference share funding will be lost.

In the event of the insolvency of the borrower, a preference shareholder will rank behind secured creditors of the borrower and ahead of the ordinary shareholders of the borrower.

What are the differences between lending to institutional / professional or other borrowers?

Lending to large corporations/institutional investors is less burdensome, particularly on enforcement, than lending to individuals or small corporations. Enforcement of a lender's rights under a loan advanced by a lender to an individual or any other entity regulated by the National Credit Act requires the lender to first refer the applicable borrower to a debt counsellor in order to agree a payment plan before the lender is entitled to enforce its rights under the applicable credit agreement.

A lender is also obliged to ensure that, when lending to an individual or small corporation, that individual or small corporation will not become over-indebted as a result of loan advanced by the lender. The lender must take reasonable steps to ascertain a borrower's understanding of the credit agreement it is to enter into, its debt repayment history and its existing financial means, prospects and obligations.

Do the laws recognize the principles of agency and trusts?

Under South African law, an agent does not have locus standi (the right to bring an action) in litigious proceedings before South African courts. South African law therefore does not recognize the provision of security in favor of an agent (on behalf of other parties) or in favor of a trust (other than a trust which has been properly established in accordance with South African law). Further, the Deeds Registries Act does not permit registerable security (mortgage bonds, special notarial bonds and general notarial bonds) to be registered in favor of an agent. Security, under South African law, should be provided to the finance parties directly or to a special purpose vehicle (Security SPV) as described below.

For syndicated lending transactions, the most common security structure in the South African markets, involves the creation of a guarantee and indemnity structure and the interposition of a Security SPV (which is owned by an independent orphan trust). Pursuant to the structure, the special purpose vehicle issues an on demand guarantee in favor of the finance parties, in terms of which the Security SPV undertakes to guarantee the obligations of the borrower in favor of the finance parties. The security providers then enter into an indemnity agreement in terms of which the security providers indemnify the Security SPV against any claims made against it under the guarantee. All security provided by the security providers is provided in favor of the Security SPV as security for the security providers' obligations under the indemnity agreement.

Are there any other notable risks or issues around lending?

Generally

No contractual arrangement may breach a legal rule or public policy. Legal rules may be derived from statute or from the common law whereas public policy is a subjective determination made by a judge by taking into account various policy issues, including the spirit and purport of the Constitution of South Africa.

There are a number of rules regarding the charging of interest and penalties. For instance, the in duplum rule states that the amount of interest charged by a lender may not exceed the capital amount of the loan. Further, under and in terms of the Conventional Penalties Act, a creditor shall not be entitled to recover, in respect of an act or omission which is the subject of a penalty stipulation, both the penalty and damages or, except where the relevant contract explicitly provides, to recover damages in lieu of a penalty. A court may also reduce a penalty where it is of the opinion that the penalty is out of proportion to the prejudice suffered by the creditor.

The rights of a creditor may also be limited by application of insolvency, reorganization, business rescue or other similar laws and a creditor may therefore not be able to enforce its rights under a finance agreement to the full extent contemplated therein.

It is important that all financial assistance resolution have been passed as a failure to do so results in the provision of such financial assistance being void. For more information, see Giving and taking guarantees and security – restrictions.

Specific types of lending

Lending to individuals and small corporations which are subject to the National Credit Act requires the lender to take greater precautions in order to ensure that the borrower will not be over-indebted. For more information, see Lending and borrowing – borrower considerations.

Standard form documentation

Most syndicated and large bilateral financing transactions are governed by loan documentation based on the recommended forms published by the Loan Markets Association and which have been tailored to suit the South African market. Documentation developed in-house by the banks is more commonly used for smaller, bilateral finance arrangements.

Are there any other notable risks or issues around borrowing?

None.

Are there any restrictions on giving and taking guarantees and security?

Some of the key areas affecting the giving of guarantees and security are:

Financial assistance

When providing a guarantee or security for the obligations a related or inter-related company the guarantor or security provider must be able to comply with the financial assistance provisions and solvency and liquidity requirements as contemplated in the Companies Act. The Companies Act considers the entry into of a guarantee and/or the provision of security for the obligations of a related or inter-related company as the provision of financial assistance. Financial assistance may only be provided if the shareholders of the company, as a first step, have passed a resolution authorizing the provision of that financial assistance, in particular, or financial assistance generally. In order for a company to provide financial assistance, the shareholders of that company must have passed such a shareholder resolution within the preceding two years.

As a further step, the directors of the company will need to pass a separate resolution authorizing the provision of the financial assistance and confirming that the company will comply with financial assistance provisions as contemplated in the Companies Act which require the directors to confirm that:

  • the guarantor's/security provider's assets (fairly valued) exceed its liabilities (fairly valued);
  • the guarantor/security provider will be able to pay its debts as they fall due for the 12 months; and
  • the terms under which the financial assistance is proposed to be given are fair and reasonable to the company.

Distributions

The companies act includes, in its definition of a distribution, the incurrence of a debt or other obligation by a company for the benefit of one or more holders of any of the shares of that company or of another company within the same group of companies. The provision of a guarantee or security by a company in respect of the obligations of a company within the same group of companies would therefore be classified as a distribution. Accordingly, the company providing that guarantee and/or security will need to comply with the applicable provisions of the Companies Act and the directors of that company will need to pass a resolution confirming that, at the time if the provision of such guarantee and/or security:

  • the guarantor's/security provider's assets (fairly valued) exceed its liabilities (fairly valued); and
  • the guarantor /security provider will be able to pay its debts as they fall due for the 12 months.

Capacity

The guarantor's/security provider's constitutional documents must make provision for that guarantor/security provider to enter into a guarantee and/or provide security for the obligations of a related party or a third party;

Agency

For information regarding the provision of security in favor of an agent, see Lending and borrowing – agency and trusts.

What are common types of guarantees and security?

Common forms of guarantees

The most common type of guarantee in financing transactions is a first demand payment guarantee where the guarantor undertakes to make payment in the event of a default by the borrower.

It is important to ensure that the guarantee creates a principal obligation to pay or perform regardless of the enforceability, validity or legality of the underlying obligation. For more information, see Giving and taking guarantees and security – other issues.

Common forms of security

The most common forms of security are as follows.

Pledge of shares

Perfection requirements include the delivery of share certificates evidencing the shares together with signed, undated share transfer forms where the shares are in certificated form or the noting of the pledge on the account held by the security provider with a central securities depository where the shares are dematerialized.

Cession of rights

All incorporeal rights may be cede in security, provided that the subject of that cession does not expressly prevent the cession of such rights. The most common forms of rights ceded are rights in and to insurance policies and amounts payable thereunder; bank accounts and amounts standing to the credit thereof; key customer contracts; and debtors book.

Mortgage bonds

These provide real security over immovable property and are required to be registered in the South African Deeds Office nearest to where the property is located. This form of security must be prepared and filed by a conveyancing lawyer.

Special notarial bond

A special notarial bond is provided over specified movable assets and is required to be registered in the South African Deeds Office where the security provider's principal place of business is located. This form of security must be prepared and filed by a conveyancing lawyer.

General notarial bond

A general notarial bond is provided over the security provider's movable assets in general and is required to be registered in the South African Deeds Office where the security provider's principal place of business is located. This form of security must be prepared and filed by a conveyancing lawyer.

In relation to the Security SPV structure, also see Lending and borrowing – common structures.

Are there any other notable risks or issues around giving and taking guarantees and security?

Giving or taking guarantees

Guarantees must explicitly state that the guarantee creates a primary obligation and not a suretyship and that the guarantor's obligations thereunder will not be affected by the enforceability, legality of validity of the underlying obligations. A suretyship under South African law creates an ancillary obligation and a defect in the underlying obligation will similarly impact the suretyship. By way of example, if a company is placed under business rescue, the business rescue practitioner is entitled to cancel certain contracts in order to improve the financial position of the company. If the main contract is cancelled, then the suretyship will too be cancelled as it is merely ancillary to the principal obligations.

If the financial assistance provisions of the Companies Act have not been complied with the provision by a company of that financial assistance will be void. Directors may, however, face personal liability, in certain instances, for failing to comply with the financial assistance provisions of the Companies Act.

Giving or taking security

Under, and in terms of, the Insolvency Act, a mortgage bond passed for the purposes of securing a debt that was not previously secured must be registered in the applicable South African Deeds Office within two months from the date on which the debt it is securing is incurred. If registration has not occurred within the aforementioned time period and the security provider is liquidated within six months from the date on which the mortgage bond was registered, the mortgage bond will not secure that debt.

It is also important for the board of directors to have confirmed that the security provider is able to comply with the provisions of the Companies Act relating to financial assistance and distributions (see above) as, upon the occurrence of the liquidation in insolvency of the security provider, a liquidator may consider the provision of the security to have been a voidable disposition and require the creditor to return the assets acquired pursuant to the enforcement of such security.

Jackie Pennington

Jackie Pennington

Partner
DLA Piper South Africa Services (Pty) Ltd
[email protected]
T +27 (0)11 302 0824
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