Substance over form – a principle for b-bbee?

On 9 February 2007 the long-awaited Codes of Good Practice (“The Codes”) were promulgated and established a blueprint for the implementation of broad based black economic empowerment (“B-BBEE”) as set out in the Broad-Based Black Economic Empowerment Act 53 of 2003 (“the B-BBEE” Act”). Almost two months earlier the Department of Trade and Industry (“DTI”) had issued a press release giving a summary of the contents of The Codes. In it, the DTI referred to the application of the principle of substance over form in the implementation of BEE.

The principle of substance over form is often referred to in relation to tax cases and applied where parties enter into transactions, the sole purpose of which is to avoid the incidence of tax. In South African law the principle is less of substance over form and more readily expressed in the idea of a simulated transaction. Where an agreement entered into between two or more parties cannot stand on the terms recorded therein and the parties do not in fact intend to give effect to the transaction as it is recorded in the agreement, the transaction is considered to be simulated.

The effect of a finding by our courts that a transaction is simulated is to look through the form of the transaction and give effect to the substance or true intention of the parties. Where it is successfully relied upon in tax cases, the result is the application of the relevant taxing statute.

Unlike the area of tax law, the application of the principle of a simulated transaction is untested in the arena of B-BBEE. The principle is not contained in any statute, but was developed by our courts with reference to the many foreign jurisdictions that embrace the concept. Attempts to apply it to transactions entered into to give effect to B-BBEE will, of necessity, have reference to the established case law on the issue.

The question to be asked when seeking to apply the principle to B-BBEE is: is the transaction entered into merely to simulate the parties’ compliance with B-BBEE and thus enable the measured entity concerned to claim the higher score on the procurement recognition scorecard? The answer to the question would mean a subjective enquiry into the intention of the parties in entering into the agreement and assessment of the objective facts of the surrounding circumstances of the matter.

The result of a finding of simulation must surely be a dissolution of the transaction and a placing of the parties back in the position they were in prior to the conclusion of the transaction. Since the purpose of the transaction was purely to commit fraud, it will not be given effect to, it being ultra vires.

A number of issues are raised following a finding of simulation: did one of the parties to the agreement misrepresent to the other party the purpose of the transaction and thus induce the other party to enter into the agreement? If so, what is the other party’s right of recourse?

None of these issues are canvassed in The Codes or in the B-BBEE Act and it would appear that the basic principles of contract law must apply when assessing these issues. In the event that verification becomes mandatory, verification agencies will be required to ensure that they have sufficient skill and expertise to apply the principle of simulation and the principles of contract law.

The application of the principle of simulation must also be seen in the context of the provisions relating to fronting. These were removed from the promulgated codes and the DTI has advised that this step was taken in anticipation of fronting practices being criminalised in the latter half of this year. The mechanism in terms of which a transaction will be considered to be fronting is, in the absence of clarity on verification, uncertain. Again, if verification becomes mandatory the level of skill required to assess transactions and make the findings of fronting must surely be of professional standard.

It can be argued that fronting and simulated transactions, in the context of B-BBEE, are the same. Both are aimed at achieving an advantage that would otherwise not be available to the parties to the transaction. My view is that any party wishing to challenge a transaction would rely first on the fronting provisions (still to be promulgated) and, in the alternative, on the principle of simulation.

Parties to prospective transactions incorporating B-BBEE should be aware of these issues and ensure that their motives are based on the principles of sound business practice and good corporate governance.

Cathy Bryant Attorneys INC

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