The R600 million train blunder that broke in July 2015 is still fresh in the memory of corporate South Africa. The Passenger Rail Agency of South Africa (Prasa) received thirteen new diesel locomotives that were too high for the long distance routes they were intended for. Prasa ordered brand new diesel locomotives from Spanish manufacturer Vossloh España which were too tall for local use. The thirteen Afro 4000 diesel locomotives were worth R600 million and formed part of a larger R3.5 billion order for 70 new locomotives.

Fortunately, this was not the end of the story.  Prasa applied to the High Court to have a decision by its previous board reviewed and set aside in terms of the Promotion of Administrative Justice Act.  The court application related to the irregular, fraudulent and corrupt agreement with Swifambo Rail Agency, a BEE company, for the supply of locomotives. Swifambo bought the locomotives from Vossloh, based in Spain, and on-sold the locomotives to Prasa.

High Court provides guidelines on unacceptable fronting practices

The High Court set the contract aside in July 2017, based on various tender irregularities.  It also found that the parties participated in fronting activities. The judgement set important guidelines on the interpretation and application of the new “fronting practice” definition in Section 130 of the Broad-Based Black Economic Empowerment (B-BBEE) Act.

Soria Hay, Head of Corporate Finance at Bravura, who has specialist expertise in B-BBEE ownership transactions, outlines the significance of this for the South African corporate sector.  “The court concluded that the arrangement between Swifambo, the B-BBEE entity, and Vossloh, the supplier in Spain, constituted fronting. The court said that it was clear that Swifambo was merely a token participant that received monetary compensation in exchange for the use of its B-BBEE rating.  The agreement between Swifambo and Vossloh frustrated and undermined the implementation of the provisions of the B-BBEE Act. “

What is Fronting?

Section 1 of B-BBEE Act defines the term “fronting practice” as follows:

“[A] transaction, arrangement or other act or conduct that directly or indirectly undermines or frustrates the achievement of the objectives of this Act or the implementation of any of the provisions of this Act, including but not limited to practices in connection with a B-BBEE initiative 

(d) involving the conclusion of an agreement with another enterprise in order to achieve or enhance broad-based black economic empowerment status in circumstances in which-

(i) there are significant limitations, whether implicit or explicit, on the identity of suppliers, service providers, clients or customers;

(ii) the maintenance of business operations is reasonably considered to be improbable having regard to the resources available;

(iii) the terms and conditions were not negotiated at arm ‘s length and on a fair and reasonable basis. 

Soria says: “In the context of the ownership element, fronting is in essence the misrepresentation of the contributions of the benefits made by the measured entity to a Black individual or participants in prohibiting or limiting their right to exercise control over the resources of the company in which they may own shares and have access to voting rights. This could also be hindrances in allowing them to enjoy their share in the fruits of investments or participation in the company.”

The High Court held that the agreement between Vossloh and Swifambo fell squarely within the ambit of paragraph (d) of the fronting definition, which is satisfied where an agreement is concluded in order to achieve or enhance broad-based black economic empowerment status in circumstances in which there are significant limitations, whether implicit or explicit, on the identity of suppliers, service providers, clients or customers, or the maintenance of business operations is reasonably considered to be improbable, having regard to the resources available.

Indicators of fronting (per the B-BBEE Commission) in ownership transactions are set out below:

  1. Window-dressing: This includes cases in which black people are appointed or introduced to an enterprise on the basis of tokenism and may be:
    • Discouraged or inhibited from substantially participating in the core activities of an enterprise; and
    • Discouraged or inhibited from substantially participating in the stated areas and/or levels of their participation.
  2. Benefit diversion: This includes initiatives implemented where the economic benefits received as a result of the B-BBEE Status of an enterprise do not flow to black people in the ratio as specified in the relevant legal documentation.
  3. Opportunistic intermediaries: This includes enterprises that have concluded agreements with other enterprises with a view to leveraging the opportunistic intermediary’s favourable B-BBEE status in circumstances where the agreement involves:
    • significant limitations or restrictions upon the identity of the opportunistic intermediary’s suppliers, service providers, clients or customers;
    • the maintenance of business operations is reasonably considered to be improbable, having regard to resources;
    • terms and conditions that are not negotiated at arms-length on a fair and reasonable basis.

It is in the public interest to prevent and punish fronting practices

The High Court held that the public has a clear interest in the social and economic rights sought to be given effect to in the B-BBEE Act, and said: “It is trite that the public has an interest in the award of public tenders and that the tender process be free from corruption and fraud, and that public money does not land up in the pockets of corrupt officials and business people through inter alia fronting practices.”

At the core of B-BBEE is viable, effective participation in the economy through the ownership of productive assets and the development of advanced skills. Soria comments: “The true participation of black people in the South African economy cannot be increased as long as entities are allowed to engage in fronting practices. The recently formed B-BBEE Commission also stressed that it would clamp down on undesirable fronting practices.”

Severe penalties possible

If found to have violated the B-BBEE Act, the entities may be referred for prosecution and exposed to a fine of up to 10% of the entity’s annual turnover and the individuals involved can be fined or imprisoned for up to 10 years. The entities can also be excluded from doing business with government for a period of up to 10 years, and the contracts they have with any state-owned entity or government department can be cancelled.  The B-BBEE Commission may also approach a court of law to restrain any breach or for any appropriate remedial relief, which may include setting aside a specific transaction or initiative. The B-BBEE Act therefore not only criminalised fronting, which was not the position previously, but it created an offence for individuals who do not take proactive steps to ensure that fronting is not taking place in any ventures in which he or she may be involved.

Conclusion

The main consequences of Fronting are the hindrance to the goal to make black people main participants in the South African economy, and allowing them to participate in the economy and the advancement of the country. It is important for companies to scrutinise their current B-BBEE structures and address anything that is inconsistent with scorecard requirements and the B-BBEE Act, in order to avoid serious potential penalties.

Soria says that she cannot describe it better than the High Court when it set aside the Prasa tender: “Corruption is a cancer that is slowing eating at the fabric of our society. If it is left unchecked it will devour our entire society. Chemotherapy is needed to curb it. “

Catergories: B-BBEE,Corporate Governance,News