On Friday 23 June 2017, a black woman owned entity launched a complaint of BEE fronting against JSE listed Netcare Holdings, which operates the largest private hospital network in South Africa. The complaint has been lodged with the Broad-Based Black Economic Empowerment (B-BBEE) Commission which has been officially launched towards the end of 2016.
On 7 August 2017, the B-BBEE Commission released a press release confirming that it had initiated investigations against specific entities for possible violation of the B-BBEE Act relating to B-BBEE ownership structures and non-compliance with the Codes of Good Practice in respect of the verification process.
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.
Extent of the investigation
The press release lists 17 entities which are being investigated. Apart from Netcare Limited, the list also includes the names of MTN Group Limited and Nokia Solutions and Networks South Africa (Pty) Ltd (Nokia).
MTN is being investigated to determine whether the MTN Zakhele and the MTN Zakhele Futhi B-BBEE schemes meet the requirements for black ownership elements and comply with the B-BBEE Act. In the case of Nokia, the B-BBEE ownership transaction involving the employee trust and Sekunjalo Investment Limited (Pty) Ltd through specific entities (resulting in 26% black ownership), and the subsequent change in black ownership (resulting in 31.28% black ownership) by Sekunjalo Investment Limited, are being scrutinised.
Two government related entities are on the list. Eskom SOC Limited is investigated to determine whether the entity complied with the requirements of section 10(1) of the B-BBEE Act in the issuing and awarding of the Duvha Power Station tender to a Chinese company, which is alleged not to be B-BBEE compliant.
The complaint against South African Social Security Agency (SASSA) is that the tender for the payment of social grants to Cash Pay Master Services (Pty) Limited (CPS) was awarded to a company (CPS) that is engaging in a fronting practice in violation of the B-BBEE Act.
There also seems to be a specific clamp down on B-BBEE verification agencies. The investigation against National Empowerment Rating Agency (NERA), Empowerlogic (Pty) Ltd, AQRate Verification Agency and Premier Verification (Pty) Ltd is to determine whether the black ownership structure of each verification agency complies with the black ownership requirements and whether in its conduct of verification it follows the procedures required of a verification agency and the verification professionals in line with the B-BBEE Act. Marissimo BEE Professional Verification and Services and BEE Matrix CC are being scrutinised to determine whether the conduct of each verification agency and the professional in question is in compliance with the B-BBEE Act following numerous letters of advice to these entities.
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.
Ownership as a Core Objective
The B-BBEE Commission made it clear on its launch roadshow last year that there will be a particular focus on ensuring that the B-BBEE ownership element is being adequately and sustainably addressed. At its core, the objective is to change ownership patterns within the South African economy, with a targeted minimum of 25.1% ownership – although there are specific sectors and industries where this requirement is higher.
However, 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 Commission correspondingly stressed that it would clamp down on undesirable practices which affect ownership, but also on practices which could impact the other elements of the B-BBEE Scorecard.
What is Fronting?
The definition of Fronting was included in the Amendment Bill to the Broad-Based Black Economic Empowerment Act, 2003, which had been passed by government in November 2012 (“the Amendment Act”). Fronting has been defined as “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.”
Indicators of fronting (per the BEE Commission) in ownership transactions are set out below:
- 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.
- 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.
- 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 their business operations in a context reasonably considered improbable having regard to resources; and
- terms and conditions that are not negotiated at arms-length on a fair and reasonable basis.
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.
This seems to be exactly the grounds of the complaint lodged against Netcare. Milagros Social Development, a company whose shareholders are all black women, laid the complaint against Mother and Child Trust (MCT) – a company registered by Netcare in 2005 as part of its BEE scheme, Health Partners for Life (HPFL).
Milagros was selected as the anchor beneficiary of MCT, one of four BEE trusts registered under the BEE transaction. Milagros alleges that MCT broke the conditions of the transaction by refusing to pay it the three vestings – or the rights that beneficiaries have to the income or assets of a trust – in the months of November in 2014, 2015 and 2016. Milagros said it received the vesting for 2012 and 2013, but not for the next three years, which is why they allege fronting.
Fronting is a criminal offence
The B-BBEE Commission is tasked with receiving and investigating complaints regarding BEE, including fronting practices, either at its own initiative or in response to complaints received.
In investigating fronting practices, the Commission is empowered to:
- issue summonses, subpoenas and interrogate witnesses and alleged offenders; and
- institute court proceedings to restrain any breach of the BEE Act, including a fronting practice or to obtain appropriate remedial relief,
- if the Commission is of the view that any matter that it has investigated may involve the commission of a criminal offence in terms of the BEE Act or any other law, it must refer the matter to the National Prosecuting Authority or the appropriate division of the South African Police Service.
The Amendment Act provides that any person who knowingly engages in a fronting practice commits an offence. The Amendment Act criminalises fronting and other misrepresentations regarding the BEE status of an enterprise. Any person convicted of an offence in terms of the BEE Act may be liable to a fine or a maximum prison sentence of 10 years, or in the case of a juristic person, a fine of up to 10% of its annual turnover.
Further, any person convicted of an offence in terms of the BEE Act may not for a period of ten years from the date of conviction, contract or transact any business with any organ of state or public entity and will be registered in a register of tender defaulters with the National Treasury.
The Amendment 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.
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, in order to avoid serious potential penalties.
The need to effectively structure and implement transactions that are fully compliant and sustainable and that will meet with the approval of the B-BBEE Commission is obvious. This requires a clear and detailed understanding of the provisions of the relevant codes and policy documentation and a proactive approach to designing and engaging with structures that meet the requirements but also ensure that companies remain able to grow and thrive..