What The Law Says: The Death Of A Shareholder And What Happens To Their Shares

What The Law Says: The Death Of A Shareholder And What Happens To Their Shares

Although leaving shares to your closest relatives may appear to be a great way of securing some form of income for them in the future, it may not be ideal. It could in fact give rise to unintended consequences not only for the company and surviving co-shareholders but also for the person who inherits your shares and it may not be in the best interests of the company.

First things first, what exactly is a share?

Think about a share as a brick in a house. The house represents the company, the bricks are the shares in the company and the foundation on which the “house” is built, is the company’s governing document, the Memorandum of Incorporation (MOI). 

If you own a brick, you own a part of the house in the same way a share means you own part of the company. Whether you own one brick or many bricks of the house you have the right to participate in the management and day to day activities of the household just as owning one or many shares in a company gives you the right to vote at shareholders meetings, share in company profits where dividends are declared and have a say in how the money of the company is to be used. 

So it is clear that shares entitle the shareholder to certain income rights like dividends and control over company capital,  ultimately increasing the net value of the shareholder’s estate. This means that shares are regarded as assets, forming part of the movable property of your estate, and are transferable from you to another person according to the law [1]. If you die any shares you own in a company will form part of your estate and will be dealt with according to your will [2][3]. If you don’t have a will then your shares and estate will be dealt with according to intestate succession. 

What is the difference between having a will or not?

If you have a will then you should specify what should happen to your shares in a company if you die. The executor of your estate who has to administer your estate according to the will, must distribute and transfer your shares to the person you have written down as your successor. In this way your shares will be transferred to this person and he or she will replace you as a shareholder. If you don’t have a will your shares will be distributed intestate to your nearest relatives [4].

With intestate succession your estate is divided and distributed according to a hierarchy of family relations, where the person who is inheriting your shares will be determined according to whether you are survived by a spouse, with or without children, with living or deceased parents, brothers, sisters, nieces and/or nephews [5]. It involves a complicated process to decide who is entitled to inherit your estate so it is always better to have a will in place.

What is the role of the Companies Act? 

But whether you have a will or not, the Companies Act is the main law that regulates and governs companies in South Africa, including the transfer of shares [6]. 

According to the Companies Act the transfer of shares in a private company can only be done according to the company’s Memorandum of Incorporation (MOI) – in other words its ‘foundation’. Compare this to a public company (which is listed on the Johannesburg Stock Exchange) where shares can be freely transferred. So, if ‘bricks’ form part of a public company household, there is no boundary wall and any member of the public can pick up and buy bricks in the house. But if the ‘bricks’ are part of a private company, there is a boundary wall, which means it is not open to the public, so they cannot pick up and buy as they please. The company ‘foundation’, its MOI, will give guidance on how shares can be sold or transferred. 

Got it? So what about unintended complications that could come from this?

Although leaving shares to your closest relatives might seem a great way of securing some form of income for them in the future, it may give rise to unintended consequences for them as well as for the company and the other shareholders.  

The person who inherits your shares – your successor – may not be interested in owning shares in a company or may not have the necessary skills or qualifications to contribute and participate in its management. All of this could be bad for the future of the company and lead to its failure and the loss of the shares as a future source of income for the shareholder. Apart from having your heirs involved in a company in which they have no interest or are not qualified or experienced, your existing co-shareholders may also be stuck with an unintended, inexperienced and ultimately unwanted shareholder.

Let’s see how this can work in practice…. 

Say that you and two friends from university each hold some shares in a company specialising in big construction engineering. The qualifications, experience and interest of all three of you in engineering and the technicalities associated with construction no doubt contribute to and ensure the success of this company. If something happens and you pass away, then your shares in the company will be transferred to your heirs according to your will. 

This could spell disaster. Maybe the relative who inherits your shares has no interest in the business, or she has no engineering qualification. Imagine the burden you are placing on this person. Not only this but you are also putting a burden on the remaining two shareholders who now have to deal with an inexperienced and unwanted business partner who was never part of the original deal.  

Can you avoid the unintended consequences of your death on shareholding? 

Yes, you can. Although the Companies Act restricts the free transfer of shares in a private company, it doesn’t say how you must apply this restriction. So you and your shareholders can make your own decision about limiting the transfer of its shares. Most commonly this is done through a shareholders’ agreement  or your company MOI [7.] 

When a company is formed, all  the shareholders should agree  what  restrictions there will be on the transfer of shares based on what will be practical for the company. These restrictions will be incorporated into the MOI, and will lay down the rules and procedures for transferring shares, whether it is because someone has died or wants ‘out’ of the business.

What are the common provisions for transferring shares? 

The most common provision is that if you die, the remaining shareholders must be given the first opportunity to buy the shares at a set price and within a specified time before the shares may be transferred to your heir.  Although this restriction on the transfer of shares  does offer some protection to existing shareholders it doesn’t consider what would happen if these  shareholders didn’t have the finances to buy your shares. 

When this happens, the existing shareholders may either consent to the heir becoming a shareholder, or they may allow the heir to sell the inherited shares to a third party. However, it is clear that this creates room for uncertainty and risk as there is no guarantee that the heir or third party has the interest, skill or qualification required to contribute to the company. 

To avoid any risk and uncertainty it is best to have a shareholders agreement. 

The shareholders agreement and transferring shares 

A shareholders agreement entrenches the rights and duties of all shareholders, and it can also  make specific provision for the disposal of shares if a shareholder dies [8]. 

The shareholders agreement can provide procedures for determining the number of shares to be transferred if a shareholder dies, as well as measures to determine the value of the shares. It can say how shares should be sold and how existing shareholders should have the first opportunity to buy the shares of the deceased shareholder before it is transferred to an heir. The agreement can also impose restrictions on potential third party shareholders, make share transfers subject to shareholder or board of directors approval or specify qualifying shareholding criteria. 

To end off….. 

To avoid uncertainty and potential conflict arising after the death of a shareholder it is vital that all the shareholders agree how shares should be transferred based on what would be in the company’s best interest. This agreement must be included in the company MOI and shareholders agreement, and should also be set out and explained in the will of each shareholder. 

This means that if you currently own some ‘bricks’ or shares in a company or could be inheriting shares in a company from an existing shareholder, you must ensure that the transfer of the deceased’s shares is clearly set out in a will that aligns to the company MOI.