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Welcome to Perspectives.

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Fasken's legal voices on business.

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Welcome to Fasken podcast on the competition

and B-BBEE aspects to consider regarding

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employee share ownership plans, otherwise

known as ESOPs.

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My name is Lesley Morphet and I head up the

competition team at Fasken.

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So not surprisingly, I shall be looking at

the topic from a competition law perspective.

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My name is Daphney Willem.

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I am a partner in our Labour and Employment

Department which houses our B-BBEE practice

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group. I will provide insight on the B-BBEE

aspects of ESOPs imposed by the Competition

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Commission.

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Welcome, Daphney.

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I look forward to your insights.

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Maybe I can start with giving some

background on the topic, from a competition

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law perspective.

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The purpose of the South African Competition

Act is set out in section two and includes

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provisions such as promoting the efficiency

of the South African economy and providing

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consumers with competitive prices and

product choices.

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But the act also aims to correct the wrongs

of the past and therefore has public interest

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aspects. In 2018, the act was amended, with

the amendments coming into force in February

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2019, and one of the provisions, as it now

reads, is to promote a greater spread of

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ownership, in particular to increase the

ownership stakes of historically

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disadvantaged persons.

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The act in general focuses both on

competition and public interest aspects, and

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this dual focus is particularly notable with

respect to the merger provisions, where, when

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determining whether a proposed transaction

should be approved or not, the Commission has

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to weigh up both competition and public

interest aspects in determining whether to

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approve a merger or not, and if it does

approve the merger, whether the approval

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should be subject to conditions or not.

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Since the amendments came into force.

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The Commission has been exceptionally active

from a public interest perspective in its

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assessment of a merger.

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Section 1283 requires a consideration of the

effect that a merger will have on, amongst

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others, the promotion of a greater spread of

ownership, in particular to increase the

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levels of ownership by historically

disadvantaged persons and workers in firms in

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the market. The Commission sees these

provisions as placing a positive obligation

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on parties to mergers, to ensure that there

is a positive effect on ownership by

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historically disadvantaged persons and

workers.

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Therefore, there are regular requirements

that merging parties either introduce an ESOP

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or increase the ownership levels of the

ESOP.

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Daphney, can you perhaps provide background

to ESOPs from your perspective, what are they

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and how do they work?

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So an ESOP is an employee share ownership

scheme, which is established to enable

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employees to enjoy the benefits associated

with indirect ownership.

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The scheme is housed in a vehicle either in

the form of a company or a trust, which buys

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or has shares donated to it in a measured

entity.

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In the competition case, the measured entity

would be the merged entity and the shares are

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held for the benefit of the beneficiaries of

the scheme.

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In essence, the employees would be

considered indirect shareholders of the

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measured entity by virtue of either being

shareholders of an intermediary company or

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beneficiaries of a trust, depending on the

entity that the employer, or in this case,

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the merged entity uses as an intermediary.

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From a B-BBEE perspective, black people are

allowed to hold shares in a measured entity

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through a recognised business entity,

provided that they do so using a recognised

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business entity that meets the prescribed

qualification criteria.

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An ESOP is one of the recognised business

entities, and it can hold shares and

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contribute to a measured entity's black

shareholding, provided that it meets a

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qualification criteria for such recognition.

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In that case, an ESOP would be regarded as

any other shareholder, and it will have

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voting rights and share in the measured

entity's dividends in proportion to the

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shares that it holds in such a measured

entity.

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Super. Thanks very much, Daphney.

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Now that we understand in general what an

ESOP is, let's look more closely at what the

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Commission requires in this respect.

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It's noteworthy that the previous Minister

of Trade, Industry and Competition, Ebrahim

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Patel, was very in favour of ESOPs, which is

why I think they hold such prominence in the

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public interest guidelines.

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In fact, he held a conference on them

shortly before the elections earlier this

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year to showcase all the successful ESOPs

that had been put in place to buy parties to

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mergers. President Ramaphosa was the keynote

speaker at that conference, and he

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highlighted the value of ESOPs as an

instrument to broaden ownership and with

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time, to enable greater control of the

economy by previously disadvantaged groups,

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especially women and black South Africans.

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He also stated that the schemes allowed

workers a seat at the table where strategic

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corporate decisions were made, so it can

clearly be seen why the government considers

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them such a valuable instrument to rectify

the wrongs of the past.

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And the DTIC has used ESOPs in this way in

its competition legislation.

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Turning back to mergers and ESOPs in

mergers, the Commission has sought to provide

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guidance to merging parties as to how they

will deal with the application of the law

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regarding public interest, including putting

in place ESOPs through issuing guidelines.

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Although these guidelines are not binding on

the Commission, they do give guidance on how

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they are likely to tackle the public

interest aspects of a merger before them.

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In draft guidelines issued late last year,

the Commission included detailed provisions

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regarding the requirements for the ESOP.

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In March this year, final revised public

interest guidelines came into effect.

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The point of departure is that a merger must

promote a greater spread of ownership.

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They will look at pre-merger ownership

levels by workers and historically

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disadvantaged people, where a merger does

not promote a greater spread of ownership.

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In this way, they will look at ownership

remedies, in particular ESOPs in relation to

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workers. There is far less detail regarding

the requirements for ESOPs than there was in

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the draft guidelines.

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The final guidelines simply say an ESOP

concluded in accordance with the design

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principles articulated in case precedent and

refined by the competition authorities from

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time to time.

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The ESOP must hold a minimum range of 5 to

10% of the equity of a merging party or the

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merged entity and must represent a broad

base of workers as opposed to a few highly

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skilled workers.

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However, the comment that it should be in

accordance with the design principles

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articulated in case precedent does lead one

back to the more detailed provisions that we

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have seen in past mergers.

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Daphney, perhaps you can take us through

these.

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Thanks, Lesley.

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And as you have already said, the the final

guideline does not set out these design

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principles that the Commission will use.

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However, if we look at the draft guidelines,

as well as past mergers that the Competition

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Commission has approved.

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They indicate the type of design principles

that the Commission may impose.

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So I'll deal with some of these design

principles.

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The first theme I will start with is the

structure of the SOP.

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The Commission has indicated that it prefers

a unitised employee share ownership trust.

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And this obviously is as opposed to a

company that can also be used to house an

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employee share ownership scheme.

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A Unitised trust presents challenges and

complicates the trust provisions.

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Units presents the risk of being regarded as

equity instruments that present tax

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challenges and may require complex

structuring in order to avoid the vesting of

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the units and tax liabilities for the

beneficiaries due to the units vesting in

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them. Units also add an unnecessary layer of

complexity and administration for the trust,

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as a register of units must be kept

regulating the issuing and cancellation of

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units given the resignation and employment

of new beneficiaries, this will require

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administration that often leaves the

trustees with no choice but to outsource the

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administration of the trust.

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This will increase the expenses that the

trust will incur, and consequently reduce the

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benefits that may be shared by the

beneficiaries.

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An alternative and simple way to deal with

the distribution of benefits to beneficiaries

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would be to use a formula.

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Formulas are easily applied by the trustees

when benefits are paid to the trust, and

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would not be subject to any manipulation, as

the trustees would not have any discretion

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when it comes to the distribution of the

benefits.

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This approach is very simple and only

requires keeping of a register of

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beneficiaries, which can easily be

reconciled by the employer with the

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employee's information.

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The use of formulas is an approach that is

also recognised by the triple B codes.

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The second item under the theme structure is

whether an SPV may be interposed between the

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ESOP and the measured entity.

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There isn't a commercial reason for

interposing a company between the ESOP and

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the measured entity, but this may be

appropriate if the intention is for the ESOP

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to eventually hold shares in other entities.

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The SPV may be considered an investment

holding company that will hold shares in

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multiple companies for the benefit of the

ESOP.

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Remembering that we are looking here at how

the Commission has dealt with aspects of

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ESOPs in the past, and not at what they have

put in their final guidelines.

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What are their views as to whether employees

must pay to participate in an ESOP?

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The Commission has in the past noted that

workers are not required to pay to

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participate in the ESOP.

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This view is consistent with how ESOPs are

operating in the B arena and is welcome.

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The third theme is governance of the ESOP.

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The Competition Commission has noted that

the Board of Trustees must comprise of three

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trustees one appointed by the workers, one

appointed by the founder of the ESOP, and a

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third being an independent trustee to be

recommended and appointed by the workers,

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provided that that person is acceptable to

the measured entity.

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It is impractical to get all workers to

participate in the appointment of the

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independent trustee.

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Think about a situation where the measured

entity employs thousands of employees.

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It will be impractical for all of them to

vote on the appointment of one independent

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trustee. This will present great

difficulties if the appointment of the

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independent trustee is a requirement for the

ESOP to be established.

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Furthermore, the Commission does not define

what constitutes independent, nor does it

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prescribe a qualification criteria for the

independent trustee.

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So quite frankly, Daphney, it might never get

established.

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Yes, a possible way around this impulse and

to ensure that the ESOP is registered is for

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an independent trustee to be appointed by

the measured entity for registration

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purposes. Was. Thereafter, an independent

trustee may be appointed by the trustees

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jointly. The initial independent trustee

will only be for purposes of registration and

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will resign simultaneously with the

appointment of the independent Trustee by all

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the trustees together.

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The trustee appointed by the merged entity

will assist with compiling a list of

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independent trustees from which the two

trustees can choose, subject to an agreed

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qualification criteria.

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We have found that this alternative works in

resolving the impulse between the employees

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as well as the employer and ensures that the

ESOP is registered timelessly.

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The fourth theme is the duration of the

ESOP.

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The Commission approves an evergreen ESOP

for purposes of catering to the ever-changing

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workplace. This, in our view, is appropriate

given the ever-changing number of employees

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in a specific workplace.

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The last theme is participation benefits.

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Here, the Commission recognises that the

ESOP will not be given shares in the merged

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entity for free and approves the use of a

vendor financing loan, which will be an

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interest free loan to be given to the ESOP

for purposes of acquiring the shares.

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In addition to that, the Commission has

highlighted a dividend policy, which includes

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the payment of a typical dividend to the

ESOP for as long as the vendor financing loan

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remains outstanding, the dividend will be

used to pay off the loan and still provide

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benefits to the beneficiaries, Series at a

ratio of 35 and 65.

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35% of the dividends will flow to the

beneficiaries, and at most 65% of the

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dividends will be used to service the vendor

financing loan.

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While the vendor financing loan is an

acceptable way to introduce an ESOP in a

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measured entity shareholding, the use of a

loan may have B-BBEE consequences on the

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measured entity.

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As such, a loan will be considered

acquisition debt and and may affect the

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measured entity's net value points.

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A trickle dividend is normal practice, but

the ratio recommended and seen from past

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merger approved transactions may not be

sufficient to address the requirements of net

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value and the repayment of the loan.

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Thank you. Daphney, What do you think of the

interest free aspect that I can remember them

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imposing in past matters?

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Is that not perhaps onerous on the merging

entities?

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Yes. We had said it shouldn't be interest

free.

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It should be at a rate less than prime.

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Because that's how much?

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Oh, no. That. So this is what we said.

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If the ESOP would go to a a bank, they would

have to pay interest.

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So why is the commission looking at us and

saying we shouldn't get we shouldn't impose

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interest. We are also understand that the

ESOP.

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Well, what the commission is trying to do is

facilitate the introduction of the ESOP,

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making it easy for them.

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So if the Commission doesn't want to impose

interest at the rate that is charged at the

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banks, rather reduce the rate, but still

impose the interest because it is a third

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party transaction.

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So the ownership element under the B-BBEE

codes, and B-BBEE sector codes comprises of

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three sub elements.

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Economic interest, exercisable voting rights

and net value.

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Net value looks at the loan that black

people are given to acquire their shares in

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the merged entity, and the repayment of that

loan is subject to a time graduation factor,

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which sets out the percentage that needs to

be repaid of the loan on an annual basis for

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a period of ten years.

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So if a measured entity is black, shareholder

has an acquisition debt, that acquisition

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date needs to be repaid in accordance with

the time graduation factor, failing which the

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entity will not receive any point under the

third sub element of the ownership element

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being the net value element.

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Importantly, the net value element is also a

priority element, meaning that in addition to

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complying with the time graduation factor, a

measured entity to be able to get points

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under that sub element needs to meet 40% of

the points available.

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Failure to do so will result in that

measured entity being discounted by one

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contributor status level.

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So for example, if a measured entity gets

undergoes a B-BBEE verification, they get a

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level five contributor status level.

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However, the acquisition loan was not paid

in accordance with the time graduation

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factor, and they don't get 40% of the points

available in that sub element.

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They will be discounted by A level so they

will no longer be considered a level five B

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contributor, but will now be a level six

B-BBEE contributor.

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Moving one level down so that sub element is

is crucial for for measured entities that

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actually have acquisition debt.

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That's quite a big impact that it might have

on them.

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So perhaps the competition guidelines need

to take this into account.

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Or the Commission, in its imposition of

ESOPs as a condition of mergers, needs to

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understand these dynamics and apply them

more carefully.

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Definitely, Leslie, and the Commission needs

to take this into consideration, especially

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when considering the ratio that they impose

as part of the dividend policy, because

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currently that ratio is not subject to any

movement.

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It is what the Commission has prescribed.

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It says at most 65%.

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So entities are not allowed to go past or

pay more than 65% of the dividends towards

00:19:21,860 --> 00:19:23,340

the repayment of the loan.

00:19:23,340 --> 00:19:27,450

We must be careful here because those were

the draft guidelines that set out all these

00:19:27,450 --> 00:19:34,620

details that we've been unpacking, but we do

think that that is how they look at matters

00:19:34,620 --> 00:19:37,380

based on case precedent.

00:19:37,830 --> 00:19:42,570

Perhaps the flexibility that they've brought

in in the final guidelines gives us an

00:19:42,570 --> 00:19:47,040

opportunity to negotiate more with the

commission on these points.

00:19:47,070 --> 00:19:48,120

Definitely.

00:19:48,480 --> 00:19:50,370

Thanks very much for these insights.

00:19:50,490 --> 00:19:55,530

Do the requirements of the Commission

dovetail broadly with the provisions of the

00:19:55,530 --> 00:19:57,780

triple B, double E codes?

00:19:57,810 --> 00:19:59,160

It sounds as if they do.

00:19:59,160 --> 00:20:00,690

But there are some differences.

00:20:00,720 --> 00:20:07,890

Yes. So there is there is an overlap between

what the commission seeks to achieve and what

00:20:07,890 --> 00:20:09,900

the B-BBEE codes regulate.

00:20:09,900 --> 00:20:15,930

For example, I've mentioned that the an SOP

is one of the recognised entities that can be

00:20:15,930 --> 00:20:18,570

used to contribute to one's black

shareholding.

00:20:19,590 --> 00:20:24,660

However, the requirements or the design

principles that the Commission seeks to

00:20:24,660 --> 00:20:31,470

impose may have adverse consequences on the

recognition of the ESOP from a B-BBEE

00:20:31,500 --> 00:20:37,650

perspective. So to mitigate against any

adverse B-BBEE consequences that may be

00:20:37,650 --> 00:20:42,180

suffered by the measured entity that has

adhered to the directions or conditions

00:20:42,180 --> 00:20:48,510

imposed by the Commission, and the

Commission should, from now on, consider

00:20:48,510 --> 00:20:53,550

aligning its requirements and possibly using

the same principles set out in the B-BBEE

00:20:53,580 --> 00:20:55,620

code when imposing the ESOPs.

00:20:55,620 --> 00:21:01,650

Because this will make the ESOP more

attractive to a measured entity, because they

00:21:01,650 --> 00:21:07,590

can get recognition under the B-BBEE code,

as well as comply with the conditions that

00:21:07,590 --> 00:21:10,620

are imposed by the Competition Commission.

00:21:10,620 --> 00:21:17,940

If there is a gap, there may be a lot more

pushback from measured entities in adhering

00:21:17,970 --> 00:21:24,610

to the conditions imposed by the by the

Commission because of the consequences that

00:21:24,610 --> 00:21:27,670

the conditions may have on there be

recognition.

00:21:28,690 --> 00:21:35,140

So to to kill two birds with one stone

alignment is crucial in these instances to

00:21:35,170 --> 00:21:39,970

ensure that um measured entities are not

adversely affected.

00:21:40,600 --> 00:21:41,890

Thanks very much, Daphney.

00:21:41,890 --> 00:21:48,250

It's these have been an important factor in

our merger clearances, and certainly parties

00:21:48,280 --> 00:21:54,370

need to think very carefully about how they

will deal with this provision.

00:21:54,370 --> 00:22:00,220

Should it be something that the Commission

is looking to impose in future mergers and

00:22:00,220 --> 00:22:06,340

make sure that they get proper advice from

somebody knowledgeable in the codes?

00:22:06,370 --> 00:22:08,470

Thanks very much for this insight.

00:22:08,470 --> 00:22:10,810

It's been a very interesting chat for me.

00:22:10,810 --> 00:22:14,500

I hope you, our listeners, have found it

useful and informative.