Article by listed Attorney: Nanika Prinsloo
We mentioned in our general article on Close Corporations that the Association Agreement is the single most important document of any Close Corporation if there is more than one member.
This article will explain more about how an Association Agreement works, what it should contain and what the effect of it is.
If a Close Corporation has more than one member, it is never a good idea to not have a signed Association Agreementin place. Each member should have a signed copy and the original should be stored either in a bank deposit box or with the Close Corporation’s attorney.
It is not compulsory to have an Association Agreement, but it will make life so much easier and simpler if there was an Association Agreement in place. The Association Agreement is entered into between the members with each other, and the members with the Close Corporation. All in one document.
The Association Agreement basically pens down all the rights and obligations of each member. It sets out what percentage of membership of the Close Corporation each member has, what each member can and cannot do, can and cannot get, voting rights, basically everything that regulates the agreement between the members and the Close Corporation.
The Association Agreement is a lot like a Partnership Agreement. Read our article on Partnerships if you want to know more about doing business in a Partnership. Members in a Close Corporation has an interest in the Close Corporation and this interest has a value. In a Partnership each partner owns a share of the assets and liabilities of the Partnership’s assets.
The Association Agreement can make provision for basically anything that the members want it to make provision for and each Association Agreement is drafted particularly for each Close Corporation individually. We strongly advise against finding examples on the Internet or elsewhere and then “cut and paste”. There are certain requirements that must be in the Association Agreement to make it a useful and valid agreement.
One of the most important issues that must be dealt with in an Association Agreement, is what must happen when a member wants to exit the Close Corporation and dispose of his/her shares. Equally this will apply in the case of the death of a member. Also, the Agreement must determine what must happen to the member’s interest when the members decide to close down (deregister) the Close Corporation or sell it. With “what must happen with a member’s interest” we mean that first of all the value of the interest must be determined; the Agreement must set out how that value will be determined, and when exactly that value will be determined (for e.g. on the day of resignation; the day before death) and by whom the value will be determined.
There should be clause for a Buy-and-Sell Agreement or a seperate Buy-and-Sell Agreement in place and the members should take policies on each other’s lives to make provision for when a member exits the Close Corporation – either by resignation or death. (The Association Agreement will take preference over a Buy-ad-Sell Agreement so make sure that there is not a clash between the two agreements).
The Association Agreement must set out exactly what will happen if there is a difference between the members in making a decision and the Agreement should indicate what route must be followed in such an instance: either mediation or arbitration or such like.
Members nearly always lend money to the Close Corporation to start or fund the Close Corporation and there will nearly always be loan accounts owing to members. The Association Agreement must very clearly set out how much a loan account can be; how and when it will be repaid by the Close Corporation; what must happen with the loan account when a member exists. Remember that if a member dies, his/her loan account is an asset in his/her estate and the executor will call up the loan. The Close Corporation must then be in a position to repay such a loan. We therefore suggest that a policy be taken out by the Close Corporation to enable it to pay out loans to members should they wish to exit or die before the loan is repaid.
If a new member joins the Close Corporation, the Close Corporation does not cease to exist as is the case with a Partnership. The new member is however bound by the Association Agreement if it was signed before his/her entry as a member and even though he/she did not sign the Association Agreement.
The Association Agreement must also state what the duties of each member is; what each member can do and cannot do. For example Members X and Y will have signing power to the bank account but no member’s D and E.
A very important section in the Association Agreement is also to set out when payment will be made to members. For example profits will be paid out quarterly or yearly or whatever the case may be.
The Association Agreement should also set out under what circumstances a member is obliged to resign (for example if he/she is found guilty of a crime) and under what circumstances a new member can be allowed in (for example if a specialist’s expertise is required.)
There are certain things that are regulated by the Close Corporation Act 69 of 1984 and which cannot be changed by an Association Agreement. We look at this in the next paragraph.
If the members did not sign an Association Agreement certain clauses of the Close Corporations Act will still apply.
Certain things cannot be altered by an Association Agreement which are determined in the Close Corporations Act. The sections of the Act will apply even if it is contained in the Association Agreement, and they are:
The way in which members manage the Close Corporation: The Close Corporation Act states that every member is entitled to be involved in the carrying on of the business of the Close Corporation. This means that the Association Agreement cannot state that A and B will have the right to represent the Close Corporation in its business dealings but that C & D do not. Even if the Agreement contains such a clause it will mean nothing as the section in the Act overrides the Agreement.
Members are not liable for the debt of the Close Corporation – unless a member signs surety for the debt of the Close Corporation in his/her personal capacity, the member is not liable for the debt of the Close Corporation, even if the Association Agreement states so.
Decisions are made by way of majority votes. - each member has a vote in according with his/her percentage interest in the Close Corporation and this vote percentage cannot be changed by an Association Agreement.
Each member has an equal right to manage the business (Unless a member is disqualified from doing so). Members all can manage the business, even if the Association Agreement may state otherwise.
75% consent of each member is required for a change in the business of the Close Corporation; a disposal of the assets of the Close Corporation. This also cannot be changed by the Association Agreement.
Payments to members will be in proportion to their percentage interest in the Close Corporation – members cannot change the percentage in which each member will share in the profits of the Close Corporation in the Assocation Agreement and the Act will apply.
The Association Agreement is an agreement like any other, and must be signed by all the parties to it. It must be initialled on each page by each member and the witnesses and the last page must be signed in full. Make sure that each member has a copy of the agreement and that the original is safely stored, preferably away from the premises.
The Association Agreement is the most important document of the Close Corporation and is therefore the one document that must be in order. There are certain things that must be in the agreement, therefore be sure to use a professional person to draft same.
This article was written by Nanika Prinsloo of Prinsloo and Associates Attorneys and Conveyancers.
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