Fronting – beware the BBBEE Commission

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In June 2017, a black woman-owned entity launched a complaint of BEE fronting against JSE listed Netcare Holdings.

The complaint has been lodged with the Broad-Based Black Economic Empowerment (BBBEE) Commission, which was officially launched towards the end of 2016.

This development is very significant for the South African corporate sector.

Ownership

The BBBEE Commission made it clear that there will be a particular emphasis on ensuring that the BBBEE 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 actually 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 will place a high emphasis on Fronting practices, and it said that complaints received by the Commission in its first six months have been largely attributed to Fronting.

The Commission stressed that it would clamp down on undesirable practices, which affect ownership, but also on practices, which could impact the other elements of the BBBEE Scorecard, with associated penalties and implications for non-compliance.

Defined?

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 BBBEE initiative.”

Indicators

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 BBBEE 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 BBBEE 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 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.

Criminal offence

The complaint against Netcare would provide an interesting test case.  The BBBEE 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.

Consequences

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 move up the ranks in society and participate in the advancement of the country. It is important for companies to scrutinise their current BBBEE 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 that will meet with the approval of the BBBEE 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.


Sonia Hay | Head of Corporate Finance | Bravura | shay@bravura.net | www.bravura.net |


 



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