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Fronting is damaging

Mar 19 2017 07:09
Amber von Steiger

Johannesburg - Clear and consistent communication between the parties to a BEE transaction, such as one involving employees, can be the simplest, cheapest and most effective tool to ensure that all parties understand their legal rights and obligations in terms of their relationship.

It can also avoid the unnecessary burdens of an unfounded fronting allegation.

An amendment to the BEE Act in January 2014 made fronting a criminal offence.

Convicted persons may be subject to a fine, a maximum of 10 years’ imprisonment and possible prohibition from transacting any business with any organ of state or public entity.

Fronting is a serious offence and has eroded the purpose of BEE to address historical injustices and promote the empowerment of black South Africans.

It can take many different forms and was historically developed as a practical concept until a definition was introduced in the Broad-Based BEE Amendment Act of 2013.

Fronting is a transaction arrangement or other act or conduct that directly or indirectly undermines or frustrates the achievements of the objectives of the BEE Act or the implementation of any of its initiatives.

Essentially, it equates to using BEE codes for benefits one would otherwise not be entitled to.

At this year’s Transformation Forum, the BEE Commission advised that 85% of the complaints it had received related to fronting concerns.

But, as in all investigation procedures, some complaints were valid and some allegations were unfounded.

Unfounded allegations, although not necessarily vexatious in their intent, often arise owing to a misunderstanding by the accuser as to the actions or inactions that could constitute fronting, such as the commercial details of a transaction or the accuser’s legal position or fronting itself.

Unfounded accusations (whether intentional or not) are harmful to both the accuser and the accused.

The simplest and most effective tool to minimise the risk of unfounded fronting allegations is clear and consistent communication between the parties in a business relationship.

It is especially important when the parties hold different views regarding the legal arrangements governing the relationship.

Clarity around employee-share-ownership schemes is essential.

A common example of when communication is important is when employee-share-ownership schemes are introduced into a company’s shareholding.

In the build-up to introducing such a scheme, management often makes sweeping statements to create excitement among employees, such as that “employees will own shares in the company and share in the company’s profit”.

These statements often do not reflect all of the details of the structure, the funding arrangements that establish the structure and the rules governing the intended employee scheme.

Therefore, if employees’ understanding is based on these high-level statements, their understanding of their legal relationship with the corporate vehicle, the company and the consequential rights that they are entitled to may be incorrect.

For example, when any profits are declared to the company’s shareholders, employees’ expectations of the amount of profit they will receive is not in line with the agreed commercial arrangements.

These may require the financial vehicle housing the employee scheme to first repay the funding incurred in acquiring the underlying shares, or to wait for vesting dates or milestones to be reached.

Maintaining the relationship between BEE partners – especially one as important as between a company, its shareholders and its employees – is critical to the continued success of the business.

Deterioration of this relationship could create significant administrative, operational and financial burdens for it – all of which could have been avoided or mitigated by ensuring that the communication with employees was accurate, clear and consistent within the defined legal structure and arrangements from the onset.

THE CONSEQUENCES OF FRONTING ALLEGATIONS

The cost of fronting allegations against a company or its shareholders can be insurmountable in terms of financial and reputational cost, regardless of the validity of the allegation.

The consequences of an unfounded fronting allegation, whether vexatious or unintentional, can be equally serious for the accuser and accused. Relationships stand to be irreparably eroded.

In the event that the parties are still required to engage on a regular basis, the deteriorated relationship can make ongoing interactions difficult and stressful.

It will always take time to appropriately address any allegations and follow the necessary steps to resolve the issues.

Even the threat of fronting can lead to loss of business as customers terminate contracts and distance themselves from the company.

Taking the necessary steps to resolve the allegations may also result in costs being incurred by both parties, causing financial strain.

In the event that the unfounded allegation results in the financial failure of the company and its potential closure, the accusers may also face job losses.

STEPS FOR CLEAR COMMUNICATION:

. Have a structured information session with all parties to explain their rights and obligations;

. Avoid generalised and vague wording in communication; and

. Make relevant documents easily available to employees in respect of their rights and any funding arrangements attached to the transaction.

Von Steiger is a senior associate with Norton Rose Fulbright

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