The importance of having an association agreement between members of a close corporation

By Chanelle Rheeder

In terms of the Close Corporations Act, 1984, (hereafter referred to as the Act) the members have a fiduciary relationship towards the Close Corporation, not towards each other. In order to regulate the internal relationship between members and bestow upon the members specific duties towards each other the members must enter into an Association Agreement.

Although the Association Agreement is not compulsory by law, the agreement deals with very important issues such as the management of the business, dispute resolution, the consequences of the death of one of the members and the sale of interest in the business to name but a few. The agreement, therefore, covers practical issues which should be recorded between the business associates failing which; serious problems may arise during the trade of the business and also at its dissolution.

Most of the common issues of conflict that arise between members are the sale of member’s interest or death of a member. Let’s consider the death of a member.

The duties of the executor of a deceased estate to dispose of the member’s interest of the deceased member must be exercised subject to the Association Agreement. In the absence of an Association Agreement certain rules automatically apply. In terms of section 35 of the Act, the executor may only transfer the member’s interest to an heir if the heir qualifies to become a member and if the remaining members have given their consent. If they refuse to consent, the executor is forced to sell the member’s interest to the close corporation, the remaining members or an outsider. This can leave an heir in a position whereby he qualifies to act as member but is being refused the opportunity to act as such by the other member’s failure to consent, with the result that the interest is sold contrary to the wishes of the deceased.

The Association Agreement does not only protect the interest of the deceased member but also that of the remaining members. In Schwartz NO v Pike [2007] SCA 106 (RSA) upon the death of a member the executor unilaterally appointed an auditor to valuate the member’s interest and demand payment of same from the remaining members. However, in terms of the association agreement all members had to jointly agree to the appointment of the auditor. The court found that the substance of the agreement must prevail and confirmed that the terms of the association agreement must be applied in stating that "The essential exercise is to extract the parties’ true intention from the words which they used to express that intention, accepting that life can only be given to the language by a proper regard for the context in which the words appear. .…by no means a court will, in determining whether a party has complied with a contractual term, necessarily allow the unenforceability of that term to override the clear intention of the parties". As a result the executor could not enforce payment from the other members.

It is therefore essential that the Association Agreement is properly drafted to reflect the true intention of the parties especially as this agreement takes preference over any other agreement between members. Other agreement, such as a buy-sell-agreement, is subordinate to a formal association agreement. Therefore in the event of a dispute or conflict in clauses the association agreement will take preference. This is particularly important if one considers that a new member is automatically bound by the provisions of an existing association agreement (S 44(5) of the Act), even though the new member was not personally a party to the agreement.