Many businesses begin informally. Two friends identify an opportunity. They form a company. One provides equipment. Another provides working capital. A shareholder pays salaries from his personal account. Someone purchases machinery needed by the business.
Everyone is optimistic, so there is a tendency to say: “We know what we agreed. We will sort out the paperwork later.”
Then the business relationship breaks down. One shareholder says: “The company owes me money. I lent it those funds.”
The others respond: “No. You were a shareholder. That was your investment in the business.”
The distinction can be worth millions. The Supreme Court of Zambia considered issues of this nature in Pliable Engineering Limited v Mwamba [2016] ZMSC 213. The case contains an important lesson for entrepreneurs, directors, shareholders and investors: Being a shareholder does not necessarily mean that every kwacha you put into the company becomes share capital.
The Business Relationship
The dispute arose from a business venture connected to a drilling contract with Mopani Copper Mines. Friday Sebastian Mwamba became a major shareholder in Pliable Engineering Limited and provided substantial money and resources to support the company’s business. Those resources included funds towards the purchase of a drilling rig. Eventually, the business relationship broke down. Mwamba wanted his money back. Pliable Engineering resisted the claim. The High Court examined the evidence and found that Mwamba had proved that substantial amounts had been lent or advanced to the company. The Supreme Court upheld that finding.
A Shareholder Can Also Be a Creditor
This is the central commercial lesson. Suppose you own 40% of a company. The company suddenly needs ZMW2 million to complete a major contract. You provide the money.
There are at least two very different ways that transaction might be characterised.
- Capital Investment
You may be putting additional capital into the company as an investment connected to your ownership.
- Shareholder Loan
You may instead be lending ZMW2 million to the company with the expectation that the company will repay you.
Those are fundamentally different legal and financial arrangements. As the source article puts it:
“A shareholder can also be a creditor of the company.”
Owning shares and being owed money by the company are not mutually exclusive.
The Question Should Be Asked When the Money Goes In
The worst time to decide whether money was a loan or an investment is five years after it was paid. The best time is before—or immediately when—the money enters the company.
Ask:
- What exactly is this money?
If it is a loan:
- How much is being lent?
- Who is lending it?
- When is it repayable?
- Is interest payable?
- What happens on default?
- Has the company properly approved the borrowing?
If it is equity:
- Are new shares being issued?
- At what valuation?
- Does the shareholder’s percentage change?
- Have the appropriate corporate approvals been obtained?
The legal character should not be left to memory.
“EVERYONE KNOWS I GAVE THE COMPANY THAT MONEY”
This is a dangerous sentence. Everyone may know that you transferred the money. That does not necessarily mean everyone agrees why you transferred it.
One shareholder remembers: “It was a temporary loan.”
Another remembers: “It was your contribution to the project.”
The accountant treated it differently again. Years later, the directors have changed. Now the Court must reconstruct the transaction.
The Accounting Treatment Matters Too
Commercial documentation should correspond with accounting records. If the money is genuinely a shareholder loan, the company’s books should ordinarily reflect the liability appropriately. If it is equity, the corporate and accounting records should reflect that character. A legal agreement saying one thing while the company’s financial statements say another can create unnecessary difficulty. Lawyers and accountants should therefore communicate on significant shareholder funding arrangements.
The Company Is Separate From the Shareholder
There is also a broader company-law principle behind the dispute. A company is legally distinct from its shareholders. The fact that you own 60% of a company does not mean:
“Sixty per cent of the money in the company’s bank account belongs personally to me.”
Likewise, if you transfer your personal money to the company as a loan, the fact that you are also a shareholder does not necessarily eliminate the company’s obligation to repay that debt. Different legal relationships can coexist.
Joint Ventures Need More Than Optimism
The Pliable Engineering dispute also arose against the background of complaints concerning financial accountability and management. That gives the case a broader lesson for joint ventures.
Before starting a business together, agree on matters such as:
- who controls the bank account;
- who approves expenditure;
- how financial records are maintained;
- who makes major decisions;
- how additional funding is raised;
- whether shareholder funding is debt or equity;
- what happens when shareholders disagree;
- how a shareholder exits.
These conversations can feel unnecessarily pessimistic when everybody is excited about the business, they are not. They are part of building a serious enterprise.
Discuss the Business Divorce Before the Business Marriage
Business relationships often begin like personal relationships. Everyone sees opportunity. Nobody wants to discuss failure.
But sophisticated investors ask:
“What happens if this doesn’t work?”
Suppose two shareholders each own 50%. Three years later, they cannot agree on anything. Who buys whom out? How is the company valued? What happens to shareholder loans? Who owns equipment personally purchased by one shareholder? What happens to intellectual property? Who retains major clients? The best time to answer those questions is while everybody is still speaking to each other. The best time to discuss how partners will separate is while everybody is still getting along.
Documentation Is Not Distrust
African businesses, particularly family businesses and closely held companies, sometimes resist formal documentation because the parties know each other well. But proper documentation is not an accusation of dishonesty. It protects honest people from honest differences in memory. Five years later, nobody needs to argue about what was intended. The documents answer the question.
There Was Also an Appellate Lesson
The Supreme Court upheld the trial Court’s factual findings. That gives litigators another reminder. An appeal is not simply an opportunity to ask the Supreme Court to hear the entire factual dispute again because one side dislikes the result. Where the trial Court’s findings are supported by evidence, an appellate court will not lightly interfere. That makes preparation at trial critically important. Evidence that is never properly established at trial may be difficult to repair on appeal.
The DAC View
At Dzekedzeke and Company, we believe Pliable Engineering Limited v Mwamba contains a lesson that should be taught to every entrepreneur before they establish a company:
- Separate ownership from funding.
If you own shares, document your shares.
If you lend money, document the loan.
If you buy equipment personally, document who owns it.
If you contribute additional capital, document the capital contribution.
If you enter a joint venture, document how money and management will work.
- Friendship is not accounting. Trust is not documentation.
You can trust your business partners completely and still document your arrangements. In fact, clear documentation can help preserve that trust because everybody knows where they stand. So the next time you transfer ZMW1 million into a company in which you are a shareholder, do not merely tell the accountant: “Put this into the business.”
Ask first: “Am I investing this money—or lending it?”
Then document the answer.
For legal advice on shareholder disputes, company law, joint ventures, shareholder loans and commercial agreements, contact Dzekedzeke and Company.
Based on Pliable Engineering Limited v Mwamba [2016] ZMSC 213 (28 October 2016).
