B-BBEE: What is fronting?

The Broad-Based Black Economic Empowerment Amendment Act (“the Amendment Act”) was gazetted on 27 January 2014 and assented to by the President on 23 January 2014 and the majority of its provisions will come into effect by further proclamation. The Amendment Act seeks to create a more comprehensive regulatory framework within which the Broad Based Black Economic Empowerment (“B-BBEE”) programme will operate in future and is specifically aimed at policing and prosecuting fronting practices.

Before the Amendment Act there was no definition of “fronting” in the legislation. The DTI did publish non-binding guidelines on fronting practices on its website, but these had no legal authority. The Amendment Act has to a large extent codified these guidelines and now defines the concept of a “fronting practice” as follows:

“…a transaction, arrangement or other act or conduct that directly or indirectly undermines or frustrates the achievement of the objectives of the Act or the implementation of any of the provisions of the Act, including but not limited to practices in connection with a B-BBEE initiative—

(a) in terms of which black persons who are appointed to an enterprise are discouraged or inhibited from substantially participating in the core activities of that enterprise;

(b) in terms of which the economic benefits received as a result of the broad-based black economic empowerment status of an enterprise do not flow to black people in the ratio specified in the relevant legal documentation;

(c) involving the conclusion of a legal relationship with a black person for the purpose of that enterprise achieving a certain level of broad-based black economic empowerment compliance without granting that black person the economic benefits that would reasonably be expected to be associated with the status or position held by that black person; or

(d) involving the conclusion of an agreement with another enterprise in order to achieve or enhance broad-based black economic empowerment status in circumstances in which—

(i) there are significant limitations, whether implicit or explicit, on the identity of suppliers, service providers, clients or customers;

(ii) the maintenance of business operations is reasonably considered to be improbable, having regard to the resources available;

(iii) the terms and conditions were not negotiated at arm’s length and on a fair and reasonable basis; “

As can be seen from this definition, the legislation follows a substance over form approach to B-BBEE structures. Any structure or transaction that purports to comply with the legislation or codes but actually amounts to a misrepresentation will constitute a fronting practice. Of particular importance is subsection (d), which will be applicable to B-BBEE joint ventures, Special Purpose Vehicles or black-owned tender companies created by their holding companies or shareholders purely for tendering purposes. It is clear that structures such as these will only be legitimate where the tender company actually has a large degree of independence from the holding company. This accords with the provisions of the Preferential Procurement Regulations promulgated in terms of the Preferential Procurement Policy Framework Act 5 of 2000, which prohibit the awarding of a tender where the contractor will outsource more than 25% of the work to be done to a third party with poorer B-BBEE credentials.

The Amendment Act creates a new oversight body in respect of the B-BBEE programme known as the B-BBEE Commission, which will fall under the authority of the DTI. The Commission will have wide ranging powers, including the authority to investigate and prosecute (in conjunction with the NPA, SAPS and SARS) and allegations of fronting. The Commission will, amongst other things, have the power to summon and interrogate witnesses or people implicated in fronting practices and subpoena any relevant documents to an investigation, subject to certain limitations relating to confidential information. The penalties for contraventions of the Amendment Act, including fronting practices, are quite severe. A person who is found guilty of fronting may be sentenced to 10 years’ imprisonment. If the perpetrator is a juristic person, a fine of up to 10% of its annual turnover may be imposed and its name must be recorded in a “register of tender defaulters” and no organ of state or public entity may do any business with that entity for a period of 10 years after conviction.

In light of the new fronting rules and strict penalties, companies will have to be very careful in the way that they structure their B-BBEE transactions and it is recommended that expert assistance be obtained before embarking on a structure that may fall foul of these new provisions.

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