Investor-Friendly Organisational Arrangements for Group-based Land Reform Projects Contributing Authors: Mike Lyne Johann Hammand Kevin Mitchelle Stuart Ferrer Paul Zille Dave Thomson

Many farms transferred to Communal Property Institutions (CPI) representing large groups of beneficiaries have succumbed to institutional failure → disillusioned beneficiaries, falling output & resource degradation. In this “think piece”, recent advances in Economics Theory are applied to recommend organisational arrangements that promote private investment, good governance, effective management and a fair distribution of benefits in commercial enterprises undertaken by large groups of land reform beneficiaries. INTRODUCTION

To take advantage of economic opportunities offered by land reform, a CPI must adopt institutional arrangements that: (a)encourage members of the group to conserve, improve and use the land and related resources profitably and sustainably, and (b)enhance the organisation’s ability to attract debt & equity capital to finance growth. Fulfilment of (a) is a prerequisite for the realisation of (b)

Preconditions for sustainability: –create strong incentives for members (and, by extension, strategic partners) to invest in commercial enterprises, –generate regular and reliable signals of enterprise performance (e.g., profitability, liquidity, solvency & growth) so that members can assess managerial performance, –ensure accountability of management, and –distribute benefits to members in a transparent & fair way. On their own, CPAs & CTs, typically established to administer their members’ rights in land, do not satisfy these conditions

investment is undermined by the threat of free-riding. Members share Inclusive use rights Member rights Residential sites Figure 1. A CPI: members share inclusive rights farm land

Members can exchange their inclusive use rights for exclusive use rights to subdivisions of the property. Exclusive use rights (transferable between members) Member rights Residential sites exclusive use rights (transferable between members) Figure 2. A CPI: Individual exclusive use rights Subdivisions Of farm land

Members exchange their inclusive use rights for well- defined individual voting & benefit rights Exclusive use rights Member rights Commercial land- based enterprises Garden plots Residential sites Individual benefit & voting rights Figure 3. A CPI: Individual voting & benefit rights

In order to eliminate problems of free-riding, individual voting and benefit rights must be: –proportional to the financial investment made by each member, and –appreciable and tradable (between members). In practice, few legal entities meet these conditions: –Private and publicly listed companies DO. –CPAs and traditional co-operatives DO NOT. –A trust can, if it is suitably structured.

The CPA Act (Act 28 of 1996) does not permit CPAs to issue shares that confer individual voting and benefit rights of the type required to eliminate free- riding. Exclusive use rights Member rights Commercial land- based enterprises Garden plots Residential sites Individual benefit & voting rights Figure 3. A CPI: Individual voting & benefit rights

This is not to say that CPAs and Community Trusts should be replaced with investor-owned firms –They are well designed to effect a democratic, collective claim on land. –The constitutions of CPAs promote accountability and consultative decisions about individuals rights to and in the associations property. –CPAs benefit from government grants to prepare land use plans. (This provision presents planners with an opportunity to recommend rights in land that promote good institutions).

THE BASIC “TRIPARTITE” MODEL CPI allocates fully exclusive and transferable rights to residential land & garden plots among its members Use rights over non-residential land (i.e. land that lends itself to commercial farming or eco-tourism) owned by the CPI should be transferred to a separate legal entity that, in turn, allocates benefit and voting rights to the beneficiaries. In order to fulfil the requirements of proportionality, appreciability and tradability outlined earlier, this new organisation could be established as a unitised trust.

Use rights should pass to the unitised trust by means of a long-term and transferable lease with rental payments specified as a share, or graduated share, of revenue earned by the unitised trust. If a lease is transferable, it becomes an intangible asset with value determined largely by the stream of dividends expected from the commercial enterprise. Moreover, if the lease is renegotiable and requires the CPA/community trust to compensate the operating company for the residual value of improvements that it makes to the land, the value of the lease will not diminish to zero at the end of the lease period.

A range of options present themselves to these unitised trusts for the administration of land assets under their control: (a)The unitised trust and equity partner might contribute capital (including intangible assets like rental and marketing contracts) to an operating company which manages productive land owned by the CPI. (The Unitised Trust simply cedes its lease to the operating company in exchange for an equity stake in the operating company) Note that unitised trust can invest capital in a joint venture company but a CPA can’t because section 9(e)(iv) of the CPA Act forbids this.

Exclusive use rights Member rights Individual benefit & voting rights Organisation CPA/Community trust Unitised trust Operating company Equity partner Commercial land-based enterprises Garden plots Residential sites Long-term, transferable lease Lease & tangible assets as equity Marketing contracts & tangible assets as equity Lease Equity Figure 4. The Basic Tripartite Model

Figure 5. The Basic Tripartite Model

Lease Management contract Figure 5. Variants on the basic tripartite model

FURTHER CONSIDERATIONS Tax consequences –The transfer of use rights for productive land from the CPI to the unitised trust will bring about a capital gain consequence for the CPI if the lease rental rate is below the market rate.

CONCLUSIONS CPAs and CTs are well equipped to assign and allocate secure rights to land to large groups of land reform beneficiaries. However, they are not permitted to issue shares that confer individual voting and benefit rights of the type required to eliminate free-riding. This severely undermines ability of these types of institutions to promote the profitable and sustainable use of farmland resources for the benefit of their members.

CONCLUSIONS A solution to this problem is to establish a separate but complementary organisation (a unitised trust) structured with tradable benefit and voting rights proportional to each member’s investment in units to represent member interests in commercial enterprises. Planners must be aware of the potential tax consequences of the proposed tripartite model for the CPI.