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Shareholders' Rights: Right of Pre-emption

Wednesday, 5 October 2011

The Companies Act 2006 contains a general rule giving existing shareholders in a company the right of pre-emption. The relevant section of the Companies Act is section 561.

The right of pre-emption provides that where a company proposes to allot shares to a person who is not an existing shareholder, it cannot do so without first offering those shares to its existing shareholders on the same or more favourable terms. In other words, existing shareholders have a first right of refusal.

Taking a basic example:

Company X has 100 shares, of which and A and B each hold 50 shares.

Company X wants to allot 50 new shares to C at £1 per share.

The statutory right of pre-emption would operate to prevent Company X from allotting a further 50 new shares to C, unless those shares were first offered to A and B and A and B have refused the offer.

The offer to A and B would have to be on the same or more favourable terms, so the shares would need to be offered to A and B at £1 each or less.

The number of shares offered to A and B must also reflect the existing proportion of Company X's shares they hold, so in the current example, where there are 50 new shares issued, 25 would first need to be offered to A and 25 to B.

The offer to existing shareholders must be kept open for acceptance for a minimum period and where that period expires and existing shareholders have not taken up the offer, the shares can then be allotted to others. The offer must be kept open for a minimum of 14 days and can be sent to existing shareholders electronically or in hard copy.

If a company allots shares without observing the pre-emption rights of existing shareholders it, along with any directors authorising or permitting the contravening allotment, will be liable to compensate existing shareholders for their losses suffered. Such loss may include any reduction in value of existing shareholders' shares by reason of the dilution of their voting and dividend rights caused by admission of the new shareholders.

It is possible for a company to exclude the statutory right of pre-emption. A company's articles of association may provide that sections 561 and 562 of the Companies Act do not apply to any of its share allotments. Those contemplating subscribing for shares in a company which has excluded the right of pre-emption should however be aware of the risk that new shareholders can be introduced more easily which may impact adversely on the rights of existing shareholders and the value of their shares.

Where a company has not specifically excluded the statutory right of pre-emption via a provision in its articles, it is still possible for it to allot shares as if the statutory right did not apply. For example, the company can, via special resolution (a resolution passed by 75% or more of its members) allot shares as if the right of pre-emption did not apply.

Finally, the statutory right of pre-emption does not apply to:

Bonus shares

Shares issued for non-cash consideration

Employee share schemes

If you are an existing or prospective shareholder and seek more information on the right of pre-emption of shareholders' rights generally, please contact our commercial solicitors via e-mail or by phone on 0207 611 4817.