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Shareholder Disputes: Pre-emption Clauses

Tuesday, 10 July 2012

Pre-emption clauses place an obligation on sellers of shares to offer them to existing shareholders first. The clauses are often found in the articles of association of private companies and have been the cause of significant numbers of shareholder disputes.

There is a distinction between these rights which are contracted for in the articles of association and pre-emption rights imposed by the Companies Act 2006 s561 which act on an issue of new shares. It is the former that are the focus of this article.

The Purpose of Pre-emption Clauses

Existing shareholders in private companies often wish to retain close control of that company. In the event that one of the shareholders wishes to sell part or all of their holdings, the remaining shareholders are normally keen to retain those shares within their ranks. For this reason a clause is often contained in the company’s articles requiring sellers to offer those shares to existing shareholders before they can offer them to outsiders.

When the occasion arises that such clauses become active, there is normally a further incentive for existing shareholders to take up the offer. The pre-emption clause usually sets out a mechanism by which the shares are valued, often resulting in a discount to market value.

The Importance of Careful Drafting

The nature of shares is that they are freely transferable pieces of personal property. Therefore, any restriction on their transfer must be carefully worded to avoid potential conflict.

Rollingsons highly recommends that parties entering into a business relationship where this is a potential issue take appropriate legal advice. Courts are not inclined to enforce restrictions where the intention of the parties is anything less than unequivocal and particular phrasing has specific legal connotations in the interpretation of these clauses.

Breach of Pre-emption Clauses

Shareholders that benefit from pre-emption provisions have a right to protect those interests. Thus where a clear intention to breach a pre-emption clause can be proved, it gives the remaining shareholders personal rights of action to enforce their claims. Where a dispute arises because existing shareholders were not aware of their pre-emption rights, it is necessary for the outside buyer to prove that the existing shareholders did in fact have actual knowledge of their rights and waived them.

Past cases have seen breaches followed by rectification of the shareholder’s register or refusal by the directors to register the transfer. Transfers have been considered inoperative or even created a beneficial interest for the remaining shareholders where the transfer was considered effective.

When forming a company it is important that shareholders understand their legal rights and obligations. If you require further information regarding pre-emption clauses or other company related matters please contact James Crighton via e-mail or by telephone on 0207 611 4848.