Pre-Emptive Rights - What Are They And Why You Need To Know About Them?

Pre-emptive rights are a crucial consideration for any company with more than one shareholder.  If there are pre-emptive rights, and a company wants to issue new shares, or a shareholder wants to transfer their shares; those shares must be first offered to the existing shareholders in proportions reflecting their current shareholding. 

The Companies Act 1993 (Companies Act) only provides for pre-emptive rights for share issues and not share transfers.  This means if you do not have a constitution or shareholder agreement providing that there are pre-emptive rights on share transfers, then a shareholder can offer to sell shares to anyone outside the company without first offering the shares to the other shareholders.

(Confused?)  Here is a simple example.  There are five shareholders in a company, each holding 20 shares.  Shareholder A wants to sell 20 shares.  The company has a constitution with pre-emptive rights on share transfers.  Shareholder A must first offer to sell five shares to each of the other shareholders before offering those shares for sale to anyone else.

The same occurs when new shares are issued by a Board of Directors.  Using the above example, if the Board wants to issue 100 new shares, it would need to give each shareholder the first option to purchase 20 shares before they issue them to anyone else.  

Because of the limitations in the Companies Act, it is extremely important a constitution is registered when a company is incorporated, or as soon as possible after that date.

Some constitutions provide for exceptions to pre-emptive rights on share transfers.  These might include if a shareholder wants to transfer shares to a family trust, a holding company, or a spouse or child.  Great care needs to be taken when drafting constitutions because most shareholders in a closely held company want to be in business with the people they have agreed to be in business with, not their trustees, spouse or child etc.

Pre-emptive rights are one of the fundamental protections shareholders need.  A good constitution and shareholder agreement is imperative to ensure these rights are correctly covered. 

The above information is of a general nature only. You should contact our firm for advice relating to your specific circumstance.