What Are Pre-emption Rights?

Our specialist commercial litigation team handle many disputes across the full range of the commercial and corporate environment. This especially includes shareholder and investor litigation such as where there are disputes between shareholders and a board, or between shareholders themselves. This often usually requires consideration of Companies Act 2006, Articles of Association and Shareholders Agreements. Items such as pre-emption rights are important for us and in our work in this context. We act in many unfair prejudice and quasi-partnership disputes and litigation across the country. Importantly we do not draft non contentious documents and our team only gets involved where there is an underlying dispute.

Pre-emption rights allow are a mechanism allowing shareholders to maintain control over a company by giving them the . They provide existing investors with the first opportunity to purchase additional shares before offering them to external investors. It is crucial for a business’s long-term stability, encouraging loyalty and allows for strategic planning from existing investors.

This entitlement protects shareholders’ proportional ownership and voting powers, providing security and continuity. It is often vital for a business’s long-term stability, as it encourages loyalty and strategic planning from those who have already invested. 

In this article Here, we explain the purpose of pre-emption rights, why they are important, the relevant laws and exceptions, and how they impact Articles of Association and shareholder agreements. 

The Primary Purpose of Pre-emption Rights

The main purpose of pre-emption rights is to give shareholders priority, or “rights of first refusal”, to purchase new shares.

It protects their proportional interest in the business, as the company must offer the shares in an amount that reflects their existing holding. It also prevents their original investment from being undermined if and when new shareholders join. 

Why Are Pre-emption Rights Important?

Pre-emption rights are an The need for companies to offer shares to existing members first is an essential aspect of business operations, boosting financial stability and promoting longevity. They provide several benefits It provides various benefits vital to maintaining shareholder trust and confidence including:. Below are some of the core elements that highlight their importance:

• Control: Shareholders maintain control as their proportional ownership of shares won’t be reduced. This is particularly important in smaller businesses, where achieving the company’s goals depends on having fewer people in control. 
• Protection: Existing shares aren’t diluted, meaning shareholders keep the same percentage of equity in the company. Therefore, the value of existing holdings stays the same. 
• Investor confidence: By giving shareholders the first right to purchase new shares, companies promote investor confidence and reassure members that they’ll protect their interests. It increases the likelihood of future investment. 
• Fairness: Granting shareholders priority enhances fairness within the business by acknowledging the existing effort and monetary contributions they have invested. 
• Strategic stability: The mechanism prevents a sudden or unexpected change to the company’s composition, helping which helps maintain a clear business plan and its execution. 

What Are Statutory Pre-emption Rights?

Statutory pre-emption rights are dealt with under Section 561 of the Companies Act 2006 and provide a legal basis for rights of first refusal. They only apply to newly issued shares and don’t arise where members wish to transfer their holdings.

Section 561 states that a company cannot allot shares to a person on any terms unless: 

• It has already offered them to those who hold ordinary shares in the company on the same or more favourable terms and in the same proportion to their existing holding.
• The period for existing shareholders to accept the offer has expired, or the relevant investors have notified their company of their acceptance or refusal to purchase. 

The company must also comply with the requirements under Section 562 in terms of how it makes the offer:

• It may be provided in hard copy or electronically.
• It may be published in the Gazette if the holder does not have a UK-registered address or holds a share warrant (a type of holding allowing them to buy or sell shares at any time at a predetermined price and within a set time). 
• It must state how long the individual has to accept the offer, and the company must not withdraw it before the period expires. This 

The above period must be at least 14 days, beginning on the date the offer is sent or published in the Gazette. 

The Exceptions to Statutory Pre-emption Rights

Section 562 of the Companies Act lists certain exceptions to shareholders’ first-refusal entitlement. Companies are, therefore, not obligated to offer new holdings to existing investors in the following situations:

• If the offering is for bonus shares, i.e., those given to existing shareholders for free. 
• If the shares aren’t paid for in cash, either partly or wholly. 
• If they’re being allotted under an employee’s share scheme unless that employee has given up or assigned their allotment. 
• If the sale of shares results from a compromise or arrangement to help a business in financial difficulty. 
• If all shareholders agree to waive their pre-emption entitlement. 

The Role of Pre-emption Rights in Articles of Association and Shareholders’ Agreement

The Articles of Association govern how shareholders members run a business. They are a legal requirement and are available publicly on Companies House. A shareholders’ agreement is private and deals with the members’ responsibilities to each other and the company. 

Investors may disapply or amend the requirement and procedure for statutory pre-emption rights through the Articles or a private agreement, which will take precedence over the statutory requirement. It’s common for businesses to customise these documents to suit their particular needs. For example, company members may wish to include a provision for pre-emption entitlement for a share transfer, as the Companies Act does not cover this.

Sometimes, shareholders may agree to waive their rights of first refusal in specific situations, such as if a member wishes to transfer some of their shares to a close relative. Alternatively, the Articles or agreement may allow a particular third party to purchase an interest without the company complying with the usual pre-emption right procedure. 

Another way shareholders may disapply these rights is by special resolution. To do this, they must hold a general meeting where the relevant members vote on the decision. If the votes in favour exceed 75%, the resolution will pass, and the pre-emption procedure will not apply to that particular sale or transfer.

Need Advice? Contact Helix Law

If you are a shareholder involved in a dispute we would be happy to assist you. You may feel you have suffered unfair prejudice and need advice. Our specialist commercial litigation team would love to assist you and please contact Helix Law for further assistance.