Pre-emption rights on the allotment of shares are an important safeguard designed to protect existing shareholders from the dilution of their ownership interests when a company issues new shares. If new shares are allotted to external investors or selected shareholders without first offering them to existing shareholders, those existing shareholders may see their percentage ownership, voting rights and overall influence within the company reduced.
The statutory basis for these rights is found in Section 561 of the Companies Act 2006, which generally requires new equity securities to be offered to existing shareholders in proportion to their current holdings, unless the rights have been validly excluded or disapplied.
In practice, pre-emption rights are commonly structured as either a right of first refusal (ROFR) or a right of first offer (ROFO), depending on the circumstances and the company’s constitutional documents or shareholders’ agreement. Both mechanisms are intended to give existing shareholders the opportunity to acquire new or transferred shares before they are offered to third parties, helping to preserve their proportional ownership and protect them against unwanted dilution.
Right of first refusal (ROFR)
The new shares allotted must be offered to existing shareholders within the company, allowing them to buy the shares in proportion to their current stakes to prevent the dilution of their interest. The price, amount, and terms of the purchase will be decided by the company. Any remaining shares can then be offered to external investors. Even if the shareholders have no interest in purchasing new shares, it is important to allow them to refuse the offer to demonstrate fairness in company administration.
Right of first offer (ROFO)
ROFO’s go one step further than ROFR’s. The company offers shareholders the opportunity to buy new shares, but negotiations are allowed for the number of shares, price, and terms of purchase between the parties.
Both mechanisms are simple in principle – when allotting new shares, they must first be offered to the shareholders for purchase; only when there are shares leftover can they be allotted to third parties.
Limits and exceptions of statutory pre-emption rights
It is important to note that statutory pre-emption rights only apply to the allotment of ordinary shares. The statutory pre-emption rights provided by the Companies Act 2006 are limited in scope and do not generally apply to the allotment of non-equity securities, the transfer of existing shares, or the transmission of shares as a result of death or bankruptcy. These situations are instead governed by the company’s articles of association, any shareholders’ agreement, or the relevant provisions of law.
Pre-emption rights may also be excluded, disapplied or modified by the company’s articles of association or in accordance with the Companies Act 2006. For example, shareholders may choose to waive their entitlement by signing a waiver, while a special resolution passed by at least 75% of the voting shareholders can authorise the directors to allot shares without complying with the statutory pre-emption requirements or to disapply those rights in relation to a particular allotment. In the event that some or all existing shareholders have no interest in purchasing the allotted shares, by removing the pre-emption procedures, the sale of newly allotted shares may be completed faster.
Strengthening the company’s pre-emption procedures
Companies, particularly larger organisations with multiple classes of shares, often adopt bespoke pre-emption provisions to reflect their specific commercial needs and provide enhanced protection for shareholders. These contractual rights can also extend to situations that fall outside the scope of the statutory protections contained in the Companies Act 2006. Specific clauses within the shareholders’ agreement can broaden the scope of protection from different angles, such as share transfers, allotment of non-ordinary class shares, and more; by closing the gaps in statutory protection shareholders will be afforded higher degrees of security.
If you need advice or assistance, please contact Nath Solicitors on 0203 983 8278 or get in touch with the firm online.