Share dilution arises when a company creates and issues new shares, which can reduce existing shareholders’ percentage ownership and the earnings attributable to their individual holdings. This is a common feature of corporate growth strategies, particularly during early expansion phases, as companies often issue further equity to secure investment and obtain the funding required for development.
Despite the procedure itself being legitimate, the power to allot shares can be susceptible to abuse. When the dilution of shares does not arise out of genuine commercial need but out of the intention to diminish certain shareholders’ voting power, or to consolidate the position of current directors, the power of allotment is likely to have been exercised improperly.
This article examines the legal protections afforded to shareholders in England and Wales in relation to share dilution and outlines the potential steps available to shareholders who consider that their interests have been adversely affected by the issue of new shares.
Procedural Safeguards: The Companies Act 2006
Under Section 549 of the Companies Act 2006, directors are only allowed to allot shares when they are either authorised by the company’s articles of association, or by an ordinary resolution of the shareholders. In these two circumstances, the maximum number of shares that may be allotted must also be specified to avoid excess.
Section 561 of the Companies Act 2006 provides existing shareholders with statutory pre-emption rights when a company proposes to allot new shares. Unless validly excluded or disapplied, new securities must first be offered to existing shareholders in proportion to their current holdings. This mechanism allows shareholders a fair opportunity to maintain their existing percentage ownership and avoid unwanted dilution of their interests in the company.
This represents one of the key statutory protections available to shareholders against unwanted or disproportionate dilution of their shareholdings. These pre-emption rights can only be excluded or disapplied where authorised by a special resolution of shareholders, requiring at least 75% approval, or where the company’s articles of association contain express provisions permitting such exclusion.
Directors’ Duties
Even if an allotment is authorised and pre-emption protocol has been complied with, allotment may still be susceptible to challenge if the directors exercising the allotment are in breach of their duties under the Act.
In particular, Section 171 details their duties to exercise powers only for conferred purposes. The power to allot shares must only be exercised in favour of the company’s commercial interests and success. Hence, allotments made with the interests of altering the balance between shareholder interests or to marginalise minority shareholders can all become the basis for actionable shareholder claims.
Unfair prejudice claims
When shareholders have reasonable suspicion or proof that a dilutive allotment is conducted in a manner that is unfairly prejudicial to the interests of shareholders, they may be eligible to raise an unfair prejudice petition under Section 994 of the Companies Act 2006. This avenue for redress is important especially for minority shareholders for addressing any unjust treatment or abuse of power within the company.
If you wish are a shareholder who needs advice regarding unfair or improper share dilution, please contact Nath Solicitors on 0203 983 8278 or get in touch with the firm online.