Pre-emptive rights in private limited companies – guide for directors

Pre-emptive rights, also known as rights of pre-emption, generally give existing shareholders the first opportunity to buy new shares before they are offered to outside investors.

Separate pre-emption rights can also apply when existing shares are transferred or transmitted, but these arise from the company’s articles of association or shareholders’ agreement rather than the statutory pre-emption rules on new shares.

When a company is considering issuing new shares, it needs to be aware of whether and to what extent pre-emptive rights exist and proceed accordingly.

Typically, any rights will be proportionate to the shareholding, so if an individual with pre-emptive rights owns 25% of shares already in issue, they should have first refusal on the same percentage of any new share issue.

If they decide to take up the offer and pay for each new share issue, they’ll be able to maintain their percentage shareholding in the company as well as preserve their proportion of voting and other rights, such as dividend rights.

In practical terms, pre-emptive rights protect shareholders from dilution of their ownership and influence. They are particularly important in small private companies where ownership and control are closely linked.

How do pre-emptive rights arise?

Pre-emption rights can arise from any of the following three sources:

• Statutory rights under the Companies Act 2006
• Pre-emptive rights under the company’s articles of association
• Pre-emption rights within the shareholders’ agreement

Pre-emptive rights on allotment of shares under the Companies Act 2006

Statutory pre-emptive rights, as detailed in sections 561–576 of the Companies Act 2006, mean that when the rules apply, new equity securities must be offered to existing holders first, in proportion to their existing holdings.

The offer must be made in accordance with section 562, and the company must allow at least 14 days for the offer to be accepted.

These statutory rights apply to equity securities, as defined by section 560 of the Companies Act 2006. Broadly, this includes ordinary shares and rights to subscribe for or convert securities into ordinary shares. Shares whose rights to dividends and capital are limited to a specified amount fall outside the statutory definition of ordinary shares.

Statutory pre-emptive rights don’t apply in a number of circumstances, including:

• Where a private company’s articles exclude the statutory requirements or provide corresponding alternative rights
• Bonus shares
• Shares issued wholly or partly for non-cash consideration
• Securities held under an employees’ share scheme
• Where the statutory rights have been validly disapplied

The detailed rules are set out in Chapter 3 of Part 17 of the Companies Act 2006.

There are several routes by which statutory pre-emption rights can be disapplied. For example, section 569 deals with a private company that has only one class of shares, while sections 570 and 571 deal with other circumstances in which the rights may be disapplied.

Where a section 570 disapplication is linked to a general authority to allot shares under section 551, it cannot continue beyond that allotment authority. A section 551 authority can generally be granted for a maximum of five years.

If a special resolution is passed, a copy must generally be filed with Companies House within 15 days. If the company’s articles are amended, the amended articles must also be filed.

Pre-emptive rights under the company’s articles of association

Statutory rights are often excluded or alternative provisions made on share allotments in the company’s articles of association.

However, companies should not propose an issue of shares without first being certain what pre-emptive rights are included within the articles and understanding how provisions in the articles relate to statutory provisions.

Where a shareholders’ agreement exists, this is also likely to contain provisions on pre-emptive rights. If in any doubt about pre-emptive rights, it is always best to seek professional advice.

Pre-emptive provisions on transmission or transfer of shares

When existing shares are transmitted or transferred, they are not subject to the statutory pre-emption provisions in section 561. However, pre-emption provisions may be included in the company’s articles of association or shareholders’ agreement.

These provisions can apply to the transfer or transmission of shares, for example when a current shareholder wants to sell their shares, passes away or is declared bankrupt.

But regardless of the provisions made, it is important that the articles are drafted to accurately reflect the needs of both the company and the shareholders.

Pre-emption rights in a shareholders’ agreement

A shareholders’ agreement will often include provisions that control the transfer of shares and restrict the further issue of shares.

These can also be included in the articles of association, but where provisions appear in both the articles and the shareholders’ agreement, it’s important that they are consistent to avoid any problems or misunderstanding in future.

Can a company remove pre-emptive rights?

There are legitimate reasons why shareholders may agree to remove or disapply pre-emptive rights. If there are a number of shareholders, for instance, the pre-emption procedure can be both expensive and time-consuming.

For a private company, amending the articles of association to exclude the statutory provisions or provide alternative arrangements may allow for more flexibility on future share issues.

Statutory pre-emption rights can also be disapplied for particular allotments or more generally where the relevant Companies Act requirements are followed. Depending on the route used, this may require a special resolution and, in some circumstances, a written statement from the directors.

Example

If a company with four equal shareholders proposes to issue 100 new ordinary shares for cash and the statutory pre-emption rules apply, each shareholder would initially be offered 25 shares.

If all four take up their entitlement, each retains the same percentage ownership of the company. If one declines, what happens to the shares not taken up will depend on the terms of the offer and any provisions in the company’s articles or shareholders’ agreement.

Larger companies and best practice

While most small private companies only need to deal with the Companies Act provisions and their own constitutional arrangements, listed companies also follow the Pre-Emption Group’s Statement of Principles, which sets out best practice for non-pre-emptive share issues.

Although not binding on a typical small private company, these principles show how pre-emption rights are handled across the broader corporate landscape.