Essentially, pre-emption rights give a company’s existing shareholders the first opportunity to acquire shares of the company before they are offered elsewhere, either on an issue of new shares in a new funding round or a share transfer by an existing shareholder. The idea is to prevent shares from being issued or transferred to third parties to the detriment of existing shareholders, thus impacting their rights and investment in the company. When a company intends to raise funds by issuing new shares or when a shareholder intends to sell his shares, it is vitally important for the parties concerned to consider whether any pre-emption right exists and if so, what process must be followed.
This article provides a brief overview on the concept of pre-emption rights and in what context they may arise.
(a) Statutory pre-emption right to new shares
In respect of an issue of new shares, section 85 of the Malaysian Companies Act 2016 (“CA 2016”) affords a default pre-emption right to a company’s existing shareholders to be offered shares which are pro-rata to their existing shareholdings before any new shares which rank equally to their shares as to voting or distribution rights can be issued by the company, unless the company’s constitution provides otherwise. This default rule ensures that all shareholders of the same class are treated equally as they are given the opportunity to acquire their proportional shares of any additional share issuance by the company, thereby protecting their ownership interests from being diluted involuntarily without their consent.
It is noteworthy that the statutory pre-emptive rights are specific to the same class of existing shares. What this means is that if a company has different classes of shares (say, class A and class B) and the company only issues class A shares, only the class A shareholders will be entitled to subscribe for those new class A shares by virtue of their pre-emption rights at their respective proportion.
While the default pre-emption rights provides a useful tool to shareholders for preserving their ownership proportion in the company, it is never intended to impose an obligation on the existing shareholders to accept the pre-emptive offer nor attempt to allow the existing shareholders to acquire extra shares for free. The truth is that shareholders may only benefit from such anti-dilution mechanism if they are able to fork out additional capital for the additional shares. If an existing shareholder does not have the requisite financial capability to pay for the shares at the proposed price, chooses not to exercise his pre-emption right by waiving it or fails to accept the offer after a specified period of time for acceptance, then the shares would be offered to other parties which would inevitably result in a decrease of the ownership proportion of that shareholder.
On the other hand, the law makes it possible for a company to opt out, disapply or alter the default pre-emption rights by amending its constitution. For instance, a company’s constitution may allow for new shares to be issued to potential investors without the need to follow the statutory pre-emption process, subject to the consent of all or a specified proportion of the shareholders being obtained. The constitution may also set out different procedures that have to be followed for the issue of shares. Some founding shareholders may even want to ensure that shares are issued to them or a selected group of persons first rather than to all existing shareholders on a pro-rata basis. In this event, the customised provisions in the constitution and/or the shareholders’ agreement will apply in place of the statutory process. But for those companies without a constitution, the statutory pre-emption rights will apply on the allotment and issue of shares.
(b) Contractual pre-emption right to shares
In respect of a transfer of shares, it is noteworthy that the CA 2016 is silent on the pre-emption rights on share transfers. The implication is that shareholders would lack the pre-emption protection for transfer of shares if such rights are not provided in the company’s constitution or a shareholders’ agreement.
As such, a bespoke constitution and shareholders’ agreement would usually include clauses relating to pre-emption rights which apply on the transfer of shares by an existing shareholder and set out the procedures for a selling shareholder to transfer his shares together with a mechanism or formula for determining the transfer price, despite there is no statutory requirement for a company to give pre-emptive rights to its existing shareholders on share transfers. The objective underlying such pre-emptive right is to help preserve the original shareholder composition and limit the ability of an unknown or unwanted third party to become involved in the company. Another general aim is to give existing shareholders an equal right to benefit from a proportional increased stake in the company through purchasing a selling shareholder’s shares on the same terms as those offered to or by a third party while also preventing any shareholder from unfairly increasing their ownership interest in the company without the knowledge of other shareholders.
Some constitutions and shareholders’ agreements may in addition provide for exceptions to the contractual pre-emptive rights on a transfer of shares. A common example is a transfer of shares to an entity or a person related to the selling shareholder, say, its holding company, subsidiary, family member or related company.
There is a wide spectrum of possible provisions for pre-emption rights, and it is imperative that the company constitution and/or the shareholders’ agreement is/are properly drafted to reflect the intention and needs of the company and its shareholders.
Practical Tips
Pre-emption rights undoubtedly constitute a fundamental form of protection for shareholders to protect their interests in a company and are commonly granted to shareholders. Notably, the existence of pre-emptive rights will impact the process by which a company can issue shares or a shareholder can sell shares. Hence, before any new issue of shares or transfer of shares is proposed to be undertaken, it is essential to check the company’s constitution and/or shareholders’ agreement or even consult with the company secretary or legal advisor to determine whether the company shareholders have pre-emption rights. If so, directors and shareholders have to follow the specified procedures to take account of the rights, ensuring that the exercise in question is duly carried out in accordance with the CA 2016, the company’s constitution and/or shareholders’ agreement.
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About the author:
This article was written by Daphne Sit, Corporate Associate – law firm in Kuala Lumpur, Malaysia.
The view expressed in this article is intended to provide a general guide to the subject matter and does not constitute professional legal advice. You are advised to seek proper legal advice for your specific situation.
