Pre-emptive rights of shareholders - everything you need to know

1. What are pre-emptive rights of shareholders?

Pre-emptive rights of shareholders (also known as rights of first refusal) are rights that give an existing shareholder the right to buy another shareholder’s shares (or newly issued shares) before they can be offered elsewhere.

There are typically two types of pre-emption rights - pre-emption rights on the issue of shares and pre-emption rights on the transfer of shares.

Pre-emptive rights of shareholders can be found in three different places:

• Companies Act 2006 - the Companies Act 2006 (the main piece of company law in the UK) includes pre-emptive rights for shareholders on the issue of new shares by a company. These statutory rights can be disapplied if a company’s articles of association have alternative provisions dealing with pre-emption rights on the issue of shares;

• Articles of association - a company’s articles of association may include pre-emption rights on the issue of shares and/or pre-emption rights on the transfer of shares; and

• Shareholders’ agreement - a shareholders’ agreement may also include pre-emption rights on the issue of shares and/or pre-emption rights on the transfer of shares. This will also include details of the process for how those rights can be exercised.

2. How can a shareholder exercise their pre-emption rights on transfer of shares?

The specific process to be followed to exercise pre-emption rights on the transfer of shares will depend on the particular wording of the clauses in the relevant shareholders' agreement (or articles of association), but it will typically involve the following process:

• if a shareholder wants to transfer their shares, they must first provide a notice to the company that should include: (i) the number of shares they wish to transfer; (ii) the name of the proposed transferee, if any; and (iii) the price per share, if any, at which they wish to transfer the shares;

• after receipt of the above notice, the company will offer the shares to the other shareholders in the company that have pre-emptive rights;

• the shareholders that have pre-emptive rights will have a defined period to confirm whether they wish to exercise their pre-emptive right and purchase the shares; and

• if multiple shareholders wish to exercise their pre-emptive rights to purchase the shares so that there are more requests for shares than the number of shares available, they will usually be allocated between the shareholders in proportion to their existing shareholdings.

3. Why do companies offer pre-emptive rights to shareholders?

Pre-emptive rights can be used as a tool to incentive investment. A company may offer pre-emptive rights to shareholders as a way of protecting their existing shareholders' ownership and control over the company, as they allow shareholders to maintain their proportional ownership stake in the company when new shares are issued (or existing shares are being transferred). Pre-emptive rights of shareholders can increase shareholder loyalty by providing additional protection to existing shareholders in a company, whilst also being a useful tool in attracting new shareholders (and therefore additional investment capital).

4. How can pre-emptive rights of shareholders be waived?

Docue’s pre-emption waiver right letter template can be used to effectively waive a shareholder’s pre-emptive rights on transfer of shares (or issue of shares). Using this waiver letter template helps to ensure that none of the existing shareholders can claim that they weren't given the opportunity to exercise their pre-emption rights or rights of first refusal.

A waiver letter will not be required if a company's articles of association or shareholders' agreement allow for pre-emption rights of shareholders to be 'disapplied' by a shareholder resolution or with the consent of a certain group of shareholders, and not, therefore, requiring an express waiver from the shareholder with the pre-emptive right.

5. Are pre-emptive rights of shareholders legally binding?

Yes - if you include them in your shareholders' agreement or articles of association, the pre-emptive rights of shareholders will be binding on both the company and the shareholders.

Sign up to Docue today to use our shareholders' agreement template.