Pre-emptive Rights to Share Transfers
In buying or selling a company, it is important to consider if the existing shareholders have any pre-emptive, also known as pre-emption, rights. Such rights can be defined as rights that give the company’s existing shareholders the first opportunity to acquire any shares that are being transferred.
From a company’s perspective, it is important to consider how pre-emptive rights may affect company decisions. Whether you are looking to conduct a placement of shares, issue more shares or create a new special class of shares to introduce new investors, pre-emptive rights have to be considered. Some existing shareholders may not agree with the decision made by the company and may act to stop such decisions. Similarly, if you are looking to divest and sell your majority stake to another person or company, dissenting shareholders with pre-emptive rights have the power to stop this action.
Types of Pre-emptive Rights
There are 3 types of pre-emption rights, namely:
- A right of first look
- Aright of first refusal
- A right of last refusal
A right of first look gives the preferred party or shareholder the chance to offer terms, including the purchase price for the seller’s shares. If the offer of the preferred party is rejected, the seller will not be allowed to sell the relevant shares to an outsider on more favourable terms or at a more favourable price.
As for the right of first refusal, the preferred party can only accept or reject the terms offered by the seller for the shares.
Finally for a right of last refusal, the preferred party can accept or reject terms that have already been negotiated and agreed between the seller and an outsider.
Why are They Important?
Pre-emptive rights are often one of the most important mechanisms for minority shareholders to be protected from oppressive activities by majority shareholders.
For instance, the issue of additional shares by majority shareholders may lead to dilution of the proportion of shares for minority shareholders. Pre-emptive rights allow minority shareholders to buy the additional shares first to avoid this dilution. They also offer shareholders the chance to minimise their risk in any takeover.
It should be noted that the holders of these rights can choose not to exercise them by waiving them. However, if a transfer of shares is done without allowing the relevant shareholders to exercise their pre-emptive rights, the transfer can be invalidated.
Case study: Foo Jong Long Dennis v Ang Yee Lim Lawrence
To better illustrate how pre-emption rights work, the case of Foo Jong Long Dennis v Ang Yee Lim Lawrence  SGHC 10 is helpful. In this case, the defendants were accused of selling their shares in Raffles Town Club and Europa Holdings Pte Ltd to two outsiders before allowing the plaintiff, who was another existing shareholder, to exercise his pre-emption rights.
The case also defined when a pre-emption right was breached, namely when a binding agreement is executed between the offending shareholder and an outsider. The fact that an agreement was made (indicating the intent to transfer shares) is inadequate to amount to a breach of pre-emption rights if there was no exchange of money and nothing to create an option to purchase the shares.
As Part of the Company Constitution
Notably, pre-emption rights are a common inclusion in the Memorandum and Articles of Association of companies. Recent changes in the Companies Act have made it such that new companies being incorporated will now only have a single corporate constitution, which would be a combination of the old Memorandum and Articles of Association. It should be noted that the Model Constitution from Companies (Model Constitutions) Regulations 2015 suggested for companies limited by shares does not expressly mention pre-emption rights but it gives the directors of the company the right to approve any transfer of shares.
The Companies Act has made it a pre-requisite that before any private company can be incorporated, the company has to ensure that its constitution restricts the right to transfer its shares. The company can also alter any restriction on the right to transfer its shares by special resolution. Public companies do not require the same restrictions but might also have such restrictions (listed companies will normally have no restrictions, as a condition for listing). Share transfer restrictions commonly take the form of pre-emptive rights or a discretion given to directors to refuse to register a transfer.
If shareholders of a particular company have pre-emption rights, then any transfer of shares by an existing shareholder would require a notice of transfer of shares to be sent. The notice has to be written in nature. It must be sent out to all existing shareholders and signed by every existing shareholder as well. Existing shareholders also have to agree to waive their pre-emption rights by signing another document titled the Consent for Waiver of Pre-emptive rights. Unanimous consent is required from the class of shareholders who possesses such rights before a share transfer may proceed.
Before proceeding with the purchase of a company, it would be prudent to undertake an extensive due diligence process, which would also involve the highlighting of any pre-emption rights held by existing shareholders or otherwise.