Background:
Pre-emptive rights give shareholders of a private company the right to acquire additional shares in a future issue or transfer of a company’s shares prior to those shares being offered to third parties.
These rights are also known as “rights of first refusal” and are an important tool for shareholders to ensure, amongst other things, that their ownership in the company is not diluted by any new share issues by the company. Pre-emptive rights also provide an opportunity to the existing shareholders of a company to acquire the shares of other shareholders of the company, which such shareholders intend to transfer to third parties, prior to those shares being transferred to third parties.
Failure to provide for pre-emptive rights in the relevant documents of a company can therefore pose a risk for the shareholders.
What are pre-emptive rights in relation to private companies:
Not all pre-emptive rights are provided for in terms of the Companies Act No. 71 of 2008 (“Companies Act”).
Section 39(2) of the Companies Act grants each shareholder of a company a right before any other person who is not a shareholder of a company, to be offered, and within a reasonable time to subscribe for, a percentage of the shares to be issued equal to the voting power of that shareholder’s general voting rights immediately prior to the offer being made. This right is automatically applicable and can be limited, negated, restricted or be made subject to certain conditions by the company’s memorandum of incorporation (“MOI) with respect to some or all classes of shares within the company.
Section 8(2)(b)(ii)(bb) of the Companies Act requires an MOI of a private company to restrict the transferability of its securities. The Companies Act however does not set out the terms of such restriction or how the transferability must be restricted. Pre-emptive rights in respect to share transfers are therefore contractual in nature.
Disputes amongst shareholders relating to share transfers can be mitigated by concluding a shareholders’ agreement between the shareholders of the company and the company. Shareholders’ agreements can make provision for pre-emptive rights in various ways, such as standalone pre-emptive rights clauses or as part of other provisions relating to the sale of shares.
In some instances, pre-emptive rights can be accommodated for in the company’s MOI. Whether pre-emptive rights are included in a shareholders’ agreement or an MOI will depend on the terms of the pre-emptive rights and the intentions of the parties, and should be assessed on a case by case basis. One must however bear in mind that a restriction of the pre-emptive rights relating to the issue of shares contained in section 39(2) of the Companies Act, would have to be included in the MOI.
Concluding remarks:
As the pre-emptive rights relating to share issues contained in section 39(2) of the Companies Act can be restricted by an MOI, and pre-emptive rights relating to share transfers are contractual in nature, the company and its shareholders could benefit from setting out the pre-emptive rights of shareholders in the shareholders agreement and/or the MOI.
In the event that no provision for pre-emptive rights is made in an existing shareholder’s agreement or MOI, it is recommended that such document be amended, to the extent required, to align with the intention of the relevant parties.
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Published 21 February 2023