If a company wants to raise money by issuing additional shares then, under company legislation, it is obliged to offer these shares to existing shareholders first. If this does not happen, this can be a breach of a shareholder’s rights.
‘Sometimes the company’s articles of association or the terms of a shareholder agreement might provide that this pre-emption right is not applicable, meaning the company is not obliged to offer the shares to existing shareholders first at a reduced price, and can offer these to anyone on the open market,’ says Kiran Solanki Solicitor at Crane and Walton Solicitors LLP. ‘However, this still has to be carried out by the directors subject to all of their legal duties to the company as directors.’
If new shares are issued that are not actually for the benefit of the company, but instead to dilute the shares of existing shareholders, and in turn to reduce their voting rights, then this can be a breach of the directors’ duties towards the company, as well as a possible breach of a shareholder agreement.
Kiran looks at the rights that a shareholder has in a rights issue, and how to resolve a dispute that might arise between a company and shareholders.
What are a shareholder’s rights when the company wants to issue new shares?
A rights issue occurs when a company offers its existing shareholders the chance to buy additional shares for a reduced price, usually within a specific period of time. This may occur as a result of pre-emption rights, following the sale of another shareholder’s shares when they decide to exit the company. Alternatively, it may take place if the company wants to raise capital more widely via a share sale, and there is a pre-emption right given to existing shareholders to be offered these shares first.
The number and type of shares that a shareholder can buy during this period is usually proportionate to their existing shareholding, and the mechanics of a share offer and purchase will often be set out in the company’s articles of association or separate shareholder agreement.
The starting point is that if a company wants to issue new shares to raise additional capital, then it is obliged under company legislation to first offer these to existing shareholders. However, it is possible for a limited company to override this legislation by agreeing different provisions in either the company’s articles of association or in a shareholder agreement, which could mean that existing shareholders do not have the right of first refusal before the company offers its shares to the open market. This may be fine, as long as it is for the good of the company and not prejudicial to specific shareholders.
What are a shareholder’s rights if there is a dispute with regard to the issue of new shares by the directors?
If there is a dispute over the issue of new shares, then the position should first be checked in the articles of association and the shareholder agreement, to see what rights they have, and what process must be followed by the company directors, to check if there has been a breach. Even if the right of pre-emption has been overridden by the constitutional documents of the company, it may be that there are other matters of concern. For example, shareholders may have agreed that the issue of new shares to other classes of shareholder is a variation of the class rights of the shares held by the shareholders who do not benefit from that allotment, and this therefore requires their consent before it can proceed. Has the requisite consent been sought and agreed?
Notwithstanding that the company legislation may have been disapplied in the company’s own documents, the directors still have a duty to act for the good of the company in all of their actions, and to follow the company’s own agreed rules in this regard. If they do not, they will leave the company open to dispute and a claim by a shareholder or shareholders.
What legal options does a shareholder have if they dispute the company’s conduct on a rights issue?
If a shareholder believes that the directors have not acted correctly in the issuance of new shares, there are several options open to them. If there is a shareholder agreement which covers the rights issue which has clearly been breached, then a shareholder can bring an action against the company for damages for breach of that agreement. How this action should commence is often set out in the shareholder agreement itself, which may suggest some form of alternative dispute resolution such as mediation or arbitration, before resorting to court action. Even if there is no shareholder agreement, there are options available to shareholders who believe the company has breached their rights in this area.
Unfair prejudice claim
If a shareholder feels that they have been prejudiced by a breach of a rights issue, or that the directors are not acting in the best interests of the company and they have been prejudiced as a result, a shareholder can bring an ‘unfair prejudice’ claim to court, to say that they have been unfairly prejudiced by the actions of the management of the company. The shareholder will need to show how they have been prejudiced. If they are successful, the court can make any order that it thinks is appropriate. This might include ordering the company to pay compensatory damages for any loss suffered. Alternatively, if appropriate, the court might order the company to purchase that shareholder’s shares, to release them from their shareholding at a fair market value.
Derivative action
Another alternative is for a shareholder or shareholders to bring a derivative claim in court. This is an application brought by a shareholder on behalf of the company as a whole, to show the company has been prejudiced by the actions of the management. In this example, it may be that the directors’ attempts to dilute certain shareholders’ voting rights will give them greater freedom to take certain action, that may not actually be in the interests of the company, and would ordinarily be blocked by voting shareholders before their votes were diluted by the sale of additional shares.
The court will need to find that the actions of the director(s) in how they dealt with the rights issues were contrary to the company’s overall interests.
If the court finds in favour of the claimant here, it can make any order that is appropriate for the company.
Just and equitable winding up
This is a drastic option and, as a result, it is only likely to be granted in exceptional circumstances because it will lead to the end of the company if granted. If there is another suitable remedy, the court will avoid winding up. In this case an application will be made by a shareholder to the court for the winding up of the company.
This would most likely only be suitable if shareholders and directors have lost all trust in each other, communication has broken down completely, and it is believed that the only remedy is to wind up the company. This should not be considered lightly.
How we can help
A rights issue that is not completed correctly in line with legislative and shareholder rights within in the company can be detrimental not only to individual shareholders, but to the company as a whole.
If you are in a dispute over a rights issue, it is important that you consult an expert to ensure that any dispute is resolved as soon as possible, ensuring the least damage is caused to all parties.
For further information and assistance, please contact Crane and Walton Solicitors LLP in Coalville on 01530 834466. Crane and Walton LLP also has offices in Ashby, Leicester and Melbourne.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.
