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Pre-Emptive Rights

13.09.2021
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Running a business with other people is tricky. Someone’s life can change at the drop of a hat, and at that stage the human thing to do is to look out for number one. This is especially true in our current pandemic-riddled, steadily heating up world. The problem is, when that person needs to leave your company as a shareholder, you may not have prepared for that eventuality. Unfortunately, this happens quite often. This is where pre-emptive rights (also known as “rights of first refusal”) can come in useful.

Setting up the relationship is important

A golden thread running through most of my blog articles is the importance of setting up your relationship properly from the very beginning. Even though verbal agreements are indeed binding in South Africa, they are notoriously difficult to prove. Specifics are often quibbled over in court, costing thousands that the parties may not have. The easiest way to obviate this is through the use of a contract. The best agreement to set the specifics of the relationship between shareholders of a company is, and this may shock you, a shareholders agreement! These agreements not only regulate the relationship between shareholders and other shareholders, as well as the relationship between shareholders and the company itself. A shareholders agreement is also where pre-emptive rights can be agreed on.

What are pre-emptive rights and why are they important?

In relation to private companies, pre-emptive rights can mean any one of the following:

  • A right granted by a shareholder of a company in favour of the other shareholders in terms of which the shareholder agrees to offer their (already issued and vested) shares for sale to the existing shareholders first before offering them to any third parties. Crucially, the shares need to be offered to the existing shareholders at the same or lower price as they would be offered to a third party. The selling shareholder cannot offer their shares to the existing shareholders for R10 per share, and then offer it to a family member or friend for R5 per share. They must first go back to the existing shareholders and offer it at the lower price before they can offer it to someone else.
  • The right created in section 39(2) of the Companies Act, in terms of which each shareholder of a company has a right before any other non-shareholder to be offered and, within a reasonable time, to subscribe for a percentage of any shares that a private company proposes to issue. This is, however, limited to a number of shares equal to the voting power of that shareholder’s general voting rights before the offer was made.

Pre-emptive rights are important and useful tools as they act as protection for minority shareholders.

So, what do I need to look out for in a shareholders agreement, or how do I get this set up in my shareholders agreement?

Generally, a shareholders agreement will provide for pre-emptive rights in some way or another. Often there is simply a clause called “pre-emptive rights”, in which case look no further. Other times, however, pre-emptive rights can be hidden in provisions relating to the sale of shares. Less commonly, pre-emptive rights can be provided for in the company’s memorandum of incorporation (“MOI”).

The right created by section 39(2) as stated above is an automatic right created by the Companies Act. However, it is noteworthy that this right can be limited by a company in the MOI.

If you don’t have pre-emptive rights set out in your shareholders agreement, this means one of two things:

  1. You need to get your shareholders agreement properly amended, either by creating an addendum document, or by creating an updated version of your shareholders agreement. In either case, the other shareholders will need to sign it for it to be valid; or
  2. You don’t have a shareholders agreement in the first place. It’s definitely worthwhile to get one if you are running a company with other people.

Conclusion

When it comes to pre-emptive rights, you don’t need them until you really, really need them. It brings fantastic peace of mind to know that if one of your co-shareholders needs to sell their shares suddenly, they are forced to offer it to you and the other existing shareholders first.

Kyle Freitag – 13 September 2021

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