Shareholder engagement needed if large companies wish to disapply pre-emption rights, expert says

Martin Webster of Pinsent Masons, the law firm behind Out-Law.com, said that a new 'statement of principles' issued with the support of major institutional investors (10-page / 215KB PDF) contained some surprising additions. Although statement authors the Pre-emption Group had made it clear that its content was "not a rule book", Webster said that the "implied threat" of withdrawal of investor support for future requests was severe enough that large companies in particular should take note of its content.

"In a big change, the principles now catch 'cash box' transactions, where a specially-incorporated company is capitalised and the listed company acquires that cash box by issuing its own shares for what is treated as non-cash consideration," he said. "How companies will react and whether cash boxes will survive remains to be seen."

"The Pre-emption Group has insisted that the new statement of principles is 'not a rule book', and as such there is no clear sanction for ignoring its content. However, companies that do not comply with both the letter and the spirit of the statement are 'likely to find that their shareholders are less inclined to approve subsequent requests'. Large companies in particular, which are more likely to have institutional shareholders, should be aware of this and seek to involve shareholders in their plans for new share issues as early as possible," he said.

The Companies Act protects a UK company's shareholders from having their stake in the company diluted by giving them pro rata rights to subscribe for new shares issued for cash unless those rights are disapplied by special resolution. The same rules apply to non-UK companies with a premium listing on the London Stock Exchange (LSE) by virtue of the Listing Rules overseen by the Financial Conduct Authority (FCA).

The Pre-emption Group was set up in 2005 in order to provide the market with a clear view of what is usually regarded as acceptable practice for companies seeking to raise pre-emptive equity and capital. Its statement of principles was last updated in 2008, and provides guidance to companies and shareholders on the factors that they should take into account when considering whether to disapply pre-emption rights for a particular share issue.

The 2015 statement has been updated to make it clear that it applies to all issues of equity securities for the purposes of raising cash for the issuer or its subsidiaries, regardless of the legal form of the transaction. This explicitly includes the creation of 'cash box' companies as a means of issuing equity securities for non-cash consideration, even though these fall outside the scope of statutory pre-emption rights, according to the statement. However a 'vendor placing', a method of using shares to fund an acquisition, remains excluded, the statement said.

Shareholders should consider company requests for disapplication of pre-emption rights on a case by case basis, according to the statement. When making a request, companies should clearly set out the business case for doing so. Shareholders will usually consider the strength of that business case, the size and stage of development of the company, the company's track record on governance, the level to which their existing rights would be diluted by the issue and any other potential financing options available to the company when making their decision, the statement said.

"Whilst not undermining the importance of pre-emption rights, a degree of flexibility is appropriate in circumstances where issuance of equity securities on a non-pre-emptive basis would be in the interests of companies and their owners," the statement said.

"Companies should, where possible, signal an intention to undertake a non-pre-emptive issue at the earliest opportunity and to establish a dialogue with the company's shareholders. They should also keep shareholders informed of issues related to an application to disapply their pre-emption rights. Shareholders should, where possible, engage with companies to help them understand the specific factors that might inform their view on a proposed disapplication of pre-emption rights by the company. They should review the case made by a company on its merits and decide on each case individually using their usual investment criteria," it said.

The existing annual limit for a non-pre-emptive share issue remains at 5% of issued share capital, according to the statement. However, an additional 5% may be allowed for an acquisition or specified capital investment, in line with existing market practice, it said. Using this additional 5% to create a 'war chest' in order to fund unspecified or speculative opportunities "will be regarded as contrary to these principles", the statement said.

The Pre-emption Group said that it would monitor the development of practice in relation to disapplying pre-emption rights following the publication of its new statement of principles. However, it would not "express a view on or otherwise intervene in" specific cases, it said.