Pre-emption right

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A pre-emption right, right of pre-emption, or first option to buy is a contractual right to acquire certain property newly coming into existence before it can be offered to any other person or entity. [1] It comes from the Latin verb emo, emere, emi, emptum, to buy or purchase, plus the inseparable preposition pre, before. A right to acquire existing property in preference to any other person is usually referred to as a right of first refusal .

Contents

Company shares

In practice, the most common form of pre-emption right is the right of existing shareholders to acquire new shares issued by a company in a rights issue, usually a public offering. [2]

The legal foundation for pre-emption rights varies by jurisdiction but generally ensures that shareholders can maintain a proportional stake in the company's authorized capital.

When a company (AG, SE, or PLC) issues new ("young") shares, it must define the subscription terms. These terms include the subscription ratio, the subscription price, the dividend entitlement, and the subscription period (which must be at least 14 days in the EU/UK). [7] The subscription price is typically set below the current market price of the "old" shares to mitigate issuance risk and encourage participation. [8]

Until the young shares reach dividend parity with old shares, they may trade at different prices on the stock exchange. Dividend entitlement for young shares often begins only with the start of the new fiscal year. [9] The value of the subscription right is mathematically determined by the interplay of the current share price, the subscription price, and the dividend differential. [10]

Background and rationale

The reasons for granting pre-emption rights are multifaceted. In many European jurisdictions, such as Germany, granting these rights is mandatory for capital increases exceeding 10% unless extraordinary circumstances apply. [3] The primary purpose is to protect existing shareholders from the dilution effect, which reduces their effective stake in the company. [8] This protection applies both to the influence exerted through voting rights associated with common stock and to the relative share of dividends for both common and preferred stock. [11]

Rights issue procedure

In the European Union and the United Kingdom, the procedure for a capital increase with pre-emptive rights follows strict statutory timelines. Shareholders must be offered the new shares for a period of at least 14 days. [7] If no stock exchange holidays fall within this period, this typically equates to ten trading days. The offer must specify the exact subscription price or the formula used to determine it; in the latter case, the final price must be announced at least three days before the offer period expires.

Mathematical Evaluation (Subscription Formulas)

The valuation of these rights is determined by comparing the share capital before and after the increase. [12]

The rechnerische value of the subscription right is derived from the market price of old shares () and the subscription price of new shares (). [10]

History

The concept of pre-emption has evolved from 18th-century land claims to a fundamental principle of modern corporate governance.

Land and international law

In the 18th-century United States, a pre-emption right (often associated with "squatter's rights") referred specifically to the right to purchase land titles before they were offered to the general public. [13] A primary example is the Phelps and Gorham Purchase, where a syndicate paid Massachusetts $1,000,000 for the pre-emptive rights to land in Western New York. [14]

Evolution of corporate pre-emption

During the 19th century, pre-emption rights transitioned into corporate law to protect shareholders from "oppression" by directors.

See also

References

  1. ↑ Garner, Bryan A. (2009). Black's Law Dictionary (9th ed.). Thomson Reuters. ISBN   978-0-314-19949-2. Right of pre-emption. A potential buyer's contractual right to have the first opportunity to buy, at a specified price, if the seller chooses to sell within the contractual period. Also termed 'first option to buy'.
  2. ↑ "Preemptive Right: What It Is, How It Works, and Benefits". Investopedia. Retrieved 2025-12-31.
  3. 1 2 "Section 186 AktG: Subscription Right". Federal Ministry of Justice (Germany).
  4. ↑ "Section 221 AktG: Convertible Bonds; Profit-Participation Bonds". Federal Ministry of Justice.
  5. ↑ "Companies Act 2006, Section 561". UK Government Legislation.
  6. ↑ "Dilution". U.S. Securities and Exchange Commission.
  7. 1 2 3 "Second Council Directive 77/91/EEC". EUR-Lex.
  8. 1 2 "Dilution - Definition, Types, and Calculation". Corporate Finance Institute.
  9. ↑ "Rights Issue Explained". London Stock Exchange.
  10. 1 2 Herbert Vormbaum (1981). Finanzierung der Betriebe. p. 145.
  11. ↑ "Voting Right: Definition and How It Works". Investopedia.
  12. ↑ Herbert Vormbaum (1981). Finanzierung der Betriebe. pp. 145–147.
  13. ↑ Henry, Marian S. (February 25, 2000). "The Phelps-Gorham Purchase" . Retrieved 31 December 2012.
  14. ↑ Milliken, Charles F. (1911). A History of Ontario County, New York and Its People Vol. 1. Lewis Historical Publishing Co. p. 15.
  15. ↑ "Gray v. Portland Bank, 3 Mass. 364 (1807)". Caselaw Access Project.
  16. ↑ "Companies Act 1980". UK Government.
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