Pre-Emptive Rights

Tag along rights, carry along rights, Russian roulette clauses and piranha clauses are all expressions that you might hear from time to time. In this article we explain what they are and when you might use them.

The short answer is that they are all variations of pre-emptive rights i.e. rights conferred on shareholders of unlisted companies that are triggered when another shareholder wishes to exit the company.

The perennial problem facing shareholders in unlisted companies is the marketability of their shares. Coupled with that, where there is only a small number of shareholders, the identity of the shareholders becomes important. Obviously whenever a shareholder exits existing relationships are broken and the remaining shareholders have no guarantee about the intentions, good or otherwise, of an incoming shareholder.

The protection available to shareholders in these circumstances is generally in the form of pre-emptive rights. Standard pre-emptive rights entitle the remaining shareholders first entitlement to purchase the shares of an outgoing shareholder.

The price for those shares is usually nominated by the outgoing shareholder. If the remaining shareholders believe that price is too high, normally they have the right to have the price for the shares determined by an independent valuer, subject to the outgoing shareholder being entitled to withdraw his or her sale offer if the price is too low.
Standard pre-emptive rights only work where the remaining shareholders are not under financial constraints i.e. they are of no use if the remaining shareholders do not have the financial wherewithal to make use of them. Additionally, they are flawed if the nature of the company is such that an independent valuation is not feasible or is likely to result in a valuation that does not reflect the company’s circumstances. For example, if the shareholders have historically elected to forego dividends, instead wishing to consolidate the company, it would be inappropriate to value the shares on the basis of historical dividends and estimated future maintainable dividends. Often these circumstances apply in a company’s formative period.

To overcome these tensions there are various alternative forms of pre-emptive rights. Each needs to be modelled to fit the occasion. The most common alternative forms are tag along and carry along rights. These are particularly common where there is a single majority shareholder, perhaps holding 60 to 70% of the shares. Where the majority shareholder wishes to exit its shareholding inevitably there will be limited opportunities for sale unless the purchaser is able to acquire the whole company. Hence, a majority shareholder in an unlisted company would be well advised to seek ‘carry along pre-emptive rights’ in the company’s constitution or in a shareholders agreement.

Such rights entitle the majority shareholder to offer all the shares for sale and ensure the purchaser may acquire 100% of the company. This is achieved by making the majority shareholder agent for the minority shareholders with the power to sell their shares on the same terms as those on which the majority parcel is sold.

Tag along rights are similar, but looked at from the perspective of the minority shareholder. Where the constitution (or shareholders agreement) provides for these, the minority shareholder may require an outgoing majority shareholder to also offer the minority shares for sale. This enables the minority shareholder to ride on the coat-tails of the majority holder and is a safeguard against the intentions of the incoming shareholder.

Russian roulette clauses, sometimes called ‘piranha clauses’ are different again. By these clauses whenever an exiting shareholder offers his or her shares for sale, the recipient of the offer has two choices. He or she may purchase the shares at the price at which they are offered or instead require the exiting shareholder to purchase his or her own shares at the same price.
If the recipient of the offer believes the price set by the exiting shareholder is too high this gives the recipient the opportunity to demand that same price for his or her own shares. Essentially this acts as a self-policing mechanism and demands that the exiting shareholder set a price for his or her shares that is reasonable. These clauses are designed to overcome the situation where the shares are not easily capable of independent valuation and only the shareholders themselves are properly able to access the value of the company.RFPs

Requests for Proposals (“RFPs”) are becoming more and more common as businesses seek to outsource specific services or wish to benefit from a tender for product supply or management services.

Accordingly, we have developed a template form of agreement that may be used for RFPs, which we would be happy to provide on a complimentary basis.

The template is designed in such a way that the proponent stipulates its requirements and the terms and conditions attaching. These include the intended timeframe for appointing a tenderer and provision that the proponent is not bound by anything contained in the RFP until an agreement is signed. The template stipulates both instructions for submission of proposals and the required format and content of proposals. We also accommodate some description by the tenderers of the benefits of their proposal, resources required and relevant prices or fees.

If you would like to discuss RFPs please do not hesitate to contact us.

For more information please contact:

Brendan Meech
Partner
t: +64 9 979 2209
e: Brendan Meech

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This article is intended to be brief in nature and should be used for information only. It should not be relied on as legal advice.