Rights issues are utilised by many companies as a means of raising finance and capital either to boost an ailing balance sheet or to fund an acquisition and promote growth without having to take on any further debt commitments with third party lenders. While rights issues will, as a matter of course, be offered to all shareholders pro-rata to their existing holdings in the company, there are circumstances that can arise in which a member may assert that the rights issue was in fact unfairly prejudicial to him and may attempt to commence an action against the Company. Directors of BVI companies who have duties to the Company but also need to consider whether they have acted oppressively as a shareholder, need to be cognisant of this risk when considering the implementation of a rights issue and this article will highlight some of the ways in which directors can protect the Company and themselves against any claims of unfair prejudice.
In terms of directors considering their actions as against the Shareholders, Section 184(I) of the BVI Business Companies Act, 2004 (as amended) states that a member of a company who considers that the affairs of the company have been, are being or are likely to be conducted in a manner that is, or any act or acts of the company have been, or are, likely to be oppressive, unfairly discriminatory, or unfairly prejudicial to him in that capacity may apply to the court for an order. The Court may grant an order (inter alia):
- requiring that the company acquire the shareholders shares;
- requiring the company to pay compensation to the shareholder; or
- regulating the future conduct of the company.
The general approach by the courts is that there must be both prejudice and unfairness. Prejudice will often be established by reference to conduct having a depressive effect (actual or threatened) on the value of the person’s shareholding. Unfairness most often connotes breach of the memorandum and articles of association, statute or general principles of company law but has been construed more widely such that the courts will consider whether a reasonable bystander observing the consequences of conduct would regard it as having unfairly prejudiced the shareholder’s interests.
Some of the key points that directors should bear in mind when considering the approval of a rights issue are as follows:
- The rights issue must be priced at a level which is fair to all.
The value of the rights issue shares offered to majority in a private company will often be greater than the value of the rights issue shares offered to the minority. This reflects the fact that the minority holdings will usually attract a discount. In a case where it is known or foreseen that the minority shareholders will or may not have the funds or inclination to subscribe, the directors should, consider what price could and should be extracted from those willing and able to subscribe. The directors should not unthinkingly issue shares at par value. The pricing of the rights issue should be considered in detail by the directors and if necessary external advice should be taken by an independent valuation agent. If the minority shareholders are unable or unwilling to subscribe, but the majority are willing, the duty of the directors will ordinarily be to get the best price they can from the shareholders willing to subscribe. The other ‘non participating’ shareholders will inevitably suffer a dilution in the proportion of the shares held by them but the adverse impact on the value of their shareholdings will be minimised.
- The Purpose behind the rights issue should be to create additional capital in the Company.
There should be a genuine and evidential need for the Company to raise additional capital to ensure that there is no determination that the purpose behind the rights issue was to dilute the minority shareholders. The directors should also consider whether a rights issue is the right and appropriate method of raising capital. The directors should be able to demonstrate that they have considered other methods of raising capital and have determined that a rights issue is the best approach and that the number of shares proposed to be issued, to raise the desired capital, is reasonable in the circumstances.
- The rights issue should be offered to all shareholders on a fair and equal basis.
Even if the rights issue appears on the face of it to be offered to all shareholders of the Company, if there is evidence that it was known that the minority shareholders would not be in a position to take up their rights, then in such a case there may be a prejudice to the minority in strict terms of the dilution of their interest in the Company. This prejudice may be classed as ‘unfair’ if it can be inferred from the knowledge and presumed intent of the majority and the directors that they were acting for an improper purpose.
- Practical Safeguards
When undertaking a rights issue, the directors should note the following:
- When passing any resolutions or making any decisions in relation to a potential rights issue, the directors of the Company must be careful to declare any and all interests they have in the rights issue (i.e. if they are also shareholders in the Company);
- the directors should at all times be impartial and ensure that they are acting in accordance with their statutory duties to act in good faith and in the best interests of the Company;
- accurate and detailed records should be kept of all salient matters surrounding the rights issue;
- the directors should ensure that they fully inform the shareholders of the Company of the options available to them in respect of the rights issue and provide detailed explanations as to why a rights issue is the best option for the Company and why other approaches have been rejected.
Unfortunately there are no guarantees that even if the above matters are considered by the directors, a Shareholder will not assert that they have been unfairly prejudiced because of a proposed rights issue. However, if the directors of the Company can demonstrate to the Shareholders that they have considered all of the available options to raise capital and have acted in accordance with the guidance above, they will nevertheless minimise any risk to the Company that a Shareholder will succeed in a claim of unfair prejudice in relation to the rights issue.