A typical Ugandan scenario: What are Preemptive rights?

The year 2011 witnessed some heated annual general meetings (AGMs). The National Insurance Corporation (NIC) AGM was one of them. The meeting was expected to draw a feud between the minority and the majority shareholders/ management given the mid year suspension of the counter from trading at the securities exchange, not to mention the highly publicized saga concerning a possible withdrawal of Makerere University dons from a retirement scheme with the corporation. My sources tell me there was tight security.

One of the debatable issues that arose from the meeting was the suggestion by the board of directors to introduce a second share offer to the public. A big cross section of the audience seemed to have bought the idea with the exception of a few shareholders. Among these few was the famous tycoon, Mr. Sudhir Ruparelia, who seemed to have been in total disagreement with the suggestion. Well, Sudhir’s shareholding in the corporation totals to 20% hence effectively placing him on the driving seat among the minority shareholders. In my view, this position bestows on him the right to champion the interests of the minority. We can however not rule out the chance that some of his interests contravene those of other minority shareholders. 

The history of NIC

It is not without reason that a bat prefers it’s upside down posture. Sudhir was not outrageous for no reason. In the year 2005,
the government of Uganda tendered for sale 60% of its stake in the then 100% state owned corporation. The tender turned out to have been a fight between two bulls, namely; Sudhir Ruparelia and IGI Plc (A Nigerian based insurance firm fronted by Corporate Holdings Limited led by Patrick Bitature). Nigerians are typically known for playing dirty and guess what? They played the dirty game as usual. Somehow the Nigerians managed to access Sudhir’s bid through an insider who then unscrupulously topped up their bid with USD$1 to surpass that of Sudhir. IGI effectively became the majority shareholder at NIC. This was a blow on Sudhir but quite undaunted he has since then bought an amazingly 20% stake of the corporation, a move that has left IGI puzzled in its wake.

Now that Sudhir is high flying, the Nigerians may be planning to teach him a lesson. The only way to do so would be to dilute (reduce) his current 20% shareholding. A second issue of shares to the public (akin to an IPO) would effectively deny existing shareholders their right (preemptive right) to enjoy the new shares basing on their current shareholding. This would effectively dilute (reduce) shares held by Sudhir to, say 15%, from the current 20%. 

What is this right?

A preemptive right is a privilege extended to select shareholders (usually equity shareholders) of a corporation that gives them the right to purchase additional shares in the company before the general public has the opportunity in the event there is a seasoned offering. The question however is, when and how do you exercise your rights?

Some countries provide shareholders preemptive rights as a matter of law, while others require that preemptive rights be expressly granted in a company’s articles and memorandum of association. In these particular cases, shareholders are entitled to any new issue of shares pro rata (in proportion, say one share for every five held) to their current shareholding. 

Whenever a company opts to issue new shares that are subject to shareholders’ preemptive rights, the company commonly sends each shareholder a subscription warrant notifying him/her of the number of shares he is entitled to purchase. Quite simply, the prerequisite in exercising such a right would be the possession of cash to buy out the entitlement of shares. We therefore can’t agree more that a shareholder without the cash would be striped off his/her right and the shares instead issued to the public.  

Notably, preemptive rights do not apply to offerings such as employee share options, an issue of shares for the purpose of a strategic acquisition as well as public offerings such as an IPO. As such, a second share offer to the public by NIC would not fall under the scope of preemptive rights and hence resulting in a dilution of current shareholding.

For further reading, please visit these links:

http://eatrader.blogspot.com/2010/01/nigerian-insurance-corporation-ipo-in.html

http://eatrader.blogspot.com/2010/03/nic-share-appreciates-by-33-on-day-one.html