INTRODUCTION

Preemptive rights give a shareholder the opportunity to buy additional shares in

any future issue of a company's common stock before the shares are made
available to the general public. This right is a contractual clause that is generally
available in the U.S. only to early investors in a newly public company or to
majority owners who want to protect their stake in the company when and if
additional shares are issued.
A U.S. company may give preemptive rights to all of its common shareholders.
but this is not required by federal law. If the company recognizes such rights, it
will be noted in the company charter. The shareholder also may receive a
subscription warrant entitling them to buy a number of shares of a new issue,
usually equal to their current percentage of ownership.

A preemptive right is sometimes called an anti-dilution provision or subscription

rights. It gives an investor the ability to maintain a certain percentage of
ownership in the company as more shares are issued.
understanding Preemptive Rights
A preemptive right is essentially a right of first refusal. The shareholder may
exercise the option to buy additional shares but is under no obligation to do so.
The preemptive right clause is commonly used in the U.S. as an incentive to early
investors in return for the risks they undertake in financing a new venture. That
early investor generally buys convertible preferred shares in the company at the
time that it is still a private entity. The preemptive rights give the investor the
option to convert the preferred shares to common shares after the company goes
public.

Types of Preemptive Rights

A contract clause may offer either of two types of preemptive rights, the weighted
average provision or the rachet-based provision.

 The weighted average provision allows the shareholder to buy additional

shares at a price that is adjusted for the difference between the price paid for
the original shares and the price of the new shares. There are two ways to
calculate this weighted average price: the "narrow-based" weighted average
and the "broad-based" weighted average.
 The ratchet-based provision, or "full ratchet," allows a shareholder to
convert preferred shares to new shares at the lowest sales price of the new
issue. If the company's new shares are priced lower, the shareholder is
effectively compensated with a greater number of shares in order to
maintain the same level of ownership.

Benefits of Preemptive Rights

Preemptive rights generally are meaningful only to a major investor with a large
stake in a company and a vested interest in maintaining a voice in its decisions.
Few individual investors acquire a large enough stake in a company to raise any
concerns about a reduction in the fractional percentage that their shares represent
among millions of shares outstanding.

Those more likely to benefit are early investors and company insiders.

The Benefit to Shareholders

Preemptive rights protect a shareholder from losing voting power as more shares
are issued and the company's ownership becomes diluted.
Since the shareholder is getting an insider's price for shares in the new issue, there
also can be a strong profit incentive.

In the worst case, there is the option of reducing losses by converting preferred
stock to more shares if the new issue is priced lower.

DIFFERENCE BETWEEN RESTRICTION AND transfer OF SHARES

Restrictions can apply to all transfers or only to those in specific cases, such as
transfers between spouses or other family members. Shares can usually be
transferred to both individuals and entities, such as partnerships and corporations.
Transfer of shares refers to the intentional transfer of title of the shares
between the transferor (one who transfers) and the transferee (one who receives).
The shares of a public company are freely transferable unless the company has a
valid reason to disallow the same.
Private corporations – transfer of shares
In privately owned corporations, when transferring shares shareholders must
adhere to the restrictions and conditions that are set out in the
corporation’s Articles of Incorporation and By-laws. If a shareholders agreement
exists, it may also contain restrictions relating to share transfers. Restrictions can
apply to all transfers or only to those in specific cases, such as transfers between
spouses or other family members. Shares can usually be transferred to both
individuals and entities, such as partnerships and corporations.
Common share transfer restrictions include:
 who can buy or sell shares,
 how many shares can be transferred,
 a requirement that the existing shareholders must agree to the transfer, and
 a requirement that a shareholders’ resolution approving the transfer be passed.
Share transfer requirements and restrictions in privately held corporations can be
established for several reasons, but the most common is that the shareholders are
usually also the directors, officers and employees of the company, and as such,
they want to have a say about who they are going to do business with and work
with.
If you are a shareholder of a private corporation, you have the right to see the
corporate minute book. The minute book contains the Articles of Incorporation and
the By-laws, which will set out the conditions for share transfers.
If you are considering buying the shares of a private company, it is a good idea to
get legal advice from a lawyer. In such a case, it is advisable for you to do your
‘due diligence’ and investigate the corporation’s finances, assets, legal liabilities,
business history, etc. For example, you will not want to purchase shares in a
corporation that has no assets and is heavily in debt.
Public corporations – transfer of shares
For public corporations, the transfer of shares happens differently.
Provincial Securities Transfer Acts set out the rules regarding the transfer of shares
(also called securities), in public companies. Generally speaking, shares are openly
traded on a stock exchange, such as: the Alberta Stock Exchange, Canadian
Securities Exchange, Montreal Exchange, Toronto Stock Exchange, TSX Venture
Exchange and the Vancouver Stock Exchange. In a public company there is no
control over whom the shares are transferred to on the stock exchange.
Shares can be traded with help from professionals such as investment advisors,
stock brokers, and investment dealers. Some people also choose to buy and sell
shares on their own.
While shares can generally be transferred between shareholders with a written
agreement, provincial laws may determine such things as:
 the delivery procedures for the share transfer
 the rights of the purchaser
 endorsements and instructions of the transfer
 liability of guarantor, endorser (person who signs security certificate) and
originator
 if a security certificate is required
 duty of issuer to register the transfer
 obligations of transfer agent, issuer, authenticating trustee.
In order to keep a record of the current shareholders (on the official master
shareholder listing), public corporations usually hire transfer agents to keep track
of all transfers. Transfer agents (also referred to as share registries, stock transfer
agents or transfer agencies) are companies which cancel the name and certificate of
the shareholder who sold the shares and substitute the new shareholder’s name.
Extent at which CAMA allow the tranfer of share and pre-emptive right.
CAMA 2020 gives shareholders of a private company the liberty to include the
following preemptive rights in their articles of association. (i) A shareholder of a
private company who intends to transfer its shares to a third party is required to
first offer the shares to the existing shareholders of the company.
 Distinction Between Restriction on Transfer of Shares and Pre-Emptive
Rights of Shareholders
It may be right to say that a pre-emptive right is a form of restriction on transfer of
shares. On the other hand, a restriction on transfer may permit sale to non-members
without first offering to members but a pre-emptive right requires members to first
offer other members and only when they refuse or waive it that they can transfer to
non-members. More so, a restriction on transfer may simply involve giving the
board power to decide whether to accept the prospective member while a pre-
emptive right deals more with the members and not necessarily involving the
board. Another difference is that a restriction is only present in a company’s article
of association while a pre-emption clause is also stated in CAMA.

Succinctly, restrictions on the transfer of shares are limitations placed on existing

shareholders when they wish to sell their shares to third parties, while preemptive
rights grant existing shareholders the first option to purchase additional shares
before they are offered to outside investors. Both mechanisms aim to protect the
interests of current shareholders and maintain the stability and control of the
company’s ownership structure.

 Restriction on transfer of shares and Pre-Emptive Rights Under CAMA

 Restriction on the Transfer of Shares
The general rule is that shares are the personal property of a company member,
hence, are transferrable. Section 139 of CAMA, 2020 provides that; the shares or
other interests of a member in a company shall be property transferable in the
manner provided in the articles of association of the company. This means that
shares are freely transferable unless the company’s articles impose transfer
restrictions. The ordinary rules of offer acceptance and consideration apply. It is,
however, important to note that the above provision is subject to the provision of
section 22(2) of CAMA, which mandates private companies to restrict the transfer
of their shares by their articles. Thus, in Re Smith, Knight & Co , the court held that
the company’s directors have no discretionary powers except those given to them
by the company’s constitution to refuse to register a bona fide transfer. There is,
however, no restriction per se for public companies since public companies are not
mandated to restrict transfer. However, the directors can refuse to register a
transfer if it is in the company’s interest. What can be deducted from the preceding
discussion is that transfer of shares should be in the manner prescribed by the
Articles.
The Act under s. 22(2) provides for the forms where restriction can occur. These
are:

 A shareholder of a private company who intends to transfer its shares to a third

party is required to first offer the shares to the existing shareholders of the
company.
 A shareholder or a group of shareholders of a private company acting together
shall not sell or agree to sell more than 50% of the shares in the company to a
third party unless the third party has offered to buy all the shares of the existing
shareholders on the same terms.
 A private company may not transfer assets with a value of more than 50% of
the total assets of that company without the consent of all its shareholders.
For example, it may be agreed that no member can transfer his shares without the
consent of others or it may be that the articles provide that a member that wishes to
transfer shares must inform the board and allow the board oversee the transfer. At
times, even members may execute a shareholder agreement that none of them may
transfer their shares except with the consent of the rest. It should be noted that
these restrictions are subject to the provisions of that company’s articles.

It is important to note that since restrictions on the transfer of shares are a

derogation from the common law right of free transfer, the exercise of the power
will be construed strictly, and any deviation from the power laid down will be
fatal.