It is observed that pre-emption right is frequently confused with the first option & first refusal right in practice.

While pre-emption right allows shareholder(s) to purchase, in his/ their own name, shares offered by another shareholder for sales to third parties, first option & first refusal right means an offer to other shareholders for sales before the consummation of the sales to third parties so that the sales contract is directly executed with the first option & first refusal holder before its conclusion with the third party.

Notwithstanding the foregoing, it is observed that the term “pre-emption right” is used in the context of wrong terminology in practice when, in a shareholders’ agreement, the pre-sales obligation to offer the shares to other shareholders is defined and governed.

The respective legal nature of these two rights are laid down in the paragraphs below, clearly highlighting basic differences between them.

Pre-emption Rights 

Pre-emption right is a right, use of which depends on a condition. This condition is the execution of a contract for the sales of shares subject to the right to third parties.

It is a formative right.  Thanks to it, its holder is authorized to be the buyer of those shares pre-emptively compared to a third party.

A sales agreement shall have been executed between the parties upon the unilateral expression of intention by the shareholder exercising this right. The rightful owner may demand that these shares should be entered with the share book in his own name.

As a rule, pre-emption right is non-severable, meaning that unless otherwise is agreed in the agreement shall cover all rights to be transferred. This principle intended to exercise of pre-emption right without severability targets to protect the shareholder wishing to transfer his shares in their entirety.

It is recommended that pre-emption right should be defined in the agreement in miniscule detail to avoid disputes from the very beginning. For instance, (i) the scope of the right to use that right may be expanded to cover endowments as well, or this scope may be narrowed down to a specific extent, or (ii) it may be a viable option that transfers to next of kin (spouses and descendants) or daughter companies, in particular, a company in which a contractual party is the controlling shareholder may be excluded from the scope of the right or (iii) parties to the shareholders’ agreement may exclude transfers executed between them or to their own family members.  It is possible to give more examples.

Likewise, this right may be reserved to specific groups of shareholders (Class A etc.) to create preferential share classes. Considering that it is obvious that this right may be simultaneously exercised by more than one shareholder in the same group, first a ratio should be determined. The most common practice in this respect is “utilization proportionate to the capital”.

Various provisions may be introduced by taking into account the purpose of investors in investing the company as well as requests and wishes of investors in line with future plans etc. about the Company and shares.

Advantages:

  • Prevents admission of third party shareholders to the Company.
  • The circle of shareholders is kept under control.
  • By not allowing unwanted shareholders sneaking into the company, the composition of shareholders is kept intact.
  • Shareholders willing to hold onto their original position during the foundation of the company shall be able to maintain their such status.

First Option & First Refusal Right

This right may take various forms as well with respect to its scope (limited/ unlimited) and contents (first option & first refusal in proposal/ acceptance/ offer)

The distinction between limited/ unlimited is a matter of whether or not sales price or the method to appraise the price is described in the agreement.

Distinction with respect to contents concerns whether a shareholder willing to sell his shares is obliged to make a proposal to other shareholder or merely to give a notice to him.

Basically, where this right is exercisable, if a shareholder wishes to sell his rights, the other shareholder who becomes aware of this wish (or receives a proposal before third parties) is first entitled to purchase of these shares before third parties.

Where this right differs from the pre-emption right is that it is exercised before the execution of a contract with the third party.

Its advantages:

  • This right gives its holder the power to purchase those shares with a right of first refusal compared to third parties,
  • Prevents admission of third party shareholders to the Company.
  • The circle of shareholders is kept under control.
  • By not allowing unwanted shareholders sneaking into the company, the composition of shareholders is kept intact.
  • This right does not cause the shareholder to be deprived of his right to transfer his shares. It merely gives a priority to an existing shareholder in the case that that shareholder makes an offer subject to such terms that are identical to the ones offered by a third party.
  • If a shareholder does not exercise his first option & first refusal right, the shareholder willing to transfer his shares may not sell them to a third party at such price and terms that are more favourable than the ones offered to the shareholder not exercising his right.