27/10/2011

1.   An interesting question has arisen which demonstrates (or at least we believe it does!) the potential breadth and scope of PPSA.

2.   The question is: are pre-emptive rights of shareholders a security interest and therefore able to be registered as such under PPSA? Here, we restrict our comments to pre-emptive rights given to shareholders in a shareholders agreement. (Pre-emptive rights are often also found in a company’s constitution).

3.   Pre-emptive rights allow shareholders, particularly in proprietary companies, to avoid having their shareholding diluted by new share issues. Pre-emptive rights are where shareholders have the right to be offered new shares in the company, pro-rata in the same proportion they hold of total shares in the company, before shares are offered to new shareholders.

4.   With sales of existing shares, pre-emptive provisions often require a shareholder who wants to sell shares to offer them first to existing shareholders before selling to persons who are not shareholders.

5.   So, the question is: are pre-emptive rights of shareholders a security interest under PPSA and should they be protected by registration under PPSA?

6.   Section 12(1) of PPSA defines a security interest as an interest in personal property provided for by a transaction that, in substance, secures payment or performance of an obligation. We shall briefly examine each of the phrases in bold.

7.   We consider a shareholder’s pre-emptive rights under a shareholders agreement is an interest in personal property. This is confirmed by section 10 of PPSA, which defines personal property as property other than in land. So, personal property includes goods and intangible property such as trade marks and licences.

8.   Where shareholders agree to regulate their conduct in relation to the issue or sale of shares in the company, we consider that the shareholders agreement “documents” a transaction.

9.   Generally, a shareholders agreement with pre-emptive rights secures the obligations of the company/its directors/shareholders to grant existing shareholders pre-emptive rights. Any failure to do so could be enforced by an aggrieved shareholder commencing legal proceedings. However, we think a crucial element generally required for security interests is that some actual personal property must be charged or secured to ensure compliance. The fact that a shareholders agreement states that a party must do certain things to ensure pre-emptive rights are protected, is probably not enough to make those rights a security interest under PPSA. 

10.  So, it is likely that pre-emptive rights of a shareholder under a shareholder’s agreement are not a security interest unless personal property is actually charged or secured to ensure payment. At present, this is not commonly done in shareholders agreements. It may be that, with the introduction of PPSA, a clause something like the following may become an integral part of shareholders agreements:

“A expressly charges all his interest in his personal property, of whatever type and wherever located, with compliance by A with the pre-emptive rights under this shareholder’s agreement for the benefit of ”.

11.  In summary, we believe that, if a shareholder’s personal property is expressly charged to ensure a shareholder complies with the pre-emptive rights provisions under a shareholders agreement, those pre-emptive rights are security interests under PPSA.

12.  Of course, in each case, it is important to know precisely what pre-emptive rights (if any) are actually given to shareholders. The pre-emptive rights would ideally be:

• clearly set out; and
• give the shareholder a contractual right to require the company/directors/shareholders to act in certain ways in specific cases and to take action in respect of certain secured personal property.
  

13.  This approach means that there can be no blanket rule covering every existing shareholders agreement. Rather, each shareholders agreement must be viewed on its actual wording and the circumstances of each particular case, in order to see if it is a security interest and should be registered under PPSR. 

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.