Lavania & Balan Chambers

Directors are empowered to allot and/or issue new shares in a company, primarily to raise capital, and/or to manage affairs of the company. By issuing new shares, the existing shareholders’ shareholding, voting and distribution rights are reduced. What naturally flows is that the power to allot new shares may be abused by directors to exert control in the company with improper motives, by creating a shareholding majority that is in favour of the directors.

The Companies Act 2016 (“CA 2016”) provides safeguards to protect shareholders’ rights from being diluted in bad faith under two provisions.

Section 75 CA 2016

Section 75 CA 2016 makes it mandatory for directors to obtain approval by resolution of the company before allotting any new shares, unless the issuance falls within the circumstances of section 75(2) CA 2016, which is summarised as follows:

1. Shares are allotted or rights are granted to shareholders under an offer made to the members of the company,  or under a bonus issue in proportion to their shareholding;
2. Shares are allotted to a promoter which the promoter has agreed to take; or
3. Shares which are to be issued as consideration or part, for the acquisition of shares or assets by the company and members of the company have been notified of the intention to issue the shares at least fourteen days before the date of issue of the shares. The method of notification is provided in section 75(3) CA 2016.

 

Section 85 CA 2016

Section 85 CA 2016 creates a statutory pre-emptive right for shareholders. For ease of reference:

Pre-emptive rights to new shares

85. (1) Subject to the constitution, where a company issues shares which rank equally to existing shares as to voting or distribution rights, those shares shall first be offered to the holders of existing shares in a manner which would, if the offer were accepted, maintain the relative voting and distribution rights of those shareholders.

(2) An offer under subsection (1) shall be made to the holders of existing shares in a notice specifying the number of shares offered and the time frame of the offer within which the offer, if not accepted, is deemed to be declined.

(3) If the offer is not accepted after the expiry of the period specified in the notice under subsection (2), the directors may dispose those shares in such manner as the directors think most beneficial to the company.

From the reading of section 85 CA 2016, it is rather clear that any new shares to be issued by a company must first be offered to existing shareholders in a manner that will maintain the relative voting and distribution rights of those shareholders. However, this section is subject to the constitution, which means that the pre-emptive right can be waived by a company’s constitution.

Section 85 is a new insertion in CA 2016, which was not present in the repealed Companies Act 1965.  Under the old regime, this pre-emptive right is only addressed in Article 41 of Table A (which is adopted by some companies as their constitution). Article 41 is largely similar to section 85 CA 2016, except the phrase “subject to constitution”, is substituted with “subject to any direction to the contrary that may be given by the company in general meeting.” 

Decision of the Court of Appeal in Concrete Parade v Apex Holdings^[1]  (“Concrete Parade”)

The recent Court of Appeal case of Concrete Parade had emphasized that shareholders cannot be denied of their pre-emptive rights. Here, the minority shareholder (“Appellant”) filed an oppression action against the company and its directors. The Appellant’s allegation, amongst others, is the placement of shares by the company in a merger exercise without first offering the Appellant to subscribe to the shares amounts to a breach of section 85 CA 2016 and Article 11 of the articles of association of the company. Article 11 was identical to Article 41 of Table A.

Premised on Article 11 and section 85 CA 2016, Lau Bee Lan JCA in overruling the High Court decision and allowing the oppression suit held as follows:

a.              Any “direction to the contrary” must be obtained before any shares are offered to outsiders. Here, the resolution passed at the EGM of the company was subsequent to the offer of the placement of shares made, hence it does not ratify the breach of section 85 CA 2016.

b.              The proposed resolution must expressly set out all the requisite information regarding the shareholders’ pre-emptive rights under section 85 (1) of CA 2016, namely:

1. The existing shareholders had a statutory pre-emptive right to be offered any new shares which rank equally to existing shares issued by the company;
2. By voting in favour of the resolution for the issuance of the new shares, the shareholders would be waiving their statutory pre-emptive right; and
3. A waiver by election is only valid if the party electing had knowledge of his legal rights and with that knowledge consciously chose not to exercise the same.

By failure to set out the above in the resolution to allot new shares, and/or not using specific words denoting the waiver of a right of pre-emption, the allotment of shares amounts to an oppression act. The reason being is that it has resulted in an unjustified dilution of the Appellant’s shareholding and the loss of opportunity to enhance the Appellant’s shareholding in the company.

Further, Her Ladyship emphasized that the general power of allotment under section 75 CA 2016 cannot be used by the directors to bypass the safeguards under section 85 CA 2016. In her Ladyship’s words, “Section 85 CA 2016 is not subjected to section 75 CA 2016 as the former is only subjected to the constitution, which makes no reference to the latter.”

Concrete Parade distinguished

Approximately a year after the decision of Concrete Parade, in the case of Pan Choon Weng v Mexvin Chow Yew Hoong^[2] (“Pan Choon Weng”), the minority shareholder (“Plaintiff”) made a complaint against the company, its directors and shareholders (“Defendants”) that his shares were diluted pursuant to an allotment of shares without first offered to him.

The Plaintiff relied heavily on Concrete Parade to support his claim that he was denied of his right to maintain his relative shareholding rights in the company.

He also asserted that pursuant to Article 41 of the articles of association of the company, a “direction to the contrary” was never obtained by the Defendants, nor the Defendants ever mentioned any information with regards to the Plaintiff’s pre-emptive rights under section 85 CA 2016 pursuant to the requirement to specify such information as per Concrete Parade. Hence, there was a clear breach of the Plaintiff’s statutory pre-emptive rights under section 85 CA 2016 and Article 41.

Su Tiang Joo JC (as His Lordship then was) dismissed the oppression suit. His Lordship agreed with the Defendants that sections 75 and 85 CA 2016 complement each other. Here, the shares were offered to the promoter of the company. As such, pursuant to section 75(2)(c) CA 2016 which exempts the requirement of shareholder’s approval for issuance of new shares to promoter of companies, consequently, the issuance need not be offered to shareholders at first instance.

Concrete Parade is distinguished as it does not concern with the allotment of shares to a promoter of a company.

Further, the Plaintiff executed a shareholder’s agreement with all directors and shareholders of the company (“Shareholders’ Agreement”). It is clear from Clause 3 of the Shareholders’ Agreement that the shareholders of the Company had been informed that they have a pre-emptive right over new shares in the Company and by entering into the Shareholders’ Agreement, they were waiving the same and on this basis they had joined the company. In this context, the operation of section 85 and Article 41 is waived as it is settled law that one can enter into a contract to waive a benefit conferred upon him by statute.

Although the Plaintiff argued that the company was not a party to the Shareholder’s Agreement and the Shareholder’s Agreement is not incorporated into the company’s articles, the Court held that the terms of the Shareholders’ Agreement amounted to a resolution of the Company based on the Duomatic principle. The Duomatic principle provides that unanimous directors’ and/or shareholders’ assents on a matter are binding on the company with such assent being deemed as having been passed in a resolution of the company.

Conclusion

Although it was expounded that “section 85 is not subjected section 75” in Concrete Parade, a harmonious reading of both sections adopted in Pan Choon Weng concludes that: directors are empowered to issues shares, subject to shareholder’s approval and their pre-emptive rights; however, when the issuance of shares falls within the exceptions in section 75(2) CA 2016, then the shareholders’ pre-emptive rights as provided in section 85 are automatically waived.

The decision in Pan Choon Weng seems to lean towards the less stringent High Concrete Parade Court decision in, which held that no specific terms and/or form is required to inform the shareholders of their waiver of the pre-emptive rights. A shareholder’s agreement that was entered prior to the issuance of new shares is sufficient as per the Re Duomatic Principle.

Following the case of Pan Choon Weng, shareholders are advised to be extremely cautious towards the terms of any shareholder’s agreement executed that may have the effect of waiving their pre-emptive rights. The decision in Pan Choon Weng seems to suggest that any agreements executed by directors and shareholders may waive their pre-emptive rights regardless of the protection offered under section 85.

Meanwhile, the decision of Concrete Parade is pending appeal in the Federal Court, and we shall anticipate further updates on the interplay between sections 75 and 85 CA 2016.

This article is authored by Lavinia Kumaraendran (Partner) and Melody Tan Kar Yen (Pupil) of the Commercial Litigation Practice of Lavania & Balan Chambers. It contains general information only. The contents are not intended to constitute legal advice on any specific matter nor is it an expression of legal opinion and should not be relied upon as such.