Proprietary Rights of Stockholders and Members in Corporations: The Pre-Emptive Right

In Philippine corporate law, the pre-emptive right is a key proprietary right granted to stockholders and members in corporations. It plays a critical role in allowing stockholders to maintain their proportional ownership in a corporation. Understanding the pre-emptive right, as well as its scope, limitations, and exceptions, is essential for corporate governance, as it impacts shareholder equity and control.

1. Definition and Purpose of the Pre-Emptive Right

The pre-emptive right is the statutory or contractual right of existing shareholders to purchase new shares issued by a corporation, ensuring they can maintain their relative ownership percentage. This right is typically provided under Section 38 of the Revised Corporation Code of the Philippines (Republic Act No. 11232, or the RCC). The underlying purpose of the pre-emptive right is to protect shareholders from involuntary dilution of their ownership stakes, ensuring that shareholders have the opportunity to proportionately acquire newly issued shares in line with their current holdings.

2. Legal Basis under the Revised Corporation Code

Section 38 of the RCC codifies the pre-emptive right, stating:

"All stockholders of a stock corporation shall enjoy pre-emptive right to subscribe to all issues or other dispositions of shares of any class, in proportion to their respective shareholdings unless such right is denied by the articles of incorporation or an amendment thereto."

This statutory provision underscores that pre-emptive rights are presumed to exist in a corporation unless explicitly denied or limited in the articles of incorporation.

3. Scope and Application of Pre-Emptive Rights

Nature of Shares Covered: Pre-emptive rights generally apply to shares that are issued to raise capital. This includes new shares of the same class or new classes of shares, provided they are authorized within the corporation's articles of incorporation.
Limitation to New Issues: Pre-emptive rights are limited to new issuances intended to raise capital. They do not extend to shares issued for purposes such as compensating employees, converting debts to equity, or making acquisitions or mergers.
Proportionate Subscription: The right allows shareholders to acquire shares proportional to their current ownership. If a shareholder owns 10% of the corporation’s shares, they have the right to acquire 10% of any new share issuance to maintain their proportionate stake.
Waiver and Exercise: Shareholders may waive their pre-emptive rights either expressly or by not exercising them within a specified or reasonable time. The articles of incorporation may also include provisions on how pre-emptive rights are to be exercised or waived.

4. Limitations and Exceptions to Pre-Emptive Rights

While pre-emptive rights protect shareholders, the RCC and jurisprudence recognize several exceptions:

Denial in the Articles of Incorporation: The RCC permits corporations to deny or limit pre-emptive rights in the articles of incorporation. Such denial must be clearly articulated in the articles and is typically a strategic decision for corporations seeking flexibility in raising capital or issuing shares.
Shares Issued for Non-Capital Raising Purposes: Shares issued to satisfy certain corporate requirements are excluded from the pre-emptive right. This includes:
- Shares issued to employees or officers as part of a stock option or incentive plan.
- Shares issued as part of a merger, acquisition, or consolidation transaction.
- Shares issued to settle outstanding debts (debt-to-equity conversion).
Preferred Shares: Holders of common shares generally do not have pre-emptive rights over preferred shares unless explicitly provided for in the articles of incorporation.
Waiver of Pre-Emptive Rights: Shareholders may waive their pre-emptive rights, either by entering into a shareholder agreement or by choosing not to exercise the right when new shares are offered.
Corporations with Denied or Limited Pre-Emptive Rights: Corporations with publicly traded shares often have denied or limited pre-emptive rights to enhance market liquidity and flexibility in raising capital through public offerings.

5. Procedure for Exercise of Pre-Emptive Rights

Notification and Offer to Shareholders: When a corporation intends to issue new shares subject to pre-emptive rights, it must notify existing shareholders. This notification typically includes details on the number of shares available, the subscription price, and the deadline for exercising the right.
Acceptance and Payment: Shareholders who wish to exercise their pre-emptive rights must formally accept the offer, typically through a subscription agreement, and make the required payment for the shares within the stipulated period.
Allotment of Unsubscribed Shares: If certain shareholders decline or fail to exercise their pre-emptive rights, the corporation may allot the unsubscribed shares to remaining shareholders or to new investors as per its discretion, provided it complies with corporate governance requirements.

6. Legal Remedies for Violation of Pre-Emptive Rights

Shareholders whose pre-emptive rights are denied or disregarded have legal recourse, including:

Injunction: Shareholders may petition the court to prevent the issuance of shares if such issuance violates their pre-emptive rights.
Rescission: If shares are issued in violation of pre-emptive rights, shareholders may seek rescission of the transaction.
Damages: In cases where shareholders suffer financial harm due to the infringement of their pre-emptive rights, they may claim damages against the corporation or its officers.

7. Jurisprudence on Pre-Emptive Rights

Philippine courts have provided significant jurisprudence interpreting and clarifying the nature and application of pre-emptive rights, focusing on protecting shareholders from dilutive practices while balancing corporate needs for flexibility in share issuances.

Case Law on Dilution Protection: Courts have underscored that pre-emptive rights prevent unjust dilution of shareholder interests unless waived or specifically restricted by the corporation's articles of incorporation.
Case Law on Enforcement of Pre-Emptive Rights: Courts have historically supported shareholder actions that enforce pre-emptive rights, provided the shareholder acts promptly and within procedural guidelines.

8. Corporate Governance Implications

The recognition and enforcement of pre-emptive rights underscore principles of corporate governance, including transparency, fair treatment of shareholders, and accountability. By ensuring shareholders have the opportunity to maintain their ownership stakes, pre-emptive rights contribute to shareholder protection and trust in corporate practices.

In conclusion, the pre-emptive right is a fundamental protection for shareholders within Philippine corporations, helping safeguard their proportional ownership against dilution. While the Revised Corporation Code enshrines these rights, corporations retain flexibility through the ability to restrict or waive pre-emptive rights in certain contexts, provided this is clearly stated in the articles of incorporation. The jurisprudential and corporate governance emphasis on protecting shareholder interests further reinforces the importance of understanding and respecting pre-emptive rights within Philippine corporate law.