Introduction
Although capital increases in joint-stock companies are an important mechanism for meeting a company’s financing needs, they may also directly affect the economic interests and corporate governance rights of existing shareholders. Where newly issued shares representing the increased share capital are acquired by persons other than the existing shareholders, the existing shareholders’ proportionate ownership interests in the company may be diluted, resulting in a corresponding reduction in their relative entitlements to voting rights, dividends, and liquidation proceeds. To prevent such dilution, Article 461/1 of the Turkish Commercial Code No. 6102 (“TCC”) provides that each shareholder is entitled to subscribe for newly issued shares in proportion to their existing shareholding in the company’s share capital. This entitlement is referred to in legal doctrine and practice as the “pre-emption right” (rüçhan hakkı).
The pre-emption right does not impose an obligation on shareholders to participate in a capital increase; rather, it grants them the right to subscribe for newly issued shares in proportion to their existing shareholding, thereby enabling them to maintain their shareholding percentage. In this respect, it is an important mechanism for balancing the company’s capital requirements with the protection of existing shareholders. However, the pre-emption right is not absolute and may be restricted or entirely excluded where justified by the interests of the company, provided that conditions are satisfied.
The Nature and Origin of the Pre-emption Right
Although the pre-emption right arises from shareholder status, it becomes exercisable only upon a capital increase requiring the issue of new shares. It therefore arises primarily in capital increases funded from external sources through subscriptions for capital. In legal doctrine, l he pre-emptive right is similarly recognized as a right enabling existing shareholders to subscribe for newly issued shares in proportion to their existing shareholdings in the company’s share capital, following a capital increase funded through external contributions.
Different system applies to capital increases funded from internal sources. Under Article 462/3 of TCC, upon registration of the capital increase, existing shareholders automatically acquire bonus shares in proportion to their holdings in the share capital. Accordingly, pre-emptive rights do not apply to capital increases funded from internal resources, as shareholders automatically acquire the newly issued shares without the need to exercise such rights.
Whether shares are represented by share certificates or whether they are registered or bearer shares, is not decisive for the exercise of the pre-emption right. Since the right arises from shareholder status rather than the share certificate, it belongs to the shareholder. As a rule, creation of limited rights in rem over the shares, such as usufruct or pledge rights, does not alter this position. Accordingly, the right to exercise pre-emptive rights remains with the shareholder, even where the shares are subject to such limited rights in rem.
However, the protection of the holder of a limited right in rem becomes particularly important where the terms of issue of new shares issued as a result of a capital increase lead to a reduction in the economic value of existing shares. In such a case, it is accepted that the usufruct or pledge right attached to the existing share will extend to the new shares acquired as a result of exercising the pre-emption right, to the extent corresponding to the reduction in the share’s value. In this way, the economic value of a limited right in rem established over an existing share is prevented from being eroded through a capital increase.
Exercise of Pre-emption Rights
In order for shareholders to exercise their pre-emptive rights, the company must first adopt a resolution to increase its share capital through the issuance of new shares. Upon the adoption of the capital increase resolution, the pre-emptive right, which already exists as a right arising from shareholder status but is not yet exercisable, becomes exercisable and enforceable against the company.
The terms governing the exercise of pre-emptive rights arising upon the adoption of the capital increase resolution must be determined separately. Under Article 461/3 TCC, the board of directors determines the terms and conditions for exercising pre-emptive rights by adopting a resolution and grants shareholders a period of at least fifteen days to exercise such rights. Although the law expressly requires the period for exercising pre-emptive rights to be specified in the board of directors’ resolution, it is generally accepted in legal doctrine that, to ensure the effective exercise of such rights, the resolution should also clearly specify the number and issue price of the new shares, the extent of each shareholder’s pre-emptive rights, the procedure for exercising such rights, and the bank and account details for payment of the share subscription amounts. It should also be noted that the period allowed by the board for exercising the pre-emption right is a forfeiture period: shareholders who fail to exercise the right within that period lose it in respect of the capital increase concerned.
Pursuant to Article 46/3 TCC, the board of directors’ resolution regarding the terms of exercise of the pre-emption right must be registered, published in the Turkish Trade Registry Gazette and published on the company’s website. Furthermore, pursuant to Article 74/1 of the Trade Registry Regulation, the relevant resolution must be registered prior to the registration of the capital increase. These provisions ensure that the terms and conditions under which shareholders may subscribe for new shares, as well as the period within which they may exercise their pre-emptive rights, are clearly established before the capital increase is completed.
The company may also have special provisions concerning pre-emption rights. Particular classes of shares may carry privileges in respect of pre-emption rights, or holders of participation certificates (intifa senetleri) may have been granted rights to subscribe for new shares. In such cases, these special rights must also be taken into account when determining the scope of existing shareholders’ statutory pre-emption rights.
The exercise of pre-emptive rights does not constitute an obligation for shareholders. Shareholders may exercise their pre-emptive rights in whole or in part, or may choose not to participate in the capital increase.
After the capital increase has been completed following expiry of the pre-emption exercise period and subscription for the new shares, the board of directors prepares the declaration required by Article 457 TCC at the stage of registering the increase. The declaration sets out that the cash capital has been fully subscribed and the amount due has been paid; valuation matters where capital is contributed in kind or an asset is acquired; the existence of a receivable and its eligibility for set-off where it is applied towards the capital contribution; the reasons for restricting or disapplying pre-emption rights; and how unexercised pre-emption rights have been allocated. This ensures that the legal and financial elements underpinning the capital increase are presented transparently and, in a manner, permitting scrutiny; the declaration also enables review of whether the pre-emption process has been conducted in accordance with the law and the terms laid down in the board resolution.
Restriction or Exclusion of Pre-emption Rights
As a general rule, shareholders are entitled to pre-emptive rights, while their restriction or exclusion constitutes an exception. Under Article 461(2) TCC, the general meeting may restrict or entirely disapply pre-emption rights only where there is just cause and affirmative votes representing at least sixty per cent of the share capital are obtained.
The law lists public offerings, the acquisition of businesses, parts of businesses or equity participations, and employee participation in the company as examples of just cause; the list is not exhaustive. The existence of just cause must be assessed in relation to the particular capital increase, rather than in the abstract. It is generally accepted in the legal doctrine that, in addition to serving the company’s interests, any restriction must comply with the principles of necessity, equality and proportionality.
If the intended result can be achieved by another method that interferes less with pre-emption rights, the restriction may not be justified. Similarly, a restriction aimed solely at increasing the ownership percentage of a particular shareholder or the controlling shareholder would be inconsistent with Article 461/2 of the TCC, which prohibits granting any person an unjustified benefit or causing any person to suffer a disadvantage through the restriction or exclusion of pre-emptive rights.
Where pre-emptive rights are restricted or excluded, the board of directors is required to prepare a report setting out the reasons for such restriction or exclusion. Pursuant to Article 461/2 of the TCC, the report must explain the grounds for restricting or excluding pre-emptive rights, the reasons for issuing new shares with or without a share premium, and, where applicable, the method used to calculate the share premium. The report must also be registered and published, thereby allowing the grounds for restricting or excluding pre-emptive rights to be subject to review.
Conclusion
Pre-emption rights are one of the principal mechanisms protecting existing shareholders’ positions within the ownership structure of a joint stock company following a capital increase. Effective protection requires more than statutory recognition of the right: the terms of exercise must be clearly defined, shareholders must be allowed at least fifteen days, and the necessary registration and publication formalities must be completed.
Pre-emptive rights may be restricted or excluded where justified by the interests of the company. However, any such restriction or exclusion is subject to the requirements of justifiable grounds, a qualified majority, equal treatment, and proper justification. These requirements are intended to enable companies to meet their financing needs through capital increases while preventing shareholders holding a majority of the share capital from arbitrarily weakening the position of existing shareholders within the company.
Frequently Asked Questions
- What is a pre-emption right? A pre-emption right is a statutory right in joint stock companies enabling existing shareholders to acquire new shares issued through a capital increase on a priority basis in proportion to their existing shareholdings in the company’s share capital.
- When do pre-emption rights arise? Pre-emptive rights primarily apply to capital increases through share subscriptions, namely capital increases funded through external contributions. In a capital increase funded from internal sources, shareholders automatically acquire bonus shares, so there is no separate pre-emption right to exercise.
- What is the period for exercising pre-emption rights? The board of directors must allow shareholders at least fifteen days to exercise their pre-emption rights. This period constitutes a time limit after which the right expires, and any pre-emptive rights not exercised within the prescribed period cease to exist in respect of the relevant capital increase.
- Under What Conditions May Pre-emptive Rights Be Restricted or Excluded? Pre-emptive rights may be restricted or excluded only where justifiable grounds exist and the resolution is approved by affirmative votes representing at least sixty percent of the share capital at the general assembly. In addition, the board of directors must prepare a report setting out the reasons for such restriction or exclusion, which must be registered and published.
- Who exercises the pre-emption right if a share is subject to a usufruct or pledge? Since pre-emptive rights arise from shareholder status, the right to exercise them generally remains with the shareholder, even where the shares are subject to limited rights in rem, such as usufruct or pledge right.
