Corporate Securities Info
Right of first refusal
By Raul J. Palabrica
Philippine Daily Inquirer
First Posted 04:18:00 05/16/2008
Pleading lack of funds, the government has waived its right to match the offer of London-based fund manager Ashmore Corp. to buy Aramco Overseas Co.’s 40-percent shareholding in the 40-percent government-owned oil refiner and retailer Petron Corp. for $550 million.
Had the government exercised its right of first refusal, it would have regained control of the biggest distributor of oil-based products in the country.
In the context that it is used, the right of refusal (also called “preemptive right” or “right of first offer”) refers to the option of a company or its stockholders to be the first to acquire, subject to certain conditions, the shares of stockholders who want to dispose of their holdings.
Through this process, the remaining stockholders can have a say on who can join them in the company. After all, they have a genuine stake in its continued operation, despite the desire of one or some of them to get out.
Since “first refusal” constitutes a limitation on a person’s right to the use and enjoyment of his property, the restriction should be spelled out in the corporation’s articles of incorporation or by-laws.
This way, prospective investors are made aware before they put in their money that they have to deal with the existing stockholders first before they can unload their shares in favor of third parties.
For widely held corporations, the Securities and Exchange Commission also requires the restriction to be printed on the stock certificates to put the affected stockholders on notice about it.
Conditions
Like all other rights, “first refusal” is subject to possible abuse so some guidelines should be laid down to prevent that from happening.
First, the exercise of the option must be time-bound.
The clock should start ticking as soon as the stockholder concerned informs the corporate secretary in writing of his intention to dispose of his shares.
Unless a different procedure has been agreed upon, notice to the secretary is considered notice to the company and other stockholders.
The SEC has ruled that a period of one month from the date of such notice is sufficient for the company or its stockholders to signify its or their desire to buy the shares offered for sale.
To buy or not to buy is a simple case of cash economics. There is no need to engage the services of consultants to find out if the shares are worth buying. From their vantage point, the beneficiaries of the option know the real score about those shares.
If the company is optimistic about its growth and has surplus profits in its coffers, it can undertake the shares buyback immediately.
On the part of the stockholders, if none of them has the singular capacity to acquire the shares, they can pool their resources together to ensure that the shares do not wind up in the hands of outsiders.
Computation
Second, the manner by which the shares shall be priced should be clearly stated in the corporate papers.
Without such guideline in place, an exiting stockholder who has an axe to grind against the company or his fellow stockholders can demand an exorbitant price for his shares.
Or he may impose conditions aimed at preventing them from exercising their option to pave the way for the sale of the shares to the competition.
And even if the relations between the stockholders are cordial, differences in the valuation of the shares cannot be discounted.
The exiting stockholder would want to get the best price possible for his shares. In turn, the prospective buyers would make an effort to acquire the shares at the least cost.
The usual recourse in pricing disputes of this nature is to ask a neutral party to make an objective assessment of the value of the shares in question.
But this process could entail some expenses and, worse, there is no assurance that the recommended valuation would be acceptable to both parties.
Formula
Valuation disputes can be avoided, at the outset, by stating the formula that will be used to compute the acquisition price of the shares.
The simplest would be to fix an arbitrary amount, say, the par value of the shares multiplied by the average amount of dividends received from the time of incorporation to the present.
Another approach would be to use book value as the benchmark, for example, not more than 120 percent of the book value of the shares based on the latest financial statement of the corporation.
Fixing ahead of time the acquisition price of the shares of stockholders who want out from the company may be likened to a “pre-nuptial agreement.”
It should be discussed while the parties are still in the best terms because when the parting of ways comes, emotional hurts tend to becloud reason and logic.
For good measure, a provision may be added to the effect that if the option is not exercised for one reason or another, the shares cannot be sold to third parties at terms and conditions more favorable than those earlier offered.
Somehow, this caveat could encourage good faith on the part of the exiting stockholder in the discussion on the valuation of his shares.
And in the unlikely event that the rules on “first refusal” are not observed, the secretary can withhold the registration of the sale or disposition of the affected shares in the books of the corporation.
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For feedback, please write to rpalabrica@inquirer.com.ph.
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