A pre-emptive right share issue – what to watch out for and how to prepare

A non-directed share issue, or pre-emptive right share issue, is based on the principle laid down in Chapter 9, Section 3 of the Finnish Limited Liability Companies Act, according to which all shareholders are given priority to subscribe for new shares in proportion to their existing holdings. Thus, a pre-emptive right share issue is in principle, an equal action under the law, in which each shareholder has the right to subscribe for new shares in proportion to their ownership.

The law does not bind the subscription price to fair value, as relative ownership can be kept unchanged. However, this formal equality may conceal violations of substantive equality if the pricing, timing, availability of information, or circumstances of the company (e.g., exhaustion, channeling of funds to related parties) actually make participation impossible or irrational for some of the owners. The grounds for complaint are channeled through Section 21:1 of the Finnish Limited Liability Companies Act, and the assessment is based on the principle of equality in Section 1:7 of the Act. The analogy of a directed issue (Section 9:4 of the Finnish Limited Liability Companies Act, “compelling financial reason”) also provides useful calibration for the assessment of an undirected issue: the greater the actual transfer of assets or the weaker the legal protection of the minority, the more compelling the reasons for the implementation method must be, even if the preferential right is formally realized.

This article examines the grounds on which an undirected share issue can be challenged and how the provisions of the Finnish Limited Liability Companies Act and case law (e.g., KKO 1991:46) guide the assessment. Particular focus is placed on the realization of substantive equality, the risks of abuse, and a practical checklist for boards of directors.

Introduction

In Finland, a significant proportion of companies are structured as limited liability companies. Share issues are a key instrument in developing capital structure, financing investments, and changing ownership structure. Therefore, how and under what conditions ownership can be changed is reflected not only in the financial position of individual shareholders, but also more broadly in the accumulation of wealth in society.

Unlike a directed issue, a non-directed issue appears to be “safe” in principle: everyone’s pre-emptive rights are realized, and the subscription price is not restricted by law. In practice, however, especially in small companies, non-directed issues can be used under the protection of formal equality to arrange situations where the majority directs the increase in value or cash flows to themselves and puts the minority in a position of choice: either finance the issue (perhaps on unfavorable terms) or be diluted. In these situations, substantive equality becomes the core issue.

Regulatory framework

The Finnish Limited Liability Companies Act does not define a “non-directed” issue but rather refers to all issues that do not deviate from the pre-emptive right under Section 9:3 of the Act. The essence of a non-directed issue is therefore the right to retain relative ownership and economic rights.

A non-directed issue is decided by the general meeting (Section 9:2 of the Finnish Limited Liability Companies Act), and no qualified majority is required unless the articles of association are amended. The notice must be sent at least one week in advance, unless otherwise specified in the articles of association (Section 5:19 of the Finnish Limited Liability Companies Act), and the pre-emptive right is usually exercised within two weeks of the start of the subscription period (Section 9:5.3 of the Finnish Limited Liability Companies Act). This may leave shareholders with less than three weeks to arrange financing. If the articles of association contain provisions on capital or nominal value, an amendment to the articles of association may be necessary (in which case the majority requirements become stricter).

Since relative ownership can be maintained, the law does not bind the subscription price to fair value – this differs significantly from a directed issue, where the transfer of assets to new shareholders is subject to consideration. However, freedom of pricing does not remove the requirement of material equality: if the issue effectively discriminates against a particular owner, Section 1:7 of the Finnish Limited Liability Companies Act may render the issue invalid under Section 21:1 of the Act.

A non-directed issue may also be attractive to companies from a tax perspective, for example, compared to invested unrestricted equity fund investments, which may encourage companies to use the issue as a financing channel. However, financial motives do not override the requirement of equality.

Principle of equality

Section 1:7 of the Finnish Limited Liability Companies Act stipulates the principle of equality: all shares confer equal rights, unless otherwise provided in the articles of association. Equality can be divided into formal (compliance with legislation) and substantive (actual equality) dimensions.

Formal equality means compliance with regulations, such as offering preferential rights, while substantive equality asks whether a measure produces a real benefit for the majority at the expense of another shareholder. This secondary “corrective” principle is activated especially when there is no specific prohibition in the articles of association.

Although Supreme Court case KKO 1991:46 concerned the old Limited Liability Companies Act, its essence has endured in the current Limited Liability Companies Act and its interpretation: even an overpriced issue may be contrary to equality if it channels value to the majority and forces the minority into an unfavorable choice. Similarly, in some situations, an issue at a discount may transfer wealth from non-participants to participants. The overall assessment emphasizes the actual effects of the structure, not just how the decision looks on paper.

In assessing material equality, weight is also given to whether the offer reduces someone’s ownership to less than 1/10 (exercise of minority rights, e.g., minority dividend) or 1/3 (many decision thresholds). Falling below these thresholds may in fact reduce the minority’s means of control and permanently alter the balance of power. In such cases, the acceptability of the offer must be weighed particularly carefully.

Pitfalls and grounds for appeal

Objection to a decision

Section 21:1 of the Finnish Limited Liability Companies Act allows a decision of the general meeting to be declared invalid if there has been an error in the procedure or if the decision is otherwise contrary to the law or the articles of association. In the case of a non-targeted issue, the grounds for appeal are often related to a violation of substantive equality rather than procedural errors.

The complaint must be filed within three months of the decision. Invalidity (Section 21:2 of the Finnish Limited Liability Companies Act) requires that the violation of equality is completely clear at the time of the decision, which is rare in the case of non-targeted share issues.

The success of the complaint depends on the plaintiff being able to specify:

• why the method of implementation (price, schedule, communication) restricted actual participation;

• how the overall impact of the issue weakens the financial position of minority shareholders or reduces their rights under the Finnish Limited Liability Companies Act;

• what alternatives (longer subscription period, secondary subscription, realistic financing window) the company ignored without acceptable reason.

This type of evidence directly concerns the prohibition of unjust enrichment in Section 1:7 of the Finnish Limited Liability Companies Act.

Oppression of minority shareholders

A classic example of abuse is oppression of minority shareholders: the majority diverts the company’s assets to itself, for example through excessive salaries, related party transactions, or manipulation of results. When the minority’s expected value of future returns is depressed, an undirected offering can become a kind of trapped choice, forcing the minority to either finance the offering even though the expected value is negative, or further reduce its shareholding. In this case, the minority’s incentive to participate in the offering disappears, and the offering may be fundamentally contrary to equality. In this context, the offering may be contrary to equality because the minority’s rational choice leads to a reduction in ownership and rights.

Artificiality

In a pre-emptive right share issue, the risk of abuse is linked not only to oppression of minority shareholders but also to possible artificiality. Artificial urgency and suppression of financing opportunities may also constitute grounds for criticism, especially if the timing of the share issue has been deliberately designed so that only the majority has time to arrange the necessary financing. In such cases, the pre-emptive right is essentially a mere formality. Furthermore, if, in such an urgent situation, the share issue is carried out at a discount and the minority shareholders have no realistic opportunity to participate, the issue may be considered artificial. It should be noted, however, that a share issue requiring rapid decision-making is not automatically artificial, as the actual purpose of the share issue is often to meet the company’s business needs.

Although the Finnish Limited Liability Companies Act does not require secondary subscription, decisions may specify how unsubscribed shares are to be distributed. If the model effectively excludes the most vulnerable shareholders from a potentially more favorable “second round,” the arrangement may be considered a violation of equality, especially if there is no business need for such a restriction. However, in non-directed share issues, the same price per share may be set for secondary subscription as in the first round, thereby preventing allegations of artificiality.

Pricing and minority thresholds

The fair value of private companies is often based on the so-called income value (the discounted present value of future cash flows), while case law (e.g., tax law) often relies on the net asset value. The net asset value is typically lower than the income value in continuing operations, which makes the assessment more difficult. It is therefore advisable to document the economic rationale for the price: why this particular price in this market and company situation?

Setting the subscription price below (undervaluation) or above (overvaluation) the fair value may result in a transfer of wealth from non-participating shareholders to participating shareholders. The more the price falls below the fair value, the greater the incentive for shareholders to subscribe for shares, and at the same time, the greater the potential loss for non-participants. If the minority does not have realistic financing options, for example due to the schedule, the discount may become a means of pressure that transfers wealth to the majority.

At the same time, however, KKO 1991:46 shows that a premium does not automatically “save” the arrangement. If the arrangement actually channels value to the majority and excludes the minority, even an overpriced issue may be reprehensible. It is essential to weigh the overall impact and not just assess the issue price against the “fair” value.

The loss of legal remedies available to the minority, such as the right to a minority dividend, the right to block decisions, or special supervisory measures, when the ownership share falls below 1/10 or 1/3, is a significant element of criticism. If the company can meet its business needs without falling below the minority thresholds but chooses not to do so, the chances of success of the complaint may increase.

Directed share issue in brief

According to Section 9:4 of the Finnish Limited Liability Companies Act, a directed share issue requires a compelling financial reason. The more the subscription price deviates from the fair value, which transfers value between the parties, the more compelling the reason must be. A directed share issue is widely used, for example, as a mechanism for corporate restructuring, financing, and management commitment. In the case of an unallocated issue, the standard of compelling economic reason is not directly applicable, but analogy helps to assess whether the method of implementation is acceptable in relation to the company’s purpose and the equal treatment of shareholders. In other words, if an unallocated issue actually creates a similar transfer of wealth or discriminatory effect, the board of directors should weigh and document the grounds as carefully as in a targeted issue.

Practical checklist for the board

• Genuineness of the grounds: Has the need for capital been documented in concrete terms? Could the same objective be achieved by a less discriminatory method of implementation? Why is the issue being carried out now and what is the company’s capital requirement?

• Pricing: How does the subscription price relate to the fair value? Has the analysis been documented? The goal is not a complete valuation or company valuation, but a consistent justification that shows that the pricing is not intended to conceal a transfer of value.

• Schedule: Is the subscription period realistic for all shareholders to arrange financing? If the offering is urgent, justify this and, if possible, assess the possibility of organizing a shareholders’ meeting or other similar event or providing preliminary information to shareholders about the offering before sending out the notice of the general meeting.

• Secondary subscription and those entitled to it: If not all shares are subscribed, consider secondary subscription models if the company’s business needs require full subscription. Avoid allocation rules that systematically favor parties with information advantages or liquidity without business necessity. Also evaluate the per-share subscription price for secondary subscription.

• Minority thresholds: Will anyone’s ownership be diluted to less than 1/10 or 1/3? Can this be avoided? Assess whether the offering can be implemented in stages or phases, for example, if ownership interests are diluted below the above-mentioned thresholds. Document why the chosen implementation option was chosen.

• Historical context and related parties: Are there any indications of starvation or channelling of funds to related parties? Has the company implemented a similar arrangement before, and how was the value of the shares assessed at that time? Have there been any changes in the company’s operations or business needs since the previous arrangement? Document comprehensively if there are suspicions of starvation or related party benefits in the company. If the company has previously had suspicions of starvation or favoritism toward certain shareholders, the level of requirements can be considered to be higher, as lack of transparency and the impact on minority shareholders are significant grounds for criticism.

• Documentation: Has equality been considered and is the implementation method justified in relation to the alternatives?

Conclusion

Financial challenges are part of business, which is why how they are addressed is essential. A proactive board protects the company, safeguards the interests of stakeholders, and at the same time reduces its own liability risk.

A pre-emptive right share issue is, in principle, in accordance with formal equality under the Finnish Limited Liability Companies Act when the pre-emptive right is exercised and the price is not tied to fair value. However, this does not prevent criticism if the overall structure of the issue, such as pricing, timing, information imbalance, and historical context, leads to a weakening of the financial position and legal protection of minority shareholders, i.e., a violation of substantive equality. A violation of substantive equality is typically indicated by a combination of the following factors: undervaluation + urgency + information imbalance + historical abuse.

The essence of the complaint is to show that the method of implementation was not necessary to achieve the company’s purpose and produced an unjustified advantage for the majority at the expense of the minority. On the other hand, a mere claim of lack of commercial grounds is unlikely to succeed. For the complaint to succeed, the demanding party must show that the chosen method of implementation is not necessary for the company and is not justified from the point of view of shareholder equality, for example, in that it gives the majority an unjustified advantage at the expense of the minority shareholders.

Although Section 9:4 of the Finnish Limited Liability Companies Act does not directly apply to pre-emptive right share issues, its logic serves as a kind of compass in these situations. The more significant the transfer of assets or the weakening of legal protection, the more carefully the board of directors should assess and record the grounds and alternatives it has considered. If a less discriminatory alternative had been available without commercial disadvantage, the acceptability of even a pre-emptive right share issue may be undermined.

Therefore, even though a pre-emptive right share issue can in principle be considered non-discriminatory and equitable, the board of directors should assess the matter extensively in order to avoid pitfalls and possible complaints. It is advisable to consult an expert advisor well in advance of sending out the notice of the general meeting.