Pro Rata Rights in Australian Equity Offerings: A Legal and Strategic Guide

Pro rata rights are a vital tool in Australian equity offerings. They allow existing shareholders to maintain their proportional ownership in a company when new shares are issued. Understanding the ins and outs of pro rata rights can help both companies and investors navigate capital raises while protecting shareholder interests.

What Are Pro Rata Rights?

Definition and Purpose of Pro Rata Rights

Pro rata rights, also known as pre-emptive rights, give existing shareholders the opportunity to buy additional shares in proportion to their current holdings before the company offers them to new investors. This simple mechanism has several key benefits:

1. Protect Shareholders from Dilution: Without pro rata rights, existing shareholders risk losing their ownership percentage when new shares are issued. Pro rata rights allow shareholders to maintain their proportionate stake.

2. Offer a Cost-Effective Way to Raise Capital: Pro rata rights allow companies to raise capital quickly and efficiently, as they avoid lengthy negotiations with new investors and can turn to existing shareholders for additional funding.

3. Ensure Fair Treatment of Shareholders: By offering new shares first to current shareholders, pro rata rights ensure that they are treated fairly during capital raising activities.

How Pro Rata Rights Work

In a pro rata rights issue, the company offers its existing shareholders the chance to buy more shares, often at a discount to the market price. The rights can be:

• Renounceable: Shareholders can sell their rights to purchase shares on the Australian Securities Exchange (ASX). Renounceable rights allow shareholders who do not wish to exercise their rights to sell them to others, creating liquidity.

• Non-Renounceable: Shareholders must either exercise their rights or let them expire. These rights are not tradeable on the ASX and have to be exercised within the given timeframe.

Under ASX Listing Rules, companies are generally limited to issuing new securities that exceed 15% (or 25% for small companies) of their existing capital in any 12-month period. However, a pro rata offer is an exception, which allows companies to raise more capital without breaching this limit.

The Legal Framework for Pro Rata Rights

ASIC Regulatory Oversight

The Australian Securities and Investments Commission (ASIC) ensures that companies comply with their disclosure obligations and market fairness requirements when conducting pro rata rights issues. ASIC’s Regulatory Guide 6 provides detailed guidelines on the form and content of rights issue disclosures. The aim is to protect investors and ensure that the market operates transparently.

Key Provisions of the Corporations Act 2001 (Cth)

Several provisions in the Corporations Act 2001 (Cth) govern pro rata rights issues:

• Section 254D: Requires proprietary companies to offer newly issued shares of the same class to existing shareholders before offering them to new investors. However, companies can override this requirement through their constitution.

• Section 708AA: This provision exempts rights issues from the prospectus requirement, as long as certain conditions are met. This allows companies to raise capital quickly while keeping disclosure streamlined.

• Section 615: Ensures that foreign shareholders receive equitable treatment in rights issues, preventing discrimination against international investors.

• Section 256B: Covers capital reductions, which may be relevant when a rights issue is combined with a share buyback. This section governs how companies distribute capital to shareholders in such scenarios.

Tax Implications for Investors and Companies

For Investors

Investors should be aware of several tax implications when participating in a pro rata rights issue:

• Capital Gains Tax (CGT): The cost base of shares acquired through a rights issue is included in the investor’s CGT cost base. If an investor sells their renounceable rights or is issued a tradeable right, CGT may apply to the proceeds.

• Dividend Implications: Generally, shares acquired through a rights issue do not affect dividend imputation. However, the future dividends on these shares may carry franking credits, depending on the company’s franking account balance.

For Companies

Companies also face tax considerations when raising capital through pro rata rights issues:

• Tax Deductibility: Costs associated with the rights issue, such as legal fees and advisory costs, are typically not deductible. These costs are considered capital in nature under the Income Tax Assessment Act 1997 (Cth).

• Franking Account Impact: If a company raises funds through a rights issue and later distributes them as dividends, it must ensure it has sufficient franking credits to avoid imposing additional tax burdens on shareholders.

Strategies for Maximising Participation in Pro Rata Rights Issues

Pricing and Structure Considerations

The pricing and structure of a pro rata rights issue are critical to encouraging shareholder participation:

• Offer a Discount to Market Price: Setting an attractive discount increases the likelihood that existing shareholders will exercise their rights, ensuring that the capital raise meets its target.

• Renounceable Rights: A renounceable structure allows shareholders who do not wish to participate to sell their rights on the ASX. This approach makes the offer more appealing by allowing shareholders to recover some value even if they choose not to exercise the rights.

Underwriting and Sub-Underwriting

To guarantee the success of a pro rata rights issue, companies often engage underwriters. Underwriters agree to purchase any shares not taken up by shareholders, thus ensuring the capital raise reaches its goal. Sub-underwriting by institutional investors or major shareholders can further stabilise the process.

Regulatory Compliance and Transparency

Clear and transparent communication is key to ensuring the success of a pro rata rights issue. By fully disclosing the terms of the offer, potential dilution effects, and company intentions, companies can minimise legal risk and maintain shareholder trust.

Case Studies: Successful Pro Rata Rights Issues in Australia

Commonwealth Bank of Australia (CBA) – 2015 Capital Raising

In 2015, CBA raised $5 billion through a renounceable pro rata rights issue. The offer was well-received, thanks to an attractive discount, transparent disclosure, and strong institutional participation. The success of this capital raising highlighted the importance of setting the right pricing and structure to attract both retail and institutional investors.

Qantas Airways Limited – 2020 Rights Issue

During the COVID-19 pandemic, Qantas raised $1.36 billion through a pro rata entitlement offer. The offer was structured to ensure fair access for retail investors, while institutional investors helped secure additional funding. The transparent and equitable structure of this rights issue helped Qantas weather the financial challenges brought about by the global crisis.

Practical Takeaways

Pro rata rights issues remain one of the most effective ways for Australian companies to raise capital. These issues protect existing shareholders, ensure fairness, and help companies meet their funding needs. However, issues require careful planning, pricing, and adherence to legal and regulatory requirements. Transparent disclosure, proper structuring, and strong underwriting strategies are key to maximising participation and ensuring a smooth process.

For companies considering a pro rata rights issue or seeking advice on structuring an equity offering, Allied Legal can help. Our experienced corporate law team will guide you through every step of the process, ensuring your capital raising efforts are successful and compliant with Australian law.

References for Case Studies:

1. Commonwealth Bank of Australia: CBA Institutional Entitlement Offer
2. Qantas Airways Limited: Qantas Rights Issue Announcement