Rights of securityholders: Overview, definition, and example
What are the rights of securityholders?
The rights of securityholders refer to the legal entitlements and protections granted to individuals or entities who hold securities, such as stocks, bonds, or other financial instruments, in a company or other issuing entity. These rights may vary depending on the type of security held and the terms of the offering, but they generally include the right to receive certain financial returns, vote on corporate matters, and take legal action in certain circumstances.
Securityholders’ rights can be divided into two broad categories:
- Equity securityholders (e.g., shareholders): These individuals own shares of a company and typically have the right to vote on major decisions (such as electing directors or approving mergers) and to receive dividends or other distributions if the company performs well financially.
- Debt securityholders (e.g., bondholders): These individuals or entities lend money to the company in exchange for the promise of periodic interest payments and the repayment of the principal amount of the debt. Debt securityholders generally do not have voting rights but have priority over equity holders in case of bankruptcy or liquidation.
Why are the rights of securityholders important?
The rights of securityholders are important because they help protect the interests of those who invest in a company or entity. These rights ensure that investors have a say in the governance of the company (in the case of equity holders) and are entitled to financial returns or compensation in the event of company profits or financial distress. They also establish the legal framework within which securityholders can enforce their interests and seek remedies if the terms of their securities are violated.
For example, bondholders' rights to receive timely interest payments and the return of principal are crucial for protecting their investments. Similarly, shareholders' rights to participate in annual meetings and vote on key decisions help ensure that they have a voice in how the company is managed.
Understanding the rights of securityholders through an example
Imagine a company, XYZ Corp., issues both bonds and common stock to raise capital.
- Bondholders (Debt Securityholders): John is a bondholder who lent $10,000 to XYZ Corp. by purchasing a bond. As a bondholder, John has the right to receive annual interest payments (coupon payments) at the agreed-upon rate and to have his principal returned when the bond matures. If XYZ Corp. goes bankrupt, John, as a debt securityholder, will be paid before the company's shareholders but after other secured creditors.
- Shareholders (Equity Securityholders): Jane is a shareholder who owns 100 shares of XYZ Corp. She has the right to attend and vote at the company’s annual general meeting, where she can vote on matters such as the election of directors and the approval of major corporate actions (like mergers or acquisitions). If the company declares dividends, Jane will receive a share of the profits in proportion to her ownership. However, if XYZ Corp. experiences financial difficulty, she will be paid last in case of liquidation, after bondholders and other creditors.
Example of rights of securityholders clause
Here’s how a rights of securityholders clause might appear in a bond or shareholder agreement:
“The Bondholder shall have the right to receive interest payments in accordance with the terms of the bond agreement. In the event of default, the Bondholder has the right to initiate legal action to enforce the terms of the bond and seek remedies as outlined in this agreement. Shareholders have the right to vote on major corporate decisions, including the election of the Board of Directors and any significant mergers or acquisitions, in accordance with the company’s Articles of Incorporation.”
Conclusion
The rights of securityholders are the legal entitlements that investors have in relation to the securities they hold. These rights can include receiving financial returns, voting on corporate governance issues, and seeking legal remedies in cases of breach of terms or company distress. The specific rights depend on the type of security (equity or debt) and the terms of the security agreement.
For both companies and investors, understanding these rights is essential for protecting investments, ensuring fair treatment, and facilitating clear communication between securityholders and the company. Whether it’s receiving timely payments for bonds or having a say in the company’s decisions as a shareholder, securityholders' rights are crucial for maintaining a fair and balanced investment environment.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.