Meaning
The distribution of new company equity without following the established communication protocols violates the fundamental rights of existing investors. Discovery of an unnotified share issuance often leads to litigation regarding the dilution of voting power and the breach of fiduciary duties. This event occurs when management bypasses the board or the shareholder assembly to place shares with a friendly party.
Governance Failure
Internal controls are bypassed when a company creates new stock in secret. Because unnotified share issuance ignores the pre-emptive rights of current holders, it undermines the transparency of the capital structure. The act is usually viewed as a method to entrench existing management against a hostile takeover.
Pre-emptive Right
Holders of equity generally maintain the opportunity to buy new shares to keep their percentage of ownership stable.
Remedial Action
Courts have the authority to cancel the newly issued shares or award damages to the excluded parties. When an unnotified share issuance is proven, the transaction is often set aside for lack of proper authorization. Restoring the original cap table requires a court order that voids the entries in the share register.
This remedy ensures that corporate actions remain subject to the scrutiny of all stakeholders. It acts as a deterrent against boards that might otherwise attempt to shift the balance of power without the consent of the owners.
