Dear Professional Colleagues, In this Article, I will be dealing all about preference shares under Companies Act, 2013
Section 55- Issue and Redemption of Preference Shares
[Effective from 1st April, 2014, except sub- section (3) which is effective from 1st June, 2016]
Rule-9-Companies (Share Capital and Debentures) Rules, 2014
[Effective from 1st April, 2014]
The Shares can be of the following types:
1. EQUITY SHARES
With voting rights; or
With differential rights as to dividend, voting or otherwise
2. PREFERENCE SHARES
Meaning of Preference Shares:
As per Explanation(ii) to section 42 of the Companies Act, 2013 (‘the Act’), the term preference shares mean and includes that part of the share capital the holders of which have a preferential right overpayment of dividend (fixed amount or rate) and repayment of share capital in the event of winding up of the company.
Further, as per Explanation(iii) to section 42, when a certain class of shares has either of the following features, the same shall be deemed to be preference shares.
a) in addition to the preferential right to receive dividend, the shareholders have a right to participate either fully or to a limited extent in the capital not having preferential treatment
b) in addition to the preferential repayment of share capital in the event of winding up, the shareholders are entitled to participate either fully or to a limited extent in the surplus capital of the company available
Rights Issue of Equity Shares no approval of Members required. In view of Section 55 of the Companies Act, 2013 read with the Rule 9 of the Companies (Share Capital and Debenture) Rules, 2014 Members approval by way of Special Resolution required. We need to give effect of both the Sections.
Preference shares allow an investor to own a stake in the issuing company with a condition that whenever the company decides to pay dividends, the holders of the preference shares will be the first to be paid.
In addition to their preferential rights, the following rights are also attached to the preference share capital.
a) In respect of dividend - It has a right to participate, whether fully or to a limited extent, with capital not entitled to the preferential right.
b) In respect of capital – It has a right to participate, whether fully or to a limited extent, with capital not entitled to that preferential right in any surplus which may remain after the entire capital has been repaid.
Kinds of Preference shares:
There are eight types of preference shares. In case of dissolution of the company, any of the eight types would be paid out before other types of equity. Let’s understand each of them:
Cumulative: As the word indicates, all dividends are carried forward until specified, and paid out only at the end of the specified period.
Non-cumulative: The opposite of cumulative, obviously. Dividends are paid out of profits for every year. There are no arrears carried over a time period to be paid at the end of the term.
Redeemable: Such preference shares can be claimed after a fixed period or after giving due notice.
Non-Redeemable: Such shares cannot be redeemed during the lifetime of the company, but can only be obtained at the time of winding up (liquidation) of assets.
Convertible: The shares can be converted into equity shares after a time period, or as per the conditions laid down in the terms.
Non-convertible: Non-convertible preference shares cannot be, at any time, converted into equity shares.
Participating: Such shares have the right to participate in any additional profits, after paying the equity shareholders. The surplus of profit is apart from the fixed dividend paid up for preference shares.
Non-Participating: Non-participating preference shares do not possess any right to participate in surplus profits or any surplus gained at the time of liquidation of the company.
Tenure of Preference Shares continued as 20 years except for “Infrastructural Projects” Companies having "infrastructural projects" can issue Preference Shares for > 20 years but upto 30 years subject to minimum 10% redemption of such preference shares from 21styear onward or earlier.
Explanation.—for the purposes of sub-section (2), the term ‘‘infrastructure projects’’ Means the infrastructure projects specified in Schedule VI.
Issue of the preference shares is restricted to a certain extent.
Issue of preference shares may be made either through:
Rights Issue under Section 62(1)(a) only to the existing Equity Shareholders; or
ESOP Under Section 62(1)(b) specifically provides for the issue to the employees or
Preferential Allotment under Section 62(1)(c) of the Companies Act, 2013 to any person including above can participate in this type of further issue subject to the adherence to Rule 13 of Companies (Share Capital and Debenture) Rule, 2014;
Private Placement of Shares under section Section-42 read with the rule;
Ways to issue preference shares in the private company:
Rights or Bonus Issue
Conditions for issue of preference shares
Section 55 of the Act read with Rule 9 of the Companies (Share Capital and Debentures) Rules, 2014 (‘Rules’) framed there under, inter alia, requires a company to obtain the prior approval of the Shareholders, by way of a Special Resolution for the issuance of preference shares;
As per section 55 of the Act, a company can issue only redeemable preference shares ie a company is not allowed to issue irredeemable preference shares.
Further, it is mandatory for every company issuing preference shares to redeem it within a period of 20 years from the date of issue.
However, a company may issue preference shares with a redemption period of more than 20 years time provided that a certain percentage of such shares are redeemed annually at the option of the shareholders
In order to issue securities by way of preference shares by private placement, the private company (‘the Company’) is required to circulate an offer letter to the selected group of people to whom the Company proposes to issue its shares.
Conditions to be complied with before issuing preference shares:
Whether nominal capital of company divides into Equity Share Capital and Preference Share Capital;
whether there is Provision in Article of Association of the company regarding the issue of Preference shares;
At the time of issue of Preference shares no subsisting default in the redemption of preference shares issued. (Rule-9(1)(b) of The Companies (Share Capital & Debentures) Rules, 2014;
At the time of issue of Preference shares no subsisting default in the payment of dividend due on any preference share. (Rule-9(1)(b) of The Companies (Share Capital & Debentures) Rules, 2014;
The regulations in respect of the following matters relating to preference shares are to be included in the Articles of Association of a company:-
The voting rights;
The redemption of preference shares.
The priority with respect to the payment of dividend or repayment of capital vis-à-vis equity shares.
The payment of dividend on the cumulative or non-cumulative basis.
The conversion of preference shares into equity shares. The participation in the surplus fund.
The participation in surplus assets and profit, on winding-up.
The “Explanatory Statement” to be annexed to the notice of the general meeting pursuant to section 102 shall, inter-alia, provide the complete material facts concerned with and relevant to the issue of such shares, including—
the size of the issue and number of preference shares to be issued and the nominal value of each share;
the nature of such shares i.e. cumulative or non-cumulative, participating or non-participating, convertible or non-convertible
the objectives of the issue;
the manner of the issue of shares;
the price at which such shares are proposed to be issued;
the basis on which the price has been arrived at;
the terms of issue, including terms and rate of dividend on each share, etc.;
the terms of redemption, including the tenure of redemption, redemption of shares at the premium and if the preference shares are convertible, the terms of conversion;
the manner and modes of redemption;
the current shareholding pattern of the company;
the expected dilution in equity share capital upon conversion of preference shares.
A statement of disclosures as required under Rule 9(3) of the Companies (Share Capital and Debentures) Rules, 2014 and the terms of the issue of the preference shares are as under:
Redemption of preference shares
Fully paid-up preference shares can only be redeemed.
Preference shares can be redeemed only out of the profits available for distribution to its shareholders or out of fresh proceeds of shares issued solely for the purpose of funding the redemption of the preference shares
Where the redemption of preference shares are redeemed out of the profits available for distribution, a sum equivalent to the nominal amount of shares being redeemed shall be transferred to the Capital Redemption Reserve. The CRR shall be treated as the paid-up share capital of the company for all purposes and can also be utilized for bonus issue of shares
Where the company is unable to redeem its preference shares or is unable to pay the dividend due on the preference shares, the company can replace issue such amount of preference shares as may be necessary in order to meet its obligation towards dividend payment and also the redemption of preference shares.
On the issue of such further redeemable preference shares, the unredeemed preference Shares shall be deemed to have been redeemed.
If a company is unable to redeem any preference shares or to pay dividend thereon, it may redeem such unredeemable preference shares by a further issue of redeemable preference shares equal to the amount due and dividend due thereon subject to–
a) Consent of the holders of 3/4th in a value of such preference shares;
b) Approval of NCLT
Redemption of preference shares by issuing new preference shares is subject to obtaining the consent of the preference shareholders (at least 75% of the shareholders) and also obtaining the approval of the Tribunal for such arrangement
No distinction between CRPS and NCRPS i.e. 2 Vs 3 Yrs, in the matter of the Voting Rights in the event of non-payment of dividend
The Tribunal shall order the company to immediately redeem the preference shares held by the shareholders dissenting to such arrangement. The issue of preference shares for purpose of redemption of unredeemed preference shares (along with the dividend) shall not be considered as an increase in the share capital of the company
Redemption of preference shares shall be made only from the following:
i) Out of the profits of the company which would otherwise available for dividend.
ii) Out of the proceeds of a fresh issue of shares made for the purpose of such redemption.
Partly paid up shares shall not be redeemed;
A sum equal to the nominal amount of the shares to be redeemed is to be transferred to a reserve called “Capital Redemption Reserve;
In case of such class of companies as may be prescribed and whose financial statements comply with the accounting standards.
i) Premium payable on redemption shall be provided out of the profits of the company before the shares are redeemed.
ii) Premium payable on redemption of any preference shares issued on or before the commencement of 2013 Act, shall be provided out of the profits of the company or out of the company’s securities premium account, before such shares are redeemed.
When a company is unable to redeem any preference shares, it can issue further redeemable preference shares equal to the amount due, including the dividend thereon subject to the following conditions;-
i) With the consent of the preference shareholders holding three-fourths in value; and
ii) With the approval of the Tribunal on a petition made by it in this behalf.
Redemption of preference shares
1. What is the redemption of preference shares?
It is a process of repaying an obligation, usually at the prearranged amount. These shares are issued to the shareholders on terms that holders will at some future date be repaid the amount which they invested in the company.
2. Where should the information regarding redemption of preference share be mentioned?
The redemption date is the maturity date, which specifies when repayment takes place and is usually printed on the preference share certificate.
3. What effect will the company financial structure have after redemption?
By the process of redemption, a company can adjust its financial structure, for example by eliminating preference shares and replacing them with other securities’ it might help in the company’s future growth.
4. What benefits a company will have by issuing Redeemable Preference shares?
It is a proper way of raising finance in a dull primary market.
The preference shares may be redeemed when there is a surplus of capital and surplus funds cannot be utilized in the business for profitable use.
5. What Procedure /conditions are to be followed by company while issuing redeemable Preference shares?
The shares shall be redeemed out of profits of the company which would be available for dividend or out of proceeds of fresh issue of shares made for the purpose of redemption
Preference shares can be redeemed only when they are fully paid up
If any premium payable shall be out of profits of the company/ Out of company’s securities premium account, before the shares are to be redeemed
Profits of the company usually refers to those profits available for dividends, be transferred to the reserve fund (Capital Redemption Reserve)
6. What are the modes of redemption?
There are 3 modes of redemption
Fresh issue of shares
Capitalization of undistributed profits
Combination of both
7. Will redemption of preference shares decrease the capital of the company?
Usually a gap will be created in company when redemption takes place which can be filled in any of the modes explained in detail below questions.
8. What kinds of shares have to be issued?
Equity/Preference shares to be issued and the proceeds can be utilized for redemption of Preference shares.
9. Can the securities premium amount of fresh issue of shares be utilized for redemption of preference shares at a premium?
It cannot be utilized in redemption of Preference shares at premium but can be utilized in paying up unissued of the company to be issued to the members of the company as fully paid bonus shares.
10. Why do professionals recommend issue of equity shares over preference shares?
When the liquidity position of the company is not satisfactory.
Where the company is not able to declare dividend due to insufficient funds.
Where the company has decided to have its share capital permanently over preference shares.
11. What would be the advantages of redemption of preference shares by issuing equity shares?
No cash outflow of money
New equity shares may be valued at premium
No capital gain tax for shareholders
Shareholders can retain their interest.
12. What would be the disadvantages of redemption of preference shares by issuing equity shares?
There is a possibility of dilution of future earnings.
Shareholders retain their equity interest.
13. When should the resolutions be passed?
Both the resolution for redemption and Fresh issue of shares should be passed simultaneously and it should be noted that the securities premium amount of fresh equity shares cannot be used for premium on redemption. The provision for premium on redemption should be made well in advance.
14. What is capitalization of undistributed profits method?
Another method of redemption is capitalization of undistributed profits to be utilized instead of issuing new shares.
15. What are the conditions to be satisfied under this method?
When shares are redeemed by utilizing distributable profits, an amount equal to the face value of shares redeemed is to be transferred to Capital Redemption Reserve account.
16. What are the advantages of opting capitalization of undistributed profits?
No change in the share holding pattern of the company
Future earnings is not diluted
Surplus fund can be used
17. What are the disadvantages of using the above method?
The entire contents of this article are solely for information purpose and have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation by the Author. Compliance Calendar LLP and the Author of this Article do not constitute any sort of professional advice or a formal recommendation. The author has undertaken utmost care to disseminate the true and correct view and doesn’t accept liability for any errors or omissions. You are kindly requested to verify and confirm the updates from the genuine sources before acting on any of the information’s provided hereinabove. Compliance Calendar LLP shall not be responsible for any loss or damage in any circumstances whatsoever.