Issuing Preference Shares: Key Steps and Considerations

Issue of preference shares is a significant financial manoeuvre for companies looking to raise capital. This process involves multiple strategic decisions and adherence to legal compliance measures. Understanding the intricacies of issue of preference shares is important for both corporate entities and investors. This article focuses essentially on matters relating to issuing preference shares, including their meaning, legal implications, types, procedural steps, and conditions for redemption.

 What are Preference Shares?

Preference shares, often referred to as preferred stock, represent a class of ownership in a company with preferential rights over ordinary shares. The key characteristic that distinguishes preference shares from equity shares is dividends that are paid out to shareholders before equity share dividends are issued.  The holders of Preference Shares have been given the right to be paid from company assets before equity shareholders in case the company goes into liquidation.

Generally, the preference shares have a fixed dividend unlike equity shares. These shares are appealing to investors seeking stable income with less risk compared to equity shares. Companies benefit from issue of preference shares by raising capital without diluting voting power, as preference shareholders typically do not have voting rights.

Preference Shares Meaning in Company Law

In company law, preference shares are defined as shares that carry preferential rights over ordinary shares. According to the Companies Act, 2013, “Preference Share Capital’’, with reference to any company limited by shares, means that part of the issued share capital of the company which carries or would carry a preferential right with respect to—

• payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may either be free of or subject to income-tax; and

• repayment, in the case of a winding up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up, whether or not, there is a preferential right to the payment of any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company.

In India, the issue of preference share should be in accordance with certain specific provisions and regulations. The issue of preference shares which are irredeemable is prohibited by Section 55 of the Companies Act, 2013. A company can issue redeemable preference shares for a maximum duration of twenty years from their issue date.

Additionally, preference shares can be of various types, each having distinct rights and obligations. Understanding the legal framework governing the issue of preference shares is essential for ensuring proper compliance and protecting the interests of all stakeholders.

Kinds of Preference Shares

There are different kinds of preference shares, each offering different rights and benefits to shareholders. The main types include:

1.Cumulative Preference Shares: Shareholders who own cumulative preference shares are entitled to receive cumulative dividend payments from the company even in the event that they are not profitable.
These dividends are treated as arrears and paid out cumulatively when the company makes profit.

2. Non-Cumulative Preference Shares: In non – cumulative preference shares dividends are not paid to shareholders in the form of arrears. In this case, the dividend is paid out from the profits made by the company in the current year.
Shareholders are also not entitled to dividends in any subsequent year or profit if they do not get dividend in the current year.

3.Participating Preference Shares: Participating preference shares help shareholders demand a part in the company’s surplus profit after the dividends have been paid to other shareholders.

4. Non-Participating Preference Shares: These shareholders are not entitled to any surplus profits earned by the company and only get fixed dividends.

5. Convertible Preference Shares: After a specific period or on the occurrence of certain events, this type of preference shares can be converted into equity shares.

6. Non-Convertible Preference Shares: Non-Convertible shares cannot be converted into equity shares.

7. Redeemable Preference Shares: The Preference shares which can be redeemed by the issuer at a fixed rate and date are called redeemable preference shares.

8. Irredeemable Preference Shares: These cannot be bought back by the company, but these shares are rare due to regulatory constraints in many countries.

Procedure for Issue of Preference Shares in Company Law

Pre-Conditions for Issue of Preference Shares – A corporation is not permitted to issue of preference shares which are irredeemable in accordance with Section 55 of the Companies Act, 2013. Within a maximum time duration of 20 years from the date of issuance, the preference shares must be redeemed. Issuing preference shares for a duration of more than twenty years is allowed for infrastructure projects, subject to the prescribed conditions of redemption.

The procedure for issue of preference shares involves several key steps, which must be carefully followed by companies. Here are the primary steps involved in the issue of preference shares under company law:                    

1.Board Approval: The proposal to issue preference shares is made by the board of directors to start the process. This necessitates an in-depth examination of the company’s financial requirements and the advantages of issuing preference shares.

2.Shareholder Approval: The proposal needs to be submitted to the shareholders for approval after the board gives its approval. This is normally accomplished by passing a special resolution at a general meeting.

3.Drafting of Terms: The terms and conditions of issue of preference shares, including dividend rate, redemption terms, and any conversion rights, must be clearly defined. These terms should be included in the company’s Articles of Association.   

4.Filing with Regulatory Authorities: The required forms and documents must be submitted to the Registrar of Companies (RoC) by the Company. The company must file E-form MGT-14 with the RoC within 30 days of the passing of the resolution along with the copy of special resolution, a copy of the terms of issue, extract of minutes of the general meeting and other required documents.

5.Allotment and Issuance of Share Certificates: Once regulatory approval is obtained, the company can proceed with the allotment of preference shares and file Form PAS-3 with the concerned RoC in respect of the said allotment. The Company shall issue share certificate in Form SH-1 within 2 months from the date allotment of the shares.

Conditions for Redemption of Preference Shares

When a business buys back its issued preference shares from shareholders, it is known as the redemption of preference shares. This usually occurs on a specific date and at a predetermined price. There are specific conditions and legal requirements for the redemption of preference shares:

1.  Redemption Terms: The terms of redemption, including the time and manner of redemption, must be explicitly stated at the time of issue. Generally, preference shares are redeemable on a predetermined date or after a predetermined amount of time.

2.  Source of Funds: In order to redeem preference shares, only earnings available for dividends or funds from a new issue of shares made for the same purpose can be used. 

3.  Fully Paid Shares: Only fully paid preference shares can be redeemed. If there are any unpaid amounts on the shares, they must be settled before redemption.

4.  Capital Redemption Reserve: If redemption is out of profits, the Company is required to transfer a sum equal to the nominal value of the shares redeemed to the Capital Redemption Reserve account. This reserve can be used for issuing bonus shares but not for paying dividends.

5.  No redemption at discount: reference shares can be redeemed either at par or at a premium. A company cannot redeem Preference Shares at a discount.

Frequently Asked Questions

1. What is the maximum tenure of preference shares?

• Preference shares must be compulsorily redeemed at the end of 20 years. Hence, the maximum tenure for any preference share can be 20 years. However, issuing preference shares for a duration of more than 20 years is allowed for infrastructure projects, subject to the prescribed conditions of redemption.

• What is the key disadvantage of Preference Shares?

• The key disadvantage of Preference Shares is that there are no voting rights for the Preference Shareholders.

• Why is it called ‘Preference’ Shares?

• Preference Shares are so called because they are paid in priority as compared to the ordinary equity shares in case of payment of dividend and upon liquidation.

Conclusion

By the issue of preference shares companies can raise capital without diluting control, while investors enjoy preferential treatment in dividends and liquidation proceeds. However, the process of issue of preference shares requires diligent planning and compliance with the regulatory frameworks. With the team of professionals at InstaFiling, you can have access to expert guidance and support throughout the process of issue of Preference Shares. Our expertise ensures accurate and timely compliance with all the legal requirements.