Issue and Redemption of Preference Shares

Introduction:

Preference shares, also known as preferred stock, are shares of a company’s stock that pay dividends to stockholders before common stock payments are paid out. Preferential share capital is the company’s share capital that carries or would carry a preferential right concerning payment of dividend, repayment in case of winding up of the company or repayment of capital.[1] For example, If the company goes bankrupt, preferred shareholders have a right to be compensated from the company’s assets before ordinary shareholders. A Redeemable preference share is one of the types of preference share. Redeemable Preference Shares are those whose value can be returned to the holders of such shares. That is, the company can repay the capital raised through the issue of Redeemable Preference Shares to such shares. Redemption is the process of paying back capital. The Company’s authorized capital is not reduced when redeemable preference shares are redeemed. From the perspective of the creditors, the capital is preserved because the redeemed share capital is simply replaced by the nominal value of new shares issued for redemption or by a Capital Redemption Reserve Account that is, for all practical purposes, equal to the company’s paid-up capital.

Types of Preference Shares

On the Basis of Dividends

1. Cumulative preference shares: Preference shares of this type are the most common. In comparison to ordinary preference shares, these shares have a huge advantage. Even if the company does not make a profit, shareholders have the right to receive dividends. This due dividend continues to accumulate. As a result, if the company does not declare a dividend in a given year, the arrears are viewed as unpaid and carried forward.
2. Non- Cumulative preference shares: It is the opposite of a cumulative preference share. It doesn’t pay out any dividends. If a company does not pay dividends for a few years, the amount overdue for those years cannot be claimed.

On the Basis of Redeemability

1. Redeemable preference shares: the issuing company has the option to buy back the preference shares before they mature. The company must give prior notice to preference shareholders.
2. Irredeemable preference shares: These preference shares can only be redeemed if the company closes down or goes bankrupt.

On the Basis of Convertibility

1. Convertible preference shares: Shareholders can convert their preference shares into equities. This could be done after a particular amount of time has passed and at a certain ratio.
2. Non Convertible preference shares: The right to convert preference shares into equity shares is not available to these shareholders.

On the Basis of Participation

1. Participating Preference shares: Dividends are usually paid out at a fixed rate. However, if equity owners receive a larger dividend, participating preferred shareholders may be eligible for a greater payout as well. This usually happens when a company makes a large profit in a  particular year.
2. Non Participating Preference shares: The dividend payout rate is fixed in non-participating preference shares. As a result, even if the company makes a lot of money, the preferred shareholders will be paid the stipulated dividend.

Issue and Redemption of Preference Shares

Section 55 of the Companies Act, 2013 deals with the issue and redemption of preference shares. Company limited by shares shall not issue any irredeemable preference shares.[2] Section 55(2) further specifies that a company limited by shares may issue preference shares that are required to be redeemed within a period of not beyond 20 years from the date of issuance, subject to such restrictions as may be prescribed if so allowed by its Articles of Association. 

A company involved in the infrastructural projects may issue preference shares with a term of more than 20 years but less than 30 years. It is an exception to Section 55(2) of the Companies Act,2013. The infrastructure projects listed in Schedule VI are referred to as “infrastructure projects.” However, from the twenty-first year onward or earlier on a proportionate basis, at the preference shareholders’ choice, redemption is subject to a minimum of 10% of such preference shares per year.[3]

Issue of Preference Shares

Rule 9 and Rule 10 of The Companies (Share Capital and Debentures) Rules, 2014 deal with the issue and redemption of preference shares.

The issue of preference shares has to be authorized in a company’s general meeting by passing a special resolution.[4] In the case of the listed entity, intimate the stock exchange at least two days before the date of the board meeting.[5] An explanatory statement has to be annexed to the notice calling general meeting it shall contain relevant facts such as intimation for issuance of preference shares, size of the issue, number of preference shares, the nominal value of shares, nature of shares, objective and manner of issue, terms of issue, rate of dividend, terms and tenure of redemption etc.,[6] The company should have no outstanding defaults in the redemption of preference shares issued before or after the commencement of this Act, or in the payment of dividends payable on any preference shares, at the time of such issuing of preference shares.[7]

A company issuing preference shares must include information about the following in its resolution[8]:

1. Priority in dividend payments or capital repayments over equity shares.
2. Participation in the surplus fund, assets, profits on winding-up that may remain after the whole capital has been repaid.
3. whether the dividend is paid in a cumulative or non-cumulative manner.
4. conversion of preferential shares into equity shares and regarding voting rights (matters related to preference shareholders).
5. Regarding redemption of preference shareholders.

Redemption of Preference Shares

Section 55 of the Companies Act, 2013 deals with the redemption of preference shares. Preference shares shall be redeemed out of the profits of the company or out of proceeds of fresh issue of shares.[9] Preference shares can only be redeemed if they have been paid in full. If the company proposes to redeem preference shares from its profits, a sum equal to the nominal amount of the shares to be redeemed shall be transferred from such profits to a reserve account to be known as the Capital Redemption Reserve Account. The Capital Redemption Reserve is recognized as the company’s paid-up share capital for all purposes. Share Capital and Debentures of the company may use the capital redemption reserve account to pay up unissued shares of the company to be issued to members of the company as fully paid bonus shares.[10]

For such class of companies as may be authorized and whose financial statements comply with the accounting standards specified under Section 133 of the Companies Act, 2013, the premium payable on redemption shall be paid out of the company’s profits before the shares are redeemed. The premium, if any, payable on redemption shall be paid out of the company’s profits or from the company’s securities premium account before such shares are redeemed for other companies.[11]

The payment of preference shares is an “appropriation” because it is a payment to the owners, i.e., against capital. Furthermore, profit available for dividends refers to the profit after all expenses have been deducted, i.e. the surplus. Moreover, because the premium is paid on the redemption of preference shares, it should be paid from the same profit as is used to redeem the preference shares, i.e., profit available for dividend.

According to Section 55(3), if a company is unable to redeem any preference shares or pay a dividend on such shares in accordance with the terms of the issue (referred to as “unredeemed preference shares”), it may issue additional redeemable shares equal to the amount due, including the dividend, in respect of the unredeemed preference shares, with the consent of three-fourths(75%) of holders of such preference shares with the approval of National Company Law Tribunal on a petition made by the company on this behalf. The unredeemed preference shares will then be considered redeemed. However, while granting the said approval, the National Company Law Tribunal shall order the redemption immediate of preference shares held by such persons who have not consented to the issue of further redeemable preference shares.[12]

In the matter of Companies Act, 2013 under Section 55(3) and M/s. Catalyst Finance Private Limited,[13] in this case, the company filed a petition for seeking permission from the tribunal to issue further redeemable preference shares, the company conducted the Extra Ordinary General Meeting and preference shareholders gave their consent and “no objection” to the issue of new shares. And company submitted all the required documents for approval. Then National Company Law Tribunal approved the issue of new shares. 

In Bank of Baroda v. Aban Offshore Limited,[14] the court held that Preference shareholders are not remedied, and they can apply for redemption of their preference shares under Section 55(3) of the Companies Act, 2013. They can also bring a class action suit under Section 245 of the Companies Act, 2013, and the NCLT can issue an appropriate order while using its inherent power under Rule 11 of the National Company Law Tribunal Rules, 2016.

In Aditya Prakash Entertainment Pvt. Ltd v. Magikwand Media Pvt. Ltd[15], When redeemable preference shares are issued but not honoured when they are due to be redeemed, the holder does not immediately assume the role of “creditor.” The reason for this is that his shares can only be redeemed from the company’s profits, which would otherwise be available for dividends, or by issuing new shares. This is a restriction that does not apply to the company’s other creditors. In the event that the company’s redeemable preference shares are not redeemed at the appropriate time, the company’s shareholders do not become creditors. They are still shareholders, with some preferential rights, no doubt.

A company may redeem its preference shares only on the terms on which they were issued, or on terms that have been varied after due approval of preference shareholders under Section 48 of the Companies Act, 2013. Then preference shares may be redeemed:[16]

• at a fixed time or on the occurrence of a specific event.
• at any time at the company’s option (or)
• at any time at the shareholder’s option.

Methods of redemption of preference shares:

Redemption of Preference Shares Out of Profits (i.e., Divisible Profits)

In general, the following funds can be used for the payment of dividends.

1. Reserve Fund.
2. Insurance Fund.
3. General Reserve.
4. Statement of Profit and Loss.
5. Dividends Equalisation Fund.
6. Employees Compensation fund.
7. Workers Accident Fund.
8. Voluntary Debenture Redemption A/C.
9. Voluntary Debenture Sinking Fund.

When capital is made available from these accounts to redeem redeemable preference shares, the expected capital is transferred first to the Capital Redemption Reserve Account.

Redemption of Preference Shares by the Issue of Fresh Shares

The capital obtained from the new shares for this work can be used to redeem redeemable shares. Either equity or preference shares can be used to issue new shares.

New shares might be issued at the same value or at a premium :

1. If new shares are issued at par, the remaining share capital can only be utilized to redeem preference shares.
2. If new shares are issued at a premium, the share capital can only be utilized to pay preference shares. The amount of premium can’t be used for this purpose.

Redemption of Preference Shares by Issuing the New Shares and Profit

Payment of redeemable preference shares can be made in part from the Company’s profits and in part through issuing new shares. As a result, the company’s profits and the issuance of new shares are used to redeem redeemable preference shares. If the question specifies the amount of new share capital to be issued, the balance capital will be managed from the Company’s profits. If the profits of the company indicated in the questions are insufficient, the balanced capital will be managed through the issuance of new shares.

Conclusion

Redemption is the process of repaying debt in agreed-upon sums and in agreed-upon ways. It is a contract that gives the right to redeem preference shares within or at the end of a given time period at an agreed price. A company is forbidden from issuing irredeemable preference shares. Preference shares may be redeemed through the out of profits or by issuing new shares or both. National Company Law Tribunal has to give permission to the company for the issue of new shares and also NCLT should give immediate relief to the non consented shareholders.

References:

1. Mayank Garg, Issue and Redemption of Preference Shares, (20 July, 2021, 01:25 PM)

https://taxguru.in/chartered-accountant/issue-redemption-preference-shares.html

• Dr. G.K. Kapoor and Dr. Sanjay Dhamija, Company Law and Practice (Edition 24, 2019).
• Dr. Avatar Singh, Company Law (Edition 17, 2019).
• The Companies (Share Capital and Debentures) Rules, 2014.

---

Other Sources:

[1]Section 43 of Companies Act, 2013.

[2]Section 55(1) of companies Act, 2013.

[3]Rule 10 of the Companies (Share Capital and Debentures) Rules,2014.

[4]Rule 9(1)(a) of the Companies (Share Capital and Debentures) Rules,2014.

[5]Regulation 29 of SEBI (Listing Obligations and Disclosing Requirements) Regulations,2015.

[6]Rule 9(3) of the Companies (Share Capital and Debentures) Rules,2014

[7]Rule 9(1)(b) of the Companies (Share Capital and Debentures) Rules,2014.

[8]Rule 9(2) of the Companies (Share Capital and Debentures) Rules, 2014.

[9]Section 55(2)(a) of the Companies Act, 2013.

[10]Section 55(4) of the Companies Act,2013.

[11]Section 55(2)(d) of the Companies Act, 2013.

[12]Rule 69 of National Company Law Tribunal Rules, 2016.

[13]Company Petition No. 08 of 2016.

[14]Company Appeal No: 35 of 2019.

[15]Company Petition No. 404 of 2016.

[16]Rule 9(6) of the Companies (Share Capital and Debentures) Rules, 2014.