What are Preference Shares?

There are 2 types of shares in any company first is Equity shares or Common Stock and the second is Preference shares of Preferred stock. Equity shareholders are considered as real owners of the Company as they have voting rights in a company while preference shareholders don’t have voting rights on all resolutions in ordinary circumstances.

However, where the dividend in respect of preference shares has not been paid for a year or more, such class of preference shareholders shall have a right to vote on all the resolutions placed before the company.

Preference shareholders are given priority in payment of dividends and dividends in case of winding up. The rate of dividend on equity shares fluctuates every year as it depends on the amount of profit available to the company. On the other hand, Preference Shares carry either a fixed rate or a fixed amount as a dividend.

What is Redemption of Preference Shares?

Redemption is the process of repaying an obligation, at prearranged amounts and timings. It is a contract giving the right to redeem preference shares within or at the end of a given period at an agreed price. These shares are issued on the terms that shareholders will at a future date be repaid the amount which they invested in the company (along with frequent payment of a specified amount as return on investment during the tenure of the preference shares).

The redemption date is the maturity date, which specifies when repayment takes place and is usually printed on the preference share certificate. Through the process of redemption, a company can also adjust its financial structure, for example, by eliminating preference shares and replacing those with other securities if future growth of the company makes such change advantageous.

What is Section 55 of Companies Act 2013?

Section 55.Issue and redemption of preference shares.

(1) No company limited by shares shall, after the commencement of this Act, issue any irredeemable preference shares.

(2) A company limited by shares may, if so authorized by its articles, issue preference shares which are liable to be redeemed within a period not exceeding twenty years from the date of their issue subject to such conditions as may be prescribed:

Provided that a company may issue preference shares for a period exceeding twenty years for infrastructure projects, subject to the redemption of such percentage of shares as may be prescribed: on an annual basis at the option of such preferential shareholders:

Provided further that—

(a) no such shares shall be redeemed except out of the profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for such redemption;

(b) no such shares shall be redeemed unless they are fully paid;

(c) where such shares are proposed to be redeemed out of the profits of the company, there shall, out of such profits, be transferred, a sum equal to the nominal amount of the shares to be redeemed, to a reserve, to be called the Capital Redemption Reserve Account, and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the Capital Redemption Reserve Account were paid-up share capital of the company; and

(d) (i) in case of such class of companies, as may be prescribed and whose financial statement comply with the Accounting Standards prescribed for such class of companies under section 133, the premium, if any, payable on redemption shall be provided for out of the profits of the company before the shares are redeemed:

Provided also that premium, if any, payable on redemption of any preference shares issued on or before the commencement of this Act by any such company shall be provided for out of the profits of the company or out of the company’s securities premium account before such shares are redeemed.

(ii) in a case not falling under sub-clause (i) above, the premium, if any, payable on redemption shall be provided for out of the profits of the company or out of the company’s securities premium account before such shares are redeemed.

(3) Where a company is not in a position to redeem any preference shares or to pay a dividend, if any, on such shares by the terms of the issue (such shares hereinafter referred to as unredeemed preference shares), it may, with the consent of the holders of three-fourths in value of such preference shares and with the approval of the Tribunal on a petition made by it in this behalf, issue further redeemable preference shares equal to the amount due, including the dividend thereon, in respect of the unredeemed preference shares, and on the issue of such further redeemable preference shares, the unredeemed preference shares shall be deemed to have been redeemed:

Provided that the Tribunal shall while approving this sub-section, order the redemption forthwith of preference shares held by such persons who have not consented to the issue of further redeemable preference shares.

Explanation.—For the removal of doubts, it is hereby declared that the issue of further redeemable preference shares or the redemption of preference shares under this section shall not be deemed to be an increase or, as the case may be, a reduction, in the share capital of the company. (Notified on 01-06-2016)

(4) The capital redemption reserve account may, notwithstanding anything in this section, be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares.

Explanation.—For sub-section (2), the term “infrastructure projects” means the infrastructure projects specified in Schedule VI

Why Issue for Redemption of Preference Shares?

A company may issue redeemable preference shares because of the following:

1. It is a proper way of raising finance in a dull primary market.

2. A company may face difficulty in raising share capital, as its shares are not traded on the stock exchange. Potential investors, hesitant in putting money into shares that cannot easily be sold, may be encouraged to invest if the shares are redeemable by the company.

3. The preference shares may be redeemed when there is a surplus of capital and the surplus funds cannot be utilized in the business for profitable use.

In India, the issue and redemption of preference shares are governed by Section 55 of the Companies Act, 2013.

Procedure for Issue of Preference Shares

1. Check whether Articles of Association contains clauses for the issuance of preference shares. If not, amend the AOA first.

2. Convene a Board Meeting for the following purposes:

*To increase Authorized preference share capital, if required;

*To approve the issuance of preference shares; To convene General Meeting for taking approval of shareholders.

3. Convene General Meeting for the following purposes:

*To increase Authorized preference share capital, if required.

*To approve the issuance of preference shares by way of Special Resolution;

4. File form MGT-14 with the Registrar of Companies within 30 days of approval of shareholders along with the Copy of Special Resolution and Explanatory Statement.

5. Take Application Money of preference shares through banking channels.

6. Allot the preference shares within 60 days from the date of receipt of application money. Allotment can be done by the board or any committee or even an authorized person.

7. File form PAS-3 within 15 days or 30 days as the case may be, from the date of allotment.

8. Share Certificate i.e. (Form SH-1) is to be issued to the prospective preference shareholders within 2 months from the date of allotment.

Methods of Redemption of Fully Paid-up Shares

Redemption of preference shares means repayment by the company of the obligation on account of shares issued. According to the Companies Act, 2013, preference shares issued by a company must be redeemed within the maximum period (normally 20 years) allowed under the Act. Thus, a company cannot issue irredeemable preference shares. Section 55 of the Companies Act, 2013, deals with provisions relating to the redemption of preference shares. It ensures that there is no reduction in shareholders’ funds due to redemption and, thus, the interest of outsiders is not affected. For this, it requires that either fresh issue of shares is

made or distributable profits are retained and transferred to ‘Capital Redemption Reserve Account’.

The rationale behind these provisions is to protect the interest of outsiders to whom the amount is payable before redemption of preference share capital. The interest of outsiders is protected if the nominal value of capital redeemed is substituted, thus, ensuring the same amount of shareholders’ fund. In case of redemption of preference shares out of proceeds of a fresh issue of shares, replacement of capital and tangible assets is obvious. But, if redemption is done out of distributable profits, replacement of capital is ensured indirectly by retention of profit by transfer to Capital Redemption Reserve. In this case, the amount which would have gone to shareholders in the form of dividends is retained in the business and is used for settling the claim of preference shareholders. Thus, there is no additional claim on the net assets of the Company. The transfer of divisible profits to Capital Redemption Reserve makes them non- distributable profits. As Capital Redemption Reserve can be used only for the issue of fully paid bonus shares, profits retained in the business ultimately get converted into share capital.

Security cover available to outside stakeholders depends upon called-up capital as well as uncalled capital to be demanded by the company as per its requirements. To ensure that the interests of outsiders are not reduced, Section 55 provides for the redemption of only fully paid-up shares.

From the above paras, it can be concluded that the gap’ created in the company’s capital by the redemption of redeemable preference shares much to be filled in by;

(a) the proceeds of a fresh issue of shares,

(b) the capitalization of undistributed profits, or

(c) a combination of (a) and (b).

Redemption of Preference Shares by Fresh Issue of Shares

One of the methods for the redemption of preference shares is to use the proceeds of a fresh issue of shares. A company can issue new shares (equity share or preference share) and the proceeds from such new shares can be used for the redemption of preference shares.

The proceeds from the issue of debentures cannot be utilized for this purpose.

A problem arises when a fresh issue is made for the redemption of preference shares, at a premium. The point to ponder is whether proceeds of a fresh issue of shares will include the amount of securities premium for reference shares.

For securities premium account, Section 52 of the Companies Act, 2013 provides that the securities premium account may be applied by the company;

(a) Towards issue of un-issued shares of the company to be issued to members of the company as fully paid bonus securities

(b) To write off preliminary expenses of the company.

(C) To write off the expenses of, or commission paid, or discount allowed on

any of the securities or debentures of the company

(d) To provide for premium on the redemption of redeemable preference shares or debentures of the company.

(e) For the purchase of its own shares or other securities.

If maybe noted that certain clIts of Companies whose financial statements comply with the Accounting Standards as prescribed under Section 133 of the Companies Act, 2013, can’t apply the securities premium account for the purposes (b) and (d) mentioned above.

Any other way, except the above-prescribed ways, in which securities premium account is utilized# will be in contravention of the law.

Thus, the proceeds of a fresh issue of shares will not include the amount of

securities premium for the redemption of preference shares.

Reason For Issuing of New Issued Shares

A company may prefer issue of new unity shares for the following reasons:

(a) When the company has come to realize that the capital is needed permanently and it makes more sense to issue Equity Shares in place of Redeemable Preference Shares which carry a fixed rate of dividend.

(b) When the balance of profit which would otherwise be available for

dividend is insufficient.

(c) When the liquidity position of the company is not good enough.

When a Company is Unable to Redeem Preference Shares

Where a Company is not in a position to redeem any preference shares or to pay dividends if any, on such shares by the terms of issue then such shares shall be referred to as ‘unredeemed preference shares’. A Company may, with the consent of the holders of 3/4th in value of such preference shares and with the approval of the National Company Law Tribunal (NCLT) on a petition made by it in this behalf, issue further redeemable preference shares equal to the amount due, including the dividend thereon, in respect of the unredeemed preference shares, and on the issue of such further redeemable preference shares, the unredeemed preference shares shall be deemed to have been redeemed. The NCLT shall order the redemption forthwith of preference shares held by such persons who have not consented to the issue of further redeemable preference shares.

Conclusion

Preference shares are the perfect instrument for a Company that is looking for an investment Houtiluting voting rights and control over the Company. At the same time, it offers the preference shareholders a fixed income and priority of dividend and repayment.

Shubham Mishra

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