Corporate Law

# Working Note on Preference Shares

According to Section 55 of the Companies Act, 2013, a company limited by shares cannot issue any preference shares which are irredeemable. However, a company limited by shares may, if so authorised 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.

### Definition of Preference Shares

According to Section 43 of the Companies Act, 2013, the share capital of a company limited by shares can be divided into:

- Equity share capital: which includes shares with voting rights or with differential rights as to dividend, voting, or otherwise.
- Preference share capital: which carries a preferential right with respect to payment of dividend and repayment of capital in case of winding up.

### Types of Preference Shares

1. Cumulative Preference Shares: Dividends accumulate if not paid in any year and are paid in arrears before equity dividends.
2. Non-Cumulative Preference Shares: Dividends do not accumulate if not paid in any year.
3. Redeemable Preference Shares: These shares are redeemed by the company after a fixed period of time.
4. Irredeemable Preference Shares: These shares cannot be issued under the Companies Act, 2013.
5. Convertible Preference Shares: These shares can be converted into equity shares after a specified period.
6. Non-Convertible Preference Shares: These shares cannot be converted into equity shares.
7. Participating/Non-participating: Participating preference shares give their holders the right to receive a fixed dividend and participate in surplus profits of the company after equity dividends.

### Issue and Redemption Conditions

A company limited by shares may issue preference shares liable to be redeemed within 20 years from the date of issue under the following conditions:

- The shares must be fully paid.
- The shares must be redeemed out of profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purpose of redemption.
- For companies engaged in setting up and dealing with infrastructure projects, redeemable preference shares can be issued for a period exceeding 20 years but not exceeding 30 years.

### Rights of Preference Shareholders

- Dividend: Preference shareholders are entitled to receive dividends before equity shareholders.
- Repayment of Capital: Preference shareholders have the right to be paid back their capital before equity shareholders in the event of winding up.
- Voting Rights: Preference shareholders generally do not have voting rights, except in certain circumstances like resolutions directly affecting their rights, non-payment of dividends for a period of two years or more, etc.

### Key Compliance Requirements

1. Board and Shareholder Approval: The issuance of preference shares requires approval from the board of directors and shareholders through a special resolution.
2. Filing with Registrar of Companies (ROC): Necessary filings must be made with the ROC, including details of the terms of issue and the special resolution passed.
3. Maintaining Records: Companies must maintain proper records of preference shares issued, redeemed, and outstanding.
4. Return of Allotment: A return of allotment of preference shares (Form PAS-3) must be filed with the ROC within 30 days of the allotment.

### Advantages of Preference Shares

Fixed Dividends & Priority: Preference shareholders receive dividends at a fixed rate, providing a steady income stream. In case of liquidation, preference shareholders have a higher claim on assets and earnings compared to equity shareholders, making them less risky.

Flexibility for Issuers & Non-Dilution: Companies can structure preference shares in various ways. Issuing preference shares does not dilute the control of existing equity shareholders since preference shareholders typically do not have voting rights.

### Disadvantages of Preference Shares

Higher Cost & Obligation: The fixed dividend obligation can be more costly than variable dividends on equity shares. For redeemable preference shares, redemption can be a financial burden. Dividends are not tax-deductible for the company, unlike debt interest payments.

No Voting Rights & Less Capital Appreciation: Preference shareholders usually do not have voting rights and do not benefit from capital appreciation in the same way as equity shares.