by Preference Shares, also known as preferred stock, are a type of share capital that gives certain preferences to its holders over common equity shareholders. These preferences typically include a fixed dividend payout and priority in the event of company liquidation. Preference shares are a hybrid instrument, possessing features of both equity and debt. In India, the issuance and redemption of preference shares are governed by the Companies Act, 2013 and related rules.
The process of issuing and redeeming preference shares involves specific legal requirements, terms, and procedures, all aimed at protecting shareholders and ensuring proper corporate governance.
Issue of Preference Shares
The issue of preference shares is governed by Section 55 of the Companies Act, 2013. This section lays down the guidelines for the issuance of such shares, ensuring that companies follow a transparent and regulated process.
Types of Preference Shares
Preference shares can be classified into various categories based on their features:
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Cumulative Preference Shares:
These shares entitle the shareholders to accumulate unpaid dividends. If the company fails to pay the dividend in a particular year, the amount is carried forward to future years and paid when profits are available.
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Non-cumulative Preference Shares:
In this case, the shareholders do not have the right to accumulate unpaid dividends. If the dividend is not paid in a particular year, the shareholder cannot claim it in the future.
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Convertible Preference Shares:
These shares can be converted into equity shares after a specified period or upon the occurrence of certain events, as per the terms agreed upon at the time of issuance.
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Non-convertible Preference Shares:
These shares cannot be converted into equity shares and remain preference shares until they are redeemed or bought back.
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Participating Preference Shares:
Holders of these shares are entitled to a share in the surplus profits of the company in addition to the fixed dividend, usually after the equity shareholders are paid.
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Non-participating Preference Shares:
These shareholders are entitled only to a fixed dividend and have no rights over the surplus profits.
Procedure for Issuing Preference Shares
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Board Resolution:
The process begins with the board of directors passing a resolution to issue preference shares. This resolution must outline the terms and conditions, such as the type of preference shares, dividend rate, redemption period, and any conversion rights.
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Shareholder Approval:
The issue of preference shares requires approval from the company’s shareholders. This approval is generally obtained in a general meeting through a special resolution.
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Compliance with the Companies Act, 2013:
Section 55 mandates that preference shares must be issued for a maximum period of 20 years, except in the case of infrastructure projects, where shares may be issued for a longer period. Companies must also ensure that preference shares are redeemable, meaning that they will be repaid or bought back after a specified period.
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Prospectus or Offer Document:
If the company is issuing preference shares to the public, it must issue a prospectus or offer document as per the guidelines set by the Securities and Exchange Board of India (SEBI). This document provides details about the offer, including the number of shares, dividend rate, terms of redemption, and risks involved.
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Filing with Registrar of Companies (RoC):
After obtaining the necessary approvals, the company must file the relevant forms with the Registrar of Companies (RoC), including details of the issued shares.
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Issuance of Share Certificates:
Once all regulatory approvals are obtained, the company issues share certificates to the preference shareholders, marking the completion of the issuance process.
Rights of Preference Shareholders
Preference shareholders enjoy the following key rights:
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Fixed Dividend:
Preference shareholders receive a fixed rate of dividend before any dividends are paid to equity shareholders.
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Priority in Repayment:
In the event of liquidation, preference shareholders have a higher claim on company assets compared to equity shareholders.
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Voting Rights:
Typically, preference shareholders do not have voting rights in the company’s day-to-day affairs. However, they may obtain voting rights if their dividends remain unpaid for two or more consecutive years.
- Redemption:
Preference shares are redeemable, meaning that the company must repay the capital to preference shareholders after a certain period, subject to the terms of the issue.
Redemption of Preference Shares
Redemption of preference shares refers to the process by which a company repays the preference shareholders the face value of their shares. This can happen at a pre-determined time, subject to the terms agreed upon at the time of issuance.
Conditions for Redemption under Section 55 of the Companies Act, 2013
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Authorized by Articles of Association:
The company’s Articles of Association (AoA) must explicitly permit the redemption of preference shares. If the AoA does not contain such a provision, it must be amended before the redemption can take place.
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Fully Paid-up Shares:
Only fully paid-up preference shares can be redeemed. If the shares are only partially paid, the redemption process cannot be initiated until all dues are paid in full.
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Redemption out of Profits or Fresh Issue:
The company can redeem preference shares either:
- Out of profits available for distribution as dividends, or
- From the proceeds of a new issue of shares.
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Capital Redemption Reserve (CRR):
If the company redeems preference shares out of its profits, an equivalent amount must be transferred to a Capital Redemption Reserve (CRR). This CRR serves as a safeguard against the company depleting its capital base and must be maintained as long as the company is in existence.
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No Redemption at Premium Without Special Resolution:
If preference shares are to be redeemed at a premium, the terms of redemption must be specified at the time of issuance, and shareholder approval must be obtained through a special resolution.
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Filing with Registrar of Companies:
Once preference shares are redeemed, the company must file the necessary documents with the RoC, including the details of the redeemed shares.
Modes of Redemption:
Redemption can occur through one of the following methods:
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Redemption at Par:
In this case, preference shareholders are repaid the face value of their shares. No premium is involved, and the redemption amount equals the nominal value of the shares.
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Redemption at Premium:
In some cases, companies offer to redeem preference shares at a price higher than the face value. The premium must be paid out of the company’s profits or reserves and requires shareholder approval.
Process of Redemption of Preference Shares:
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Approval for Redemption:
The board of directors must first approve the redemption plan. The resolution must include details such as the type and number of shares to be redeemed, the redemption price, and the source of funds (profits or fresh issue).
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Funding the Redemption:
The company must ensure that it has sufficient funds for the redemption. If the redemption is to be made from profits, the company must set aside the requisite amount. If a fresh issue of shares is to fund the redemption, the company must raise the capital before proceeding.
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Payment to Shareholders:
Once the funds are available, the company repays the preference shareholders according to the agreed terms. This may involve either transferring the redemption amount directly to the shareholders’ accounts or issuing cheques.
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Capital Redemption Reserve (CRR):
If the shares are redeemed out of profits, an amount equal to the face value of the redeemed shares must be transferred to the CRR. This reserve cannot be used for dividend payments or general business expenses and serves to preserve the company’s capital base.
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Updating the Register of Members:
After the redemption, the company must update its register of members to reflect the reduction in the number of preference shares.
Key Differences between Issuance and Redemption of Preference Shares
| Aspect | Issuance of Preference Shares | Redemption of Preference Shares |
| Nature | Raises capital for the company | Repayment of capital to shareholders |
| Approval Required | Requires board and shareholder approval | Requires board approval and sufficient funds |
| Payment | No immediate payment to shareholders | Payment of redemption amount to shareholders |
| Capital | Increases company’s capital | Reduces company’s capital |
| Filing | Filing required with RoC for issue details | Filing required for redemption details |
| CRR | Not applicable | Creation of CRR if redeemed out of profits |
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