Preference share is a hybrid security which carries the features of both equity and debt. While preference shares allow the holder to receive income in the form of dividend alike the ordinary shares, they are redeemable after specified period of maturity alike debentures.

Preference shares vest preferential right in the holders with respect to payment of dividend and repayment of capital meaning thereby that the holders of preference shares enjoy priority in case of receipt of dividend unlike the holders of equity shares and in the case of winding up of the company, the holders of preference shares enjoy the priority of being repaid ahead of holders of equity shares.

The holder of this kind of shares indeed holds the right to receive regular fixed payments but does not get the right to vote at meetings of equity shareholders since a company cannot issue preference shares carrying voting rights.

While erstwhile Companies Act, 1956 (‘Act, 1956’) provided for cumulative and non-cumulative preference shares but the Companies Act, 2013 (‘Act, 2013’) doesn’t distinguishes preference shares on the said basis but has left to the issuer to decide the same as a part of terms and conditions of the issuance. It is very important to decide upon the nature of preference share to be issued since this forms the basis of determination of various rights of holder of such share.

Preference shares are basically classified into following:

• Cumulative and Non-Cumulative Preference Shares.
• Participating and Non-Participating Preference Shares.
• Convertible and Non-Convertible Preference Shares.
• Redeemable and Irredeemable Preference Shares.

Cumulative and Non-Cumulative Preference Shares	Cumulative Preference Shares: Where a Company does not declare dividend on preference shares in a particular year in that case the unpaid dividend is accumulated and carried forward to subsequent years. Eventually when the company decides to pay dividend then it has to first pay the accumulated dividend of previous years to the preference shareholders before paying any dividend on ordinary shares. Non-Cumulative Preference Shares: Unlike above, the unpaid dividend is not accumulated and the preference shareholders lose the right of dividend for the past year(s). In other words, the right to receive dividends gets extinguished on the expiry of due date of dividend.
Participating and Non Participating Preference Shares	Participating Preference Shares: Participating preference shares allow holders to participate on the same footings with the holders of equity shares in: profits remaining after paying fixed dividend on preference shareholders. Surplus Assets and profits on winding-up which may remain after the entire capital has been repaid. Non-Participating Preference Shares: Unlike above, the holder of these shares does not enjoy rights over and above their fixed entitlements.
Convertible and Non-Convertible Preference Shares	Convertible Preference Shares: These shares may be converted into equity at the expiry of the maturity period or any event prescribed in the terms. Convertible preference shares are further classified into following: Optionally Convertible preference shares: This class of shares can be converted into equity shares either at the option of holder or at the option of the company. The convertible portion can be in full or in part Mandatorily convertible preference shares: This class of shares are compulsorily convertible into equity shares. The convertible portion can be in full or in part Non-Convertible Preference Shares: This class of shares do not allow holders to get their shares converted into equity, they are rather redeemed at the expiry of the maturity period , these are generally called as ‘Redeemable Preference shares’.
Redeemable and Irredeemable Preference Shares	Redeemable Preference Shares: Redeemable preference shares inculcate an obligation on the issuer company to repay the capital to the holders on the specified date of maturity. Irredeemable Preference Shares: Under the Act, 2013, a company cannot issue irredeemable/ perpetual preference shares. However, under laws like Banking Regulation Act, 1949, a banking company can issue irredeemable/ perpetual preference shares.

 

Eligibility criteria for issuing preference shares

As per Section 55 of the Act 2013 read with Rule 9 made thereunder, a company is required to fulfill the following conditions before issuing preference share(s):

1.	Authority in the articles	The articles of association of a company shall contain a provision with respect to issuance of preference shares.
2.	Special Resolution	The issue shall be authorized by passing special resolution in the general meeting of a company.
3.	No Subsisting Default	There shall be no subsisting default in the redemption of preference shares issued earlier or in payment of dividend due on any preference shares.

Out of the above, while the first and second criteria are very clear, the third criteria is subject to mixed opinions on the context specifically with respect to ‘subsisting default in payment of dividend due on any preference shares’. In case of default in redemption of preference shares, there is no room of further interpretation but in case of default in payment of dividend due, there is ambiguity which has resulted into different interpretations. Let us try to understand the intent of the legislature behind the third criteria by looking into the following two questions

• When the dividend in preference shares is said to be due?
• What is meant by subsisting default?

When the dividend on preference shares is said to be due?

At the onset, we need to first understand what shall be the due date of payment of dividend for preference shares. In this regard, the Act, 2013, is silent on the due date of payment of dividend on preference shares while the Act, 1956 specifically provided the due date in the explanation to clause (b) of section 87(2),  which inter-alia provided that the dividend on preference shares shall be deemed to become due whether it was declared or not, on the following day:  

(a) On the last day specified for the payment of such dividend for such period, in the articles or other instrument executed in that behalf; or

(b) In case no day is so specified, on the day immediately following such period.

From the above provisions of Act, 1956, it means the due date of dividend was deemed to be date as specified in the terms of preference shares and if no date was specified, then the due date used to be first day of the next period. Here the ‘period’ relates to the time for which the dividend on preference shares becomes due.

But the explanation given under the Act, 1956 can’t be directly applied in the current case since the Act, 2013 doesn’t provides the same.  But at the same time, it can’t be said there will not be any due-date for payment of dividend on the preference shares. Without any due-date, neither the preference shareholders will know when to expect the dividend, nor the issuing company will be able to ascertain its liability to pay. Therefore, the due date of dividend shall be determined based upon the terms of issue of preference shares In case the terms provide for payment of dividend on yearly basis but silent on the due date of payment, then the dividend shall be deemed to be due every year i.e. within one year from the date of allotment.

When the default shall be treated to be subsisting or not?

The words ‘subsisting default’ mean the default either in payment of dividend to preference shareholders or redemption of preference shares, must be in existence, at the time of issuance of fresh preference shares. In case of dividend, the tenure of the preference shares can be upto the period of 20 years and there is a possibility during the tenure that a company may not able to pay dividend in any or all the year, as and when the dividend is due on such shares. Where a company makes default in payment of dividend on preference shares for period relating to one particular year or for whole tenure, the company by virtue of the abovementioned conditions become ineligible to issue fresh preference shares since the default of payment of dividend is subsisting.

The above interpretation looks simple and straight forward but this will paralyze a company  to issue further preference shares since the default in payment of dividend will persists during its life time. Therefore, in understanding ‘subsisting default’, it is necessary to look into the nature of the preference share i.e. cumulative or non-cumulative. In case of cumulative preference shares, the amount of unpaid dividend gets accumulated in the subsequent years and the liability to pay for past years exists during the entire tenure as opposed to non-cumulative, where such liability does not gets carry forward to the next year and since the liability to pay extinguish post due date, the ‘subsisting default’ shall be attached to the former and not to the later one. Treating default in payment of dividend due on non-cumulative preference shares post due date of payment, will create a mandatory obligation to pay for past dividend, in order to issue fresh preference shares , which will defeat the entire objective of issuing cumulative or non-cumulative preference shares.

Therefore, it can be said that the ‘subsisting default in payment of dividend’ shall be checked if the company has cumulative preference shares whether it has paid dividend during the tenure of outstanding preference shares and in case of non-cumulative, there is no subsisting default.

Now, as we have dealt with the critical issues related to issuance of the preference shares, let move to look into some other important and connected issues.

Whether the company can issue zero percent preference shares?

While we discussed about the eligibility criteria for issuing preference shares, another important factor which needs a deliberation, is on the point that whether we can issue zero percent preference shares. The definition of preference shares is defined as part of the issued share capital of the company which carries or would carry a preferential right with respect to—

(a) 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.

From the above criteria, the preference shares are described as that capital which has a fixed rate, or amount, of dividend which payable on periodical basis to the holders of these shares. This is one of fundamental difference between preference and equity shares. The fact that dividend needs to be in form of fixed amount or amount calculated at fixed rate, implies that there must be some outflow from a company to the holders of preference shares in the form of dividend whereas in case of 0% preference shares, there will not be any flow of sum and zero percent dividend is never declared or paid. Further, the usage of the phrase ‘either be free of or subject to income-tax’ also gives an indication that the dividend shall be payable. The issuance of zero percent preference shares will defeat the entire purpose of differentiation in class of capital and will also render certain other provisions of the Act, redundant.

Under the taxation laws, “zero” is regarded as a rate, as this gives the authorities a basis to increase the rate in future and levy tax but this same principle can’t be applied in case of the preference shares since the context is completely different.

Thus, in our view, a company cannot issue zero percent preference shares.

Whether valuation is required in case of issuance of preference shares:

There has been a lot of confusion surrounding the valuation requirement for issuance of preference shares on private placement basis in the light of section 62 read with rules made thereunder. Following provisions are worth considering in this regard

• Rule (9) of the Companies (Share Capital and Debentures) Rules, 2014 provides that in case of issue of preference shares, the price at which shares are proposed to be issued along with basis on which price has been arrived, shall be disclosed in the explanatory statement to the notice
• Section 62(i)(c) provides that where the company increases its subscribed capital by issuing shares (equity as well as preference) to any person whether member of a company or not, such shares have to be issued at a price determined by the registered valuer, subject to compliance with applicable provisions of Chapter III and other conditions as may be prescribed.

So, before issuing the preference shares, company need to inform the shareholders, price of issues along with manner of arriving the price. Further section 62 (1)(c) provides the requirement of valuation and compliance of other prescribed conditions. It is to be noted that under section 62 (1)(c), requirement of valuation and compliance with prescribed conditions, are two different set of obligations, which are independent of each other. This is evident from the fact from the following

• Section 62 (1)(c) uses the term ‘shares’, the term preferential offer defined in Rule 13 includes equity and convertible instruments.  
• Rule 13(1) provides that preferential offer is one of ways for issuing shares under section 61(1)(c) and Rule 13(2) provides the conditions to be complied for issues of preferential allotment and not other types of issue of shares covered under Rule 13.

The aforesaid clearly highlights that the requirement of valuation is not only limited to equity shares and convertible instrument but also to all types of shares including preference shares.

Whether approval of shareholders/board is required to declare dividend on preference shares?

Hereinbefore we have discussed how to identify, when the divided becomes due for preference shares, lets understand, how the dividend will be declared and paid. As opposed to equity shares, the rate or amount of dividend is fixed at the time of issuance of preference shares and which is also approved by the equity shareholders, there seems no requirement of obtaining approval of shareholders at the time of declaring or paying dividend to preference shareholders during the tenure of the preference shares. Further considering there is a due date of payment of dividend on preference shares, the only question which needs to be considered is with respect to approval of the Board of Directors for declaration and payment of dividend on preference shares. The Act, 2013 is silent on this. We need to consider that dividend on preference shares can’t be equated with interest in complete sense, while interest is an expense and dividend is appropriation out of the profit. Just because rate or amount of dividend in fixed, it can’t be said to be payable without approval of Board. At times, the Company might be in needs of funds and therefore don’t wish to pay dividend neither on preference shares nor on equity shares, accordingly the approval of Board for declaration and payment of dividend is important.

Further it is to be noted that for payment of dividend, other remaining procedural requirement like opening of bank account, restrictions on payment of dividend out of reserves etc., will continue to apply.

Whether Interim Dividend Can Be Declared on Preference Shares?

With respect to divided, another issue which is related to dividend on preference shares, is that whether they are eligible for interim dividend similar to equity share.

While the Act, 2013 clearly provides that preference shareholders will have preferential right over equity shareholders with respect to payment of dividend and as per clause (35) of Section 2, the term dividend includes interim dividend, therefore the preferential right should also extend to interim dividend. Where the dividend on preference shares is not due, then such preferential right of preference shareholders doesn’t extend to interim dividend so declared on equity shareholders since as per the terms of the issuance of preference shares, they are eligible for a fixed dividend payable. However, in case of arrears of dividend which is applicable only in case of cumulative preference shares, the interim dividend on equity shares so declared by the Board shall be first adjusted against such arrears.

Further even if the divided is not due but preference shares are participating in nature, the interim dividend can be declared by the board of directors but if the shares are non-participating, the approval of equity shareholders is required to declare dividend over and above the fixed rate of dividend. 

When will the voting rights will accrue?

Under the Act 1956, preference shareholders shall be entitled to voting rights only on the resolutions which directly affect their rights. Further where divided due remained unpaid for an aggregate period of two years, they get the right to vote on every resolution put before in general meeting though criteria was different for cumulative and non-cumulative preference shares.

Under the Act 2013, the provisions with regard to voting rights accrue to the holders of preference shares are para-materia same as that of Act 1956 except that the criteria of determining the rights of cumulative and non-cumulative preference shares separately have been done away with.  Under Act 2013, the legislator has used the word ‘Class’ which means voting shall accrue to such class of preference shareholders which has not been paid dividend for 2 or more years. 

The question which requires further contemplation is whether the period of default mentioned under section 47 should be taken as consecutive period of two years or any two years.

The Act, 2013 provides that in case of default in payment of dividend in respect of a class of preference shares for a period of two years or more, such class of preference shareholders shall have a right to vote on all the resolutions placed before the shareholders. The Act 2013 is silent on whether the period of two years shall be construed as consecutive or otherwise. Since the word ‘consecutive’ is missing, therefore it can be inferred that the term of two year of non-payment is not necessarily be consecutive. So, non-payment of dividend for any two years whether consecutive or not, will trigger voting rights for the preference shareholders.

Please note that every year, date of payment of dividend will depend upon the due date as discussed hereinbefore, so if two due dates are gone without payment of dividend, the voting rights will accrue to such class of preference shareholders.

Manner in which votes on preference shares will be calculated?

Preference shareholder shall have a right to vote only on resolutions placed before the company which directly affect the rights attached to his preference shares and, any resolution for the winding up of the company or for the repayment or reduction of its equity or preference share capital unless the dividend remains unpaid for 2 years or more, in which case, they have the rights to vote on all resolution placed before the shareholders.

The rights of preference shareholder on a poll shall be in proportion to his share in the paid-up preference share capital of the company, which that the proportion of the voting rights of equity shareholders to the voting rights of the preference shareholders shall be in the same proportion as the paid-up capital in respect of the equity shares bears to the paid-up capital in respect of the preference shares.

The Legislature has intentionally provided for voting rights of the preference shareholders in proportion to their paid-up capital, which bears to the overall paid -up capital of a company. If they would have just given preference shareholders right to vote on resolution without creating any level playing field then considering that equity shares will always be larger in number than preference shares, the rights given to preference shareholders wouldn’t have make much of difference because equity would always suppress the rights of preference shareholders , on the basis of their brute majority in the total paid-up capital. Following example , will help understand how the voting rights would be calculated

A company proposes a resolution on which preference shareholder can also vote and there are in total 20 equity shareholders holding 20,000 equity shares of Rs. 2,00,000 (paid-up) and 10 preference shareholders holding 10,000 preference shares of Rs. 1,00,000 (paid-up) and out of 20 equity holders, 10 voted against and 10 voted for the resolution and out of 10 preference shareholders, 5 voted against and 5 voted for the resolution, then the calculation shall be made as follows—

Equity Holders- 2/3
Preference Holders- 1/3
Votes in favour- (2/3*10/20+1/3*5/10)*100= 50%
Votes against- (2/3*10/20+1/3*5/10)*100= 50%

Herein above, the votes of the equity and preference shareholder have ben determined basis the proportion they hold in the total paid-up capital of the company 

Preference shares shall be redeemed only in the following manner:

1. Only fully paid up preference shares are eligible for redemption.
2. Preference shares shall be redeemed out of the profits of the company available for dividend or out of the proceeds of the fresh issue of shares made for the purpose of such redemption.
3. Where such shares are proposed to be redeemed out of the profits of the company then in such a case capital redemption reserve shall be created.
4. Premium on redemption shall be payable out of the profits of the company or out of the company’s securities premium account.

Where a company is not in a position to redeem any preference shares or to pay dividend thereon, then it may issue further redeemable preference shares equal to the amount due, including the dividend thereon, in respect of the unredeemed preference shares provided following two conditions are satisfied:

• consent of the holders of such shares representing 75% in value has been obtained, and
• approval of Tribunal has been obtained.

On the issue of such further redeemable preference shares, the unredeemed preference shares shall be deemed to have been redeemed.

In connection with further issuance of preference shares, the question is whether the words “not in a position to redeem” be construed as only “failure to redeem” preference share?

The legislature has used the said words to cover both the situations wherein the failure to redeem shares is anticipated beforehand or there is a failure to redeem shares on due date. These measures are incorporated in order to safeguard the interest of the holders of preference shares as well as the company. In the interest of the preference shareholders, the consenting shareholders are eligible for new shares while dissenting shareholders get their dues. A company before or after due date of redemption, may apply to the NCLT for issuance further redeemable preference shares against unredeemed shares where it is not in a position to redeem its preference shares. Thus, the said provision is applicable to cover both the circumstances where a company has either defaulted in redemption of its preference shares or is about to commit a default, under which the Company with consent of holder of preference shares may apply to NCLT for re-structuring of preference shares capital.

Whether outstanding dividend can be adjusted against issuance of further preference shares?

Under section 55(3), a company has the option to issue further redeemable preference shares in respect of the unredeemed preference shares and any dividend due thereon. Therefore, it is inferred that outstanding dividend is eligible to be adjusted against the issuance of further redeemable preference shares. Where a company wishes to issue further redeemable preference shares only against the unpaid dividend then such privilege is not allowed since the adjustment is allowed against the amount due on unredeemed preference shares which may or may not include the amount of dividend. Thus, the unpaid dividend due on preference shares on standalone basis is not eligible to be adjusted against issuance of further redeemable preference shares. In other words, it can be said that unpaid dividend on preference shares can only be adjusted only at the time of redemption of unredeemed preference shares.

Whether equity or preference shares can be issued in lieu of outstanding dividend on preference shares?

Where a company has outstanding dividend on preference shares, it shall not be eligible to adjust the same against issuance of equity shares or fresh preference shares. Section 123 of Companies Act, 2013 specifically debars a company from issuing dividend in any form other than cash. Therefore, any outstanding dividend in a company shall be payable only in the form of cash except with the approval of NCLT in case of redemption of unredeemed preference shares.

Preference share well being a part of capital of a company, is in its true sense, a hybrid version of capital and debt. Since preference shares are driven by the terms of issue, a lot of flexibility exist in hands of the issuer company, to mold or customize the instrument to the best of its advantage and therefore a company while issuing preference shares should bear in mind the rights and liabilities of the holder of such shares in case of its default in payment of dividend and/or redemption.