Process for Issue of Preference Shares

Preference shares as the term implies are the shares that rank at a priority above the equity shares. These shares contain a preferential right to receive the dividend as are declared by the company on first priority order. During the course of dividend declaration these shareholders are entitled to receive the dividend first as against the normal equity shareholder. The preference shareholders not only have a preferential right to receive dividend on preliminary basis but they also have preferential right to receive the proceeds that are realized from sale of company’s assets during the course of liquidation of the company after payments having been made to the secured creditors of the company.

As per Explanation(ii) to section 42 of the Companies Act, 2013 , the term preference shares mean and includes that part of the share capital the holders of which have a preferential right overpayment of dividend (fixed amount or rate) and repayment of share capital in the event of winding up of the company.

In other words, preference shares are the shares that carry or would carry a preferential right with respect to:

  1. Payment of dividend, either fixed or an amount calculated at a fixed rate
  2. Repayment of the amount of paid up capital share capital paid up or deemed to have been paid up, in the scenario of winding up of the company or repayment of capital.

Preference shares generally pay a higher rate of dividend however at a fixed rate or a fixed amount as dividend. The preference shareholders are also privileged and entitled to receive all dividends i.e. current as well as accrued dividend at priority before equity shareholders.

It is evident to highlight that a company can issue preference shares only if these shares form part of the authorized share capital of the company as per the Memorandum of Association. It is important to verify the Articles of Association as to whether they grant authorization to issue preference shares. In the scenario where the Memorandum of Association or the Articles of Association of the company do not bestow the requisite power to issue preference share then in such a state necessary amendments would be required to be made in these documents prior to issuing such preference shares.

Having gained an insight about the preference shares lets head towards a detailed analysis of the preference shares.

Prerequisites for the Issue of Preference Shares

Prior to issuing preference share, there are a few checkpoints which need to be observed and thereafter the issue process for preference shares can be initiated. On this note the prerequisites to be observed are as follows:

  1. Check whether the nominal capital of the company is bifurcated into equity share capital and preference share capital.
  2. Review the articles of association to verify that there are provisions enshrined relating to issuance of preference shares.
  3. Take note that there are no subsisting defaults in the redemption of preference shares already issued at the time of making issue of preference shares.
  4. Ensure that there are no subsisting defaults in the payment of dividend due on any preference share at the time of issue of preference share.

Once these aforementioned prerequisites are satisfied then the process for issue of preference shares can be initiated.

Conditions for Issue of Preference Shares

     At the time of issuing preference share, there a few conditions which need be taken care of and thereafter complied in true letter and spirit. In light of the same the conditions for issue of preference share are as follows:

  1. The issue of preference shares must be authorized via special resolution passed in general meeting of the company.
  2. Fulfill the prerequisites as already discussed above.
  3. The company issuing preference shares should maintain a register under Section 88 of such preference shareholders containing therewith the respective particulars of such shareholders 

Tenure for Preference Shares

As per section 55 of the Act, a company can issue only redeemable preference shares i.e. a company is not allowed to issue irredeemable preference shares. On this note, it is mandatory for every company issuing preference shares to redeem it within a period of 20 years from the date of issue. 

A company may issue preference shares for a period exceeding 20 (Twenty) years for infrastructure projects. Subject to redemption of a minimum 10% of such preference shares per year from the 21 (twenty first) year onward or earlier, on proportionate basis, at the option of preference share holder.

Having discussed the types of preference shares; prerequisites for issue of preference shares; conditions for issue of preference shares and the time span for preference shares now let’s head towards highlighting the detailed process for issue of preference shares.

The procedure for issue of Preference share is given under Section-62 of Companies Act 2013. It is significant to highlight that issue of share can be in three modes:

  1. Right issue of shares [Section- 62(1) (a)]
  2. Preferential allotment of shares. [Section- 62(3) (c) and Section-42]
  3. Private Placement of shares. [Section-42)

Stepwise Process for Issue of Preference Shares

Sr No. Step Compliance Required
1 Calling  the board meeting for issuing preference shares The notice of board meeting shall be to all the directors of the  company at least 7 days before the date of board meeting. The agenda of board meeting shall also be along with the notice.
2 Holding  board meeting once called. 
  • Check the quorum of Board Meeting.
  •  Approve preference share issue including “letter of offer”, which shall include right of renunciation also. (at board meeting).
  • Issue notice of general meeting.
  • one of the director of the company shall be authorised to issue notice of general meeting.
3 Hold extra ordinary general meeting
  • Check the quorum of meeting.as per Section-103.
  • Offer Letter to be presented before the members in the meeting.
  • Pass Special Resolution for issue preference of shares.
4 File e-Form- MGT-14 with registrar With resolution for issue of shares u/s 179(3).
5 Circulate Letter of Offer
  • the letter of offer shall be sent to the shareholders via  registered post or speed post or through electronic mode at least three days before the opening of the issue.
  • Offer shall be open for a span of not less than 15 (fifteen) days and  not more then 30 (Thirty) days.
6 File e-Form- MGT-14 with registrar E Form MGT-14 to be filed with the Registrar within 30 days of passing of Special Resolution.

Attachments:

  1. Notice of General Meeting along with Explanatory Statement.
  2. Certified True copy of Special Resolution.
  3. Minutes of General Meeting
Receive acceptance/renunciations/rejection of rights from members to whom offer has been sent & also from persons in whose favor right renounced
7 Calling the  board meeting  The notice of board meeting shall be forwarded to all the directors of company at least 7 days before the date of board meeting. The agenda of board meeting shall also be annexed along with notice.
8 Hold board meeting
  • Check the quorum of meeting.(Section-103)
  • Approve allotment by passing of board resolution. And present list of allottees before the board.
  • Pass resolution for Issue of share certificates.
  • Authorization to be granted two directors and one more person for signing  the share certificates.
  • Authorize a director to file E-form PAS 3(Return of Allotment) to ROC within 30 days of passing of resolution.
9 File e-Form- PAS-3 with Registrar {As per Section 39(4) and rule 12 of Companies (Prospectus and allotment of Securitas) Rules, 2014. File PAS-3 within 30 days of passing of resolution for allotment of shares.

Attachment:

  1. Resolution for allotment of Shares.
  2. List of allottees.
10 Issue share certificate as per Section- 56(4) (b) Issue share certificate in form SH-1 with in 2 month from the date of allotment of shares.

Content to be mentioned in a special resolution passed for the issue of preference shares

As mentioned above for issuing preference shares a special resolution is required to be passed and so the points to be mentioned in the special resolution passed for the purpose of issue of preference shares are as follows:
The rights of the preference shareholders with respect to payment of dividend or repayment of capital in comparison to equity shareholders.

  1. The share of preference shareholders in the surplus fund during the course of winding up
  2. The right to participation in surplus assets and profit, on winding-up(if any)
  3. The payment of dividends whether on the cumulative or non-cumulative basis as is the case
  4. The conversion of preference shares into equity shares
  5. The voting rights
  6. The redemption of preference shares

Content to be mentioned in the explanatory statement

The notice of the extraordinary general meeting shall be accompanied by an explanatory statement. The points that should be covered in the explanatory statement in this regard are as follows:

  1. Issue size along a quantity of preference shares to be issued along with the nominal value of each share;
  2. Type of such preference shares issued or to be issued ;
  3. Objectives of the issue;
  4. Manner of issue of shares;
  5. Issue price of shares as fixed ;
  6. Calculation through which the price has been decided ;
  7. The conditions related to the issue i.e. term of the issue and rate of dividend on each share, etc.;
  8. Redemption timeline highlighting the tenure of redemption, the redemption of shares at a premium and if the
  9. preference shares are convertible, the terms of conversion;
  10. Manner and modes of redemption;
  11. Current shareholding pattern of the company;
  12. The Expected dilution in equity share capital consequent to the conversion of preference shares

Points to be noted while allotment of preference shares

At the time of allotment of preference shares, the company should note the following points:

  • Allotment of shares to be made within 60 days of receiving of application money; else it will treat as deposits as per deposits rules.
  • Issue share certificate under form-SH-1
  • Make entry of allotment of preference share in the register of members as maintained in form no. MGT-1 in accordance with Section-88 and the Companies (Management and administration) Rules, 2014.

Key requirements for listed companies

Apart from the requirements highlighted under the Companies Act, 2013, a listed company must comply with the requirements of Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations, 2009 for issuing convertible preference shares and SEBI (Issue and Listing of Non-convertible Redeemable Preference Shares) Regulations, 2013 for non-convertible preference shares. Primarily a company needs to comply with the following requirement :

  • Make an application to one or more recognized stock-exchanges with one of them chosen as the designated stock exchange and receives an in-principle approval of the same
  • Make an application to depository for dematerialization of shares
  • Appoint of merchant banker(s)

Treatment of Preference shares under Foreign Exchange Management Act (FEMA), 1999

Treatment of preference shares under Foreign Exchange Management Act (FEMA), 1999 depends on the convertibility of the preference share. A fully and mandatorily convertible preference share is considered an equity instrument under FEMA. Therefore a fully and mandatorily convertible preference share will be taken into consideration for calculating the total Foreign Direct Investment in a company for the purposes of the sectoral caps. Issue and transfer of fully and mandatorily convertible preference share is governed by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000.

All other forms of preference shares other than fully and mandatorily convertible preference shares are considered debt instruments and form the part of the External Commercial Borrowings of a company. These instruments need to comply with the requirements under Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000.

Treatment of Preference Shares under Takeover Code

The SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (Takeover Code) require any person acquiring shares in a public listed company to make a mandatory public offer if that person wants to acquire shares in excess of the limits prescribed. ‘Shares’ for the purpose of the Takeover Code do not include preference shares as they do not carry voting rights (except as provided under the Companies Act, 2013). Therefore, any person acquiring preference shares in excess of the limits prescribed under the Takeover Code will not be required to make a mandatory public offer.

In case of acquisition of convertible preference shares, although the acquirer is not required to comply with the requirements of the Takeover Code at the time of acquisition the acquirer will have to make an open offer if the limits envisaged under the Takeover Code are breached upon conversion.

Redemption of Preference Shares

Only Fully paid-up preference shares can only be redeemed. Preference shares can be redeemed only out of the profits available for distribution to its shareholders or out of fresh proceeds of shares issued solely for the purpose of funding the redemption of the preference shares. Where the redemption of preference shares are redeemed out of the profits available for distribution, a sum equivalent to the nominal amount of shares being redeemed shall be transferred to the Capital Redemption Reserve (CRR). The CRR shall be treated as the paid-up share capital of the company for all purposes and can also be utilized for bonus issue of shares Where the company is unable to redeem its preference shares or is unable to pay the dividend due on the preference shares, the company can replace issue such amount of preference shares as may be necessary in order to meet its obligation towards dividend payment and also the redemption of preference shares. In the scenario where the company is unable to redeem any preference shares or to pay dividend thereon, it may then redeem such unredeemable preference shares by a further issue of redeemable preference shares equal to the amount due and dividend due thereon subject to:

  1. Consent of the holders of 3/4th in value of such preference shares;
  2. Approval of NCLT

The redemption of preference shares by issuing new preference shares is subject to obtaining the consent of the preference shareholders (at least 75% of the shareholders) and also obtaining the approval of the Tribunal for such arrangement. No distinction between CRPS and NCRPS i.e. 2 Vs 3 Yrs, in the matter of the Voting Rights in the event of non-payment of dividend. The Tribunal shall order the company to immediately redeem the preference shares held by the shareholders dissenting to such arrangement. The issue of preference shares for purpose of redemption of unredeemed preference shares (along with the dividend) shall not be considered as an increase in the share capital of the company.

It is important to note that redemption of preference shares shall be made only from the following:

i) Out of the profits of the company which would otherwise available for dividend.
ii) Out of the proceeds of a fresh issue of shares made for the purpose of such redemption.

Therefore, the Preference Shares are a conglomerate of stocks and bonds as they grant assured returns. The highlighting factor of preference shares is that they are fixed income instruments as in their value remains the same i.e. the price at which the company issued them, while their dividends are fixed,. Sometimes though, preference shares have the option to be converted into ordinary shares. In the scenario, where the company is under winding up and its assets (land, buildings, offices, machinery, furniture etc) are being sold, the money that comes from the sale is given to the shareholders. It is ultimately the shareholders who invest in a business and thereafter own a portion of it. Preference shareholders get the money first and the accounts of preference shareholders are settled before the ordinary shareholders.

Preference shares may be crafted in such a way that they may give some control to an investor in a private company by contract (through veto powers and director seats) and through the company’s articles of association.

There are a lot of investment options available to those looking to make money in the stock market. Though most investors probably think of common shares by issuers when they think of investing in stocks, preference shares can also be a lucrative investment vehicle – when available. Therefore over the years, preferred shares have become quite popular instrument used by the corporates for raising capital.

Hope that this article was informative as well as interesting in providing an in-depth insight about the issue process.

By | 2019-08-17T17:15:02+00:00 August 6th, 2019|Corporate Laws|0 Comments

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