Preference shares enjoy preferential rights (a) as to the payment of dividend at a fixed rate during the life of the company, and (b) as to the return of capital on winding up of the company. If any shares carry only one of these two preferential rights, they will be treated as equity shares. The holder of this type of shares enjoys only a preferential right over the equity shareholder.
He will receive dividend at a fixed rate, e.g., 9%, if a dividend is declared. “Unlike the debenture holder, the preference shareholder, who, after all, is a shareholder, is only entitled to income from his investment if a distributable profit within the meaning of the law is available. His right is not to dividend but to preferential treatment if and when a dividend is distributed.”
Voting rights of preference shareholders :
The preference shareholders do not enjoy normal voting rights like the equity shareholders. They are, however, entitled to vote in the following two cases.
(a) When any resolution directly affecting their rights is to be passed. It is worth noting here that any resolution for winding up of the company or for the repayment or reduction of its share capital is to be regarded as a resolution directly affecting the rights of the preference shareholders and therefore they are entitled to vote on such a resolution.
(b) When the dividend due (whether declared or not) on their preference shares or part thereof has remained unpaid: (i) in the case of cumulative preference shares, for an aggregate period of not less than two years preceding the date of the meeting; and (ii) in the case of non-cumulative preference shares, either for a period of two consecutive years or for an aggregate period of not less than three years comprised in the six years ending with the expiry of the financial year immediately preceding the dale of the meeting.
It may be observed that when the dividend due on their preference shares has remained unpaid for periods specified above, the preference shareholders are entitled to vote on every resolution placed before the company at any general meeting.
The Act further provides that where a preference shareholder has a right to vote on any resolution in accordance with the provisions mentioned above, his voting right on a ‘poll’ shall be in the same proportion as the capital paid up in respect of preference shares bears to the total paid up equity capital of the company [Sec. 87 (2)].
It is important to note that the above provisions relating to voting rights of preference shareholders do not apply to an independent private company. Such a company can issue preference shares carrying normal voting rights or even disproportionate voting rights [Sec. 90 (2)].
Kinds of preference shares :
There may be different kinds of preference shares depending upon the terms of issue which are either defined in the Articles of Association or in the Prospectus of the company. A company may issue the following types of preference shares:
1. Cumulative preference shares :
They carry the right to cumulative dividends if the company fails to pay the dividend in a particular year. The accumulated arrears of dividends shall be paid, if any dividend is declared in subsequent years, before any dividend is paid to the equity shareholders. If the company goes into liquidation, no arrears of dividends are payable unless either the Articles contain an express provision to this effect or such dividends have been declared. Of course the arrears of undeclared dividends shall be payable, even if the Articles are silent, out of any surplus left, after returning in full the preference and equity share capitals.
All preference shares are always presumed to be cumulative unless the contrary is stated in the Articles or the terms of issue.
2. Non-cumulative preference shares :
Such shares do not carry the light to receive the arrear dividend in a particular year, if the company fails to declare dividend in previous year or years. If no dividend is paid in any particular year, it lapses.
3. Participating preference shares :
These are preference shares which receive their fixed dividend e.g. 9% in the normal way, but which then participate further in the distributed profits along with the equity shares after a certain fixed percentage has been paid on them as well. The holders of such shares may also be entitled to get a share in the surplus assets of the company on its winding up if specific provision exists to that effect in the Articles.
4. Non-participating preference shares :
These shares are entitled to only a fixed rate of dividend and do not participate further in the surplus profits irrespective of the magnitude of such profit. If the Articles are silent, all preference shares are deemed to be non-participating unless stated otherwise in the terms of issue.
5. Convertible preference shares :
The holder of these shares is given the right of conversion of his shares into equity shares at a later date.
6. Non-convertible preference shares :
Here the preference shareholder is not given the right of conversion of his shares into equity shares. If the Articles are silent, all preference shares are deemed to be non-convertible unless provided otherwise in the terms of issue.
7. Redeemable preference shares :
Ordinarily capital received on the issue of shares can be returned on the winding up of the company only, because if the company is allowed to return it any time it so wished, the creditors could not rely on the company having any money at all. But Section 80 of the Companies Act authorizes a company limited by shares to issue “redeemable preference shares.” Capital received on such shares can be returned as per the terms of issue either after a specified period or whenever company so chooses after giving proper notice.