Preference shares to take the limelight?

Fine print of the Companies Act 2013 strengthens the voting rights of preference shareholders of private companies

Under the Companies Act, 1956, (1956 Act), while equity shareholders have definite power to control the company through voting rights, preference shareholders only have conditional voting rights on the matters which directly affect their interest in the company or on all matters if the dividend on preference shares is in arrears for the prescribed period.

Preference shares are considered as quasi-debt instruments since they combine the features of equity as well as debt. On one side, they carry a preferential right over the ordinary shares to receive dividend at a fixed rate and on the other, they carry an equity risk of not being secured, except to the preferential right of repayment in case of winding-up of the company. Preference shares have proved beneficial for investors, since such quasi-debt instrument provides protection to their investment by possessing voting rights on matters affecting their interest, more so with the fixed rate of dividend. For the promoters, issue of preference shares to investors ensures access to capital without a need to provide any security, with a continued control.

While the new provisions of the Companies Act, 2013, (2013 Act), continue on the premise of similar conditional voting to the preference shareholders, it is now applicable to all companies including private companies as against the 1956 Act wherein such conditional voting rights were not applicable to private companies. It could well be a game changer for the private companies, since they were earlier allowed to issue preference shares with any possible covenants as to voting rights or otherwise, subject to the articles of association.

Moreover, a few grey areas persist with respect to the applicability of new provisions under the 2013 Act.

The 2013 Act has not found a place for grandfathering provisions, which could possibly mean that the new provisions shall also apply to preference shares already issued under the 1956 Act. In case the new provisions of 2013 Act apply to preference shares issued before its commencement, it may lead to companies having unintended controlling structures and consequently forced to reorganise the controlling structures in compliance with the 2013 Act.

While the overall changes made by the 2013 Act vis-a-vis 1956 Act are a welcome one, companies are required to be careful in the transition phase where the 2013 Act will overwrite the 1956 Act in phases. It may well cast challenges for companies, which could require timely consultations.

(Hemal Uchat is an executive director. Abhijeet Shah Associate, PwC India - M&A Tax practice, co-authored this article)