PREFERENCE AND EQUITY SHARE CAPITAL

The share capital of a public company may consist only of two kinds of shares- preference shares
and equity shares. Equity Share capital may be with similar rights or with different rights as to
dividend, voting or otherwise in accordance with the companies (issue of share capital with
difference voting right) Rules 2001.

A preference share has a preference in regards to payment of fixed amount of dividend or fixed
rate of dividend and preferential right of repayment of capital in the event of winding of
company. With regard to payment of dividend, preference share may be cumulative or non-
cumulative.

Equity shareholders are entitled to the residue of the divisible profits. if any, after entitled to the
residue of the divisible profits, if any , after the preference shareholders have received their fixed
rate of dividend (section 85).

“(1)  "Preference share capital" means, with reference to any company limited by shares, whether
formed before or after the commencement of this Act, that part of the share capital of the
company which fulfils both the following requirements, namely:—

 
(a)   that as respects dividends, it carries or will carry a preferential right to be
paid a fixed amount or an amount calculated at a fixed rate, which may be
either free of or subject to income-tax; and
 
(b)   that as respects capital, it carries or will carry, on a winding up or repayment
of capital, a preferential  rights to be repaid the amount of the capital paid up
or deemed to have been paid up, whether or not there is a preferential rights to
the payment of either or both of the following amounts, namely:—
 
(i)    any money remaining unpaid, in respect of the amounts specified in
clause (a), upto the date of the winding up or repayment of capital; and
 
(ii)   any fixed premium or premium on any fixed scale, specified in the
memorandum or articles of the company.
 
                     Explanation.—  Capital shall be deemed to be preference capital, notwithstanding
that it is entitled to either or both of the following rights, namely:—
 
 (i)    that, as respects dividends, in addition to the preferential right to the amount
specified in clause (a), it has a right to participate, whether fully or to a limited
extent, with capital not entitled to the preferential right aforesaid;
 
(ii)   that, as respects capital, in addition to the preferential right to the repayment,
on a winding up, of the amounts specified in clause (b), it has a right to
participate, whether fully or to a limited extent, with capital not entitled to that
preferential right in any surplus which may remain after the entire capital has
been repaid.
 
                (2)  "Equity share capital" means, with reference to any such company, all share capital
which is not preference share capital.
 
                (3)  The expressions "preference share" and "equity share" shall be construed
accordingly.
 

The Company (Amendment )Act, 2000 has, by substituting the section 86 of the Act, empowered
companies to issue equity share capital with differential rights as to dividend, voting or otherwise
in accordance with the Companies (issue of share Capital with Differential Voting rights) Rule
2001.

Pursuant to these, Rules, a company limited by share may issue share with differential rights as
to dividend, voting or otherwise if it satisfies the condition laid down in Rule 3, which include
inter alia:

i) it has distributed profits in the 3 financial years proceeding the year in which it is
decided to issue such share;
ii) it has not defaulted in the filling of annual account and annual returns in those 3
preceding financial year;
iii) it has not failed to repay its deposit or interest or redeem debentures on due dates or
to pay dividend or to meet investors grievances;
iv) the article of the company authorize such an issue;
v) shareholders approved at a general meeting has been obtained and through Postal
Ballot in case of listed company;
vi) it has not been convicted for an offence under SEBI Act, 1992, SCRA, 1995; FEMA,
1999;

Also such company is required to maintain a register as under Section 150 of the Act, to include
particulars of differential rights to which holder is entitled.

TYPE OF PREFERENCE SHARE

PARTICIPATING AND NON-PARTICIPATING

Participating preference shares are those shares which are entitled, in addition to preference
dividend at a fixed rate, to participate in the balance of profits with the equity shareholders after
they get a fixed rate of dividend on their shares. The participating preference shares may also
have the right to share in the surplus assets of the company on its winding up. Such a right must
be expressly provided in the memorandum or the articles of association of the company.

Non-participating preference shares are entitled only to a fixed rate of dividend and do not share
in the surplus profits. The preference shares are presumed to be non-participating, unless
expressly provided in the memorandum or the articles or the terms of issue. A mere fact that the
articles of a company confer on the preference shareholders a right to participate with the equity
shareholders in the surplus profits does not necessarily mean that the preference shareholders are
entitled to participate in the surplus assets also.

 CUMULATIVE AND NON-CUMULATIVE PREFERENCE SHARES:

With regard to the payment of dividend, preference shares may be cumulative or non-
cumulative. In the case of cumulative preference shares, if the profits of the company in any
years are not sufficient to pay the fixed dividend, on the preference shares the deficiency must be
made up out of the profits of subsequent years. The accumulated arrears of dividend must be
paid before anything is paid out of the profits to the holders of any other class of shares. In the
case of non-cumulative preference shares, the dividend is only payable out of the net profits of
each year. If there are no profits in any year, the arrears of dividend cannot be claimed in the
subsequent years. Preference shares are presumed to be cumulative unless expressly described as
non-cumulative. Any ambiguous language in the articles will not be enough to make them non-
cumulative.

REDEEMABLE AND NON- REDEEMABLE

Redeemable Preference shares are preference shares which have to be repaid by the company
after the term of which for which the preference shares have been issued. Irredeemable
Preference shares means preference shares need not repaid by the company except on winding up
of the company. However, under the Indian Companies Act, a company cannot issue
irredeemable preference shares. In fact, a company limited by shares cannot issue preference
shares which are redeemable after more than 10 years from the date of issue. In other words the
maximum tenure of preference shares is 10 years. If a company is unable to redeem any
preference shares within the specified period, it may, with consent of the Company Law Board,
issue further redeemable preference shares equal to redeem the old preference shares including
dividend thereon. A company can issue the preference shares which from the very beginning are
redeemable on a fixed date or after certain period of time not exceeding 10 years provided it
comprises of following conditions :-Section 80
 1. It must be authorised by the articles of association to make such an issue.

2. The shares will be only redeemable if they are fully paid up.

3. The shares may be redeemed out of profits of the company which otherwise would be
available for dividends or out of proceeds of new issue of shares made for the purpose of
redeem shares.

4. If there is premium payable on redemption it must have provided out of profits or out of
shares premium account before the shares are redeemed.

5. When shares are redeemed out of profits a sum equal to nominal amount of shares
redeemed is to be transferred out of profits to the capital redemption reserve account.
This amount should then be utilised for the purpose of redemption of redeemable
preference shares. This reserve can be used to issue of fully paid bonus shares to the
members of the company.

Rights of preference shareholders.

If it is provided in the memorandum or the articles of association that the rights of the holders of
preference shares should come first, they cannot be postponed; 1 but if the preference shares are
issued subject to the rights of the company to issue fresh capital having such preference and
priorities as shall be agreed upon the original preference shares may be postponed.2

A declaration that the profits are to be applied first in paying a dividend on the preference share
and secondly on the ordinary shares, gives the preference shareholders cumulative dividend,
3
unless it is provided that the profits of each year are to be distributed among the preference
shareholders on the basis mentioned.4

Where preference shareholders are given a fixed preferential dividend at a specified rate, their
right to any further dividend is impliedly negative.5

  Notes to sections 80 and 475.

Where a clause in the memorandum of association provided that the preference shares should
entitle the holders to a fixed cumulative dividend at 7 p.c. on the amount for the time paid-up and
to the repayment of capital before any dividend was paid to the holders of ordinary share and to a
further dividend calculated as therein mentioned, it was held that the company could pay
dividend on ordinary share capital subject only to the fixed cumulative dividend of 7 p.c. on the

1
James v Buena Ventura Syndicate (1896) Ch 456; Welton v Saffery (1897) AC 299
2
Underwood v London Music Hall (1901) 2 Ch 309
3
Foster v Coles (1906) 22 TLR 555
4
Adair v Old Bushmills Distillery (1908) WN 24. See also Staples v Eastman Co. (1896) 2 Ch 303
5
Will v United Lankat Plantations Co. (1912) 2 Ch 571: (1914) AC 11
preference shares and that the latter were entitled in the event of a winding-up to rank pari
passuwith the holders of ordinary shares in any surplus assets of the company.6

Where the memorandum of association conferred on the preference shareholders a right to a

fixed cumulative dividend of 6 per cent per annum on the capital paid on them and they were to
rank, both as regards dividend and capital, in priority to the ordinary shares and the company
went into voluntary liquidation, it was held that after payment of the preference capital, the
preference shares were not entitled to any further priority over the ordinary shares for payment of
arrears of dividend.7

A guarantor of preference dividends who has made payments pursuant to the guarantee can claim
only to be subrogated to the rights of preference shareholders and cannot claim to be repaid as a
creditor by the company.8

CONVERSION OF SHARES INTO STOCK

The company may by ordinary resolution convert any paid up shares into stock, and re-convert
any stock into paid up shares of any denomination.

The holders of stock may transfer the same, or any part thereof, in the same manner and subject
to the same regulations, as and subject to which the shares from which the stock arose might
previously to conversion have been transferred, or as near thereto as circumstances permit; and
the directors may from time to time fix the minimum amount of stock transferable but so that
such minimum shall not exceed the nominal amount of the shares from which the stock arose.

The holders of stock shall according to the amount of stock held by them, have the same rights,
privileges and advantages as regards dividends, voting at meetings of the company and other
matters as if they held the shares from which the stock arose, but no such privilege or advantage
(except participation in the dividends and profits of the company and in the assets on winding
up )shall be conferred by any amount of stock which would not, if existing in shares, have
conferred that privilege or advantage. Such of the regulations of the company as are applicable to
paid up shares shall apply to stock, and the words "share" and " shareholder" the rein shall
include "stock" and "stockholder".

The company may, by ordinary resolution,

6
Anglo-French Music Hall v Nicoll (1921) 1 Ch 386 following Espuela Land & Cattle Co. (1909) 2 Ch 187
and Fraser & Chalmers Ltd. (1919) 2 Ch 114 in preference to National Telephone Co. (1914) 1 Ch 755.
7
Wood Skinner & Co. (1944) 1 Ch 323.
8
Walters' Deed of Guarantee (1933) Ch 227
(a) convert any paid-up shares into stock; and

(b) reconvert any stock into paid-up shares of any denomination.

This regulation corresponds to regulation 36 Table A Schedule 1

What is stock.—Stock is simply a set of shares put together in a bundle.9It is expressed in

money instead of as so many shares. A company cannot make an original issue of stock. 10Stock
not fully paid-up is wholly unlawful and confers no right on the holders. 11They may be entitled
as creditors for the amount they have paid.12 .

See sections 84 and 95 and Notes thereto.

The holders of stock may transfer the same or any part thereof in the same manner as, and
subject to the same regulations under which, the shares from which the stock arose might before
the conversion have been transferred, or as near thereto as circumstances admit:

Provided that the Board may, from time to time, fix the minimum amount of stock transferable,
so however that such minimum shall not exceed the nominal amount of the shares from which
the stock arose.

This regulation corresponds to regulation 37 Table A Schedule I

The holders of stock shall, according to the amount of stock held by them have the same rights,
privileges and advantages as regards. dividends voting at meetings of the company, and other
matters, as if they held the shares from which the stock arose; but no such privilege or advantage
(except participation in the dividends and profits of the company and in the assets on winding-
up) shall be conferred by an amount of stock which would not, if existing in shares, have
conferred that privilege or advantage.

This regulation corresponds to regulation 38 Table A Schedule I

Such of the regulations of the company (other than those relating to share warrants), as are
applicable to paid-up shares shall apply to stock and the words "share" and "shareholder" in
those regulations shall include "stock" and "stockholder" respectively.

This regulation corresponds to regulation 39 Table A Schedule I

9
Morrice v Aylmer (1875) 7 HL 717
10
Home Foreign Investment Co. (1912) 1 Ch 72
11
Ibid
12
Alison's case (1873) 15 Eq 395: 9 Ch App