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The Gist of Preference Shares

posted 4 months ago

Definition of Preference Shares

The Companies Act 2016 (“Companies Act”) provides the following in respect of preference share:

a) means a share by whatever name called, which does not entitle the holder to the right to vote on a resolution or to any right to participate beyond a specified amount in any distribution whether by way of dividend, or on redemption, in a winding up, or otherwise; and

b) “equity share” means any share which is not a preference share.

The Courts have given recognition to the commercial reality in the treatment of preference shares, as a hybrid of the characteristics of equity investment and loan. From a financial point of view, ordinary shares represent risk capital whereas preferential shares represent something more akin to loan capital. As such, loan capital should be repaid before risk capital and ordinary shareholders bear a higher risk and are therefore entitled to voting rights which provide for management control[1].

Unlike ordinary shareholders, preference shareholders do not have the right to vote on a resolution or to any right to participate beyond a specified amount in any distribution whether by way of dividend, or on redemption, in a winding up, or otherwise[2].

Why do investors invest in preference shares?

Investors who invest in preference shares often do not require voting rights or they are not keen to involve in the company’s management.

These investors would often rely on their independent assessment of the company’s overall performance portfolio in the trust that they will benefit from a predetermined dividend payment or attractive returns of investment in accordance with the terms of subscription.

In fact, preferential shareholders have priority over a company’s income hence they are often paid before any dividends are paid to ordinary shareholders.

Investors of preference shares with cumulative feature are further entitled to dividends accumulated from preceding years when the company has no surplus profit. Notwithstanding the entitlements to dividends, priority to dividends payment should not be misconceived as guarantee to dividends payment.

At winding up of company, preferential shareholders enjoy stronger bankruptcy protection relying on the concept of preferential payments.

Section 452 of the Companies Act[3] provides that subject to the provisions relating to the preferential payments under the Companies Act, the property of a company shall, on its winding up be applied equally in satisfaction of its liabilities, and shall subject to that application, be distributed among the members according to their rights and interests in the company, unless the constitution otherwise provides.

Preference shareholders would have priority of receiving capital as compared to ordinary shareholders (of different class rights) at the time of winding up provided that the constitution provides for such priority for preference shareholders.

Issuance of preference shares

The existing shareholders of a company are able to retain control and maintain their callability by issuing preference shares to satisfy their capital requirements. Relatively, unlike financial or credit loans, there is no requirement for the company or its existing shareholders to provide any corporate guarantee (in the case of a company) or personal guarantee (in the personal capacity of a shareholder) as security.  

The Companies Act provides that a company having share capital may issue preference shares in accordance with the constitution[4]. The constitution would generally set out the rights of shareholders with respect to:

i) repayment of capital;

ii) participation in surplus assets and profits;

iii) cumulative or non-cumulative dividends;

iv) redemption procedure;

v) voting rights; and

vi) priority of payment of capital and dividend in relation to other shares or other classes of preference shares.

Key features of preference shares

The following are the different types of preference shares which are commonly known as redeemable convertible preference shares (RCPS), redeemable cumulative preference shares (RPS) or redeemable convertible cumulative preference shares (RCCPS):

i) Cumulative: cumulative preference shares will from the date of its issuance, accrue preferential dividends in cash at the preferential fixed dividend rate of the issue price determined on a daily basis and such dividends shall be accumulated and payable by the company to the subscriber.

ii) Non-cumulative: non-cumulative preference shares do not entitle the subscriber to redeem dividends from previous year(s) if dividends are not declared for any particular year.

iii) Redeemable: the company or the investor or shareholder is allowed to redeem the money they have invested in a company at a predetermined price or date subject to Section 72 of the Companies Act.

iv) Non-redeemable: the company is not permitted to redeem irredeemable preference shares.

v) Convertible: convertible preference shares can be converted to ordinary shares of a company, at the option of the holder on a predetermined conversion term or mechanism.

vi) Non-convertible: non-convertible shares are not convertible to ordinary shares.

Legal aspects

Minimum voting rights

Despite that preference shareholders do not have rights to participate and vote for resolutions, preference shareholders may still have limited voting rights in respect of their class rights i.e., preferential payment of capital and dividend in relation to other shares or other classes of preference shares[5].

Right of Redemption

The right of redemption in respect of preference shares is a statutory right pursuant to Section 72 of the Companies Act. Therefore, the company would not be in default for failing to redeem preference shares in accordance with its contractual obligations due to its bad financial position.

Section 72(4) of the Companies Act provides that the preference shares shall be redeemable only if the shares are fully paid up and the redemption shall be out of:

i) profits;

ii) a fresh issue of shares; or

iii) capital of the company.

If any such shares are redeemed out of profits which would otherwise have been available for dividend declared for shareholders, then such profits shall be transferred into the share capital of the company, in such sum equivalent to the amount of shares so redeemed[6]

If any such shares are redeemed out of the capital of a company, redemption is subject to a solvency declaration signed by all directors of the company and filing of the same with the Registrar of the Companies Commission of Malaysia[7].

Often, directors must inquire into the company’s state of affairs and prospect and take into account all the liabilities of the company, including contingent liabilities prior to making a solvency declaration.

Preference shares in the context of MIDA equity policy

The equity policy issued by Malaysian Investment Development Authority (MIDA)[8]  pursuant to the Industrial Co-ordination Act 1975 (“ICA”) (“MIDA Equity Policy”) requires manufacturing companies with shareholders’ funds of RM2.5 million and above or engaging 75 or more full-time paid employees to apply for a manufacturing licence for approval by MIDA.

MIDA Equity Policy defines shareholders’ funds to mean the aggregate amount of a company’s paid-up capital, reserves, and balance of profit and loss appropriation account.

In determining the paid-up capital of a manufacturing company relating to MIDA Equity Policy, capital of both preference shares and ordinary shares of the company should be taken into account.

Preference shares in the context of EPU equity policy

Pursuant to Section 433B of the National Land Code (“NLC”), a non-citizen or a foreigner company is required to obtain the State Authority’s consent in writing before any acquisition of land in Malaysia. Additionally, the Guideline on the Acquisition of Properties, issued by the Economic Planning Unit[9] (“EPU Guideline”) provides the threshold and the equity policy to be complied with by foreign investors to acquire properties in Malaysia.

Unless otherwise exempted, EPU approval is in practice generally required for any application for the State Authority’s consent pursuant to Section 433B of the NLC. 

It is worth highlighting that the equity requirement or restriction in the context to obtain EPU consent for foreign acquisition of properties in Malaysia does not take into consideration preference shareholdings. In this context, the definition of foreign interest pursuant to the EPU Guideline includes only Malaysian companies with individual foreigner or foreign company with voting rights[10].  

Preference Shares in a nutshell

Companies and potential investors should understand the features, criteria, advantages or disadvantages of preference shares prior to any corporate exercise and fund raising activities. In practice, entitlements and rights of a preferential shareholder derive from the terms and features of each class of preference shares under different offers for subscription or term sheets, which are subject to independent negotiations.

Therefore, it is important to understand all terms of preference shares so to mitigate the risks of potential disputes that may arise from questions of construction.

[1] Re Sq Wong Holdings (Pte) Ltd [1987] 2 MLJ 298

[2] Companies Act 2016, s 2

[3] Companies Act 2016, s 452

[4] Companies Act 2016, s 72

[5] Companies Act 2016, s 90(4)

[6] Companies Act 2016, s 72(5)

[7] Companies Act 2016, s 72(6)

[8] MIDA, “Equity Policy” >

[9] Economic Planning Unit of the Prime Minister’s Department, “Guideline on The Acquisition of Properties, issued by the, effective from 1 March 2014” < https://www.epu.gov.my/sites/default/files/2020-03/GP_EPUJPM.pdf>

[10] Ibid.  

 

About the author
Choo Sheau Kee
Associate
Corporate/M&A, Regulatory & Compliance
Halim Hong & Quek
skchoo@hhq.com.my

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