For companies seeking to raise funds externally, issuing redeemable preference shares may be an attractive option. However, shares of this nature usually give the shareholder rights to dividends on specific dates, and often rights of redemption at the shareholder's request. If the company is unable to meet those obligations, what rights will the shareholder hold against the company? And what obligations do directors have?
These questions were recently considered by the Supreme Court of New South Wales, in the context of redeemable preference shareholders who had acquired shares pursuant to a prospectus in York Capital Limited (York): Heesh v Baker  NSWSC 711. In this case York's directors appointed administrators after the company was unable to meet dividend and redemption obligations when due. Aside from not meeting its obligations to the redeemable preference shareholders, however, York was not otherwise insolvent (and in fact had sufficient funds to pay creditors in full).
The Court found that the relevant shareholders were not creditors of the company within the meaning of a particular division (Part 5.3A) of the Corporations Act (2001 (the Corporations Act) governing voluntary administrations. The shareholders' rights against the company lay as members only, and not as creditors.
The decision has practical relevance not only to insolvency practitioners, but also companies or directors faced with insufficient profits to meet dividend or redemption obligations. This is particularly given the restrictions imposed by the Corporations Act, as follows:
- Under section 254A(3) a redeemable preference share can be redeemable either at a fixed time, on the happening of a particular event, at the company's option or at the shareholder's option.
- On redemption, the shares are cancelled (section 254J)
- Section 254K of the Act restricts redemption, as follows:
"A company may only redeem redeemable preference shares:
- If the shares are fully paid up; and
- Out of profits or the proceeds of a new issue of shares made for the purposes of redemption"
Note: for a director's duty to prevent insolvent trading on redeemable preference shares, see section 588G."
- In relation to the declaring of dividends, under section 254T, a dividend may only be paid out of profits.
- Under section 254V "a company does not incur a debt merely by fixing the amount or time for payment of a dividend. The debt arises only when the time fixed for payment arrives and the decision to pay the dividend may be revoked at any time before then."
- Under section 588G(1A), relating to directors' liability for insolvent trading, in the case of shares redeemable otherwise than at the company's option (i.e. at the shareholder's option), a debt is deemed incurred for the purposes of section 588G(1A) only, "when the shares are issued".
The Finding in Heesh v Baker
In this case York had lodged a prospectus inviting subscription for redeemable preference shares referred to in both the constitution and the prospectus as the "CPRPS shares". These shares gave rights to cumulative dividends on specified dates, and also redemption on specified "redemption dates".
The prospectus and York's constitution imposed restrictions on the declaring of dividends (to be at the directors' discretion, and out of profits), and also on redemptions, reflecting the restrictions also imposed by the Corporations Act.
York failed to generate sufficient profit to declare dividends when due, and did not meet redemptions. Administrators were appointed who received numerous proofs of debt from CPRPS shareholders claiming rights to interest (presumably dividends) and the return of monies due on redemption. As the company was otherwise solvent, the administrators sought court directions on whether the CPRPS shareholders were creditors of the company pursuant to their rights under the prospectus/constitution.
The Court found the CPRPS shareholders were not creditors, but rather had rights as members only, because:
- Dividends could only be declared out of profits. No debt arose until a final dividend was declared;
- It may also be appropriate for directors to carry profits to a reserve, or use profits for other purposes, rather than for dividends, with dividends being at the directors' discretion;
- Only declared and unpaid dividends could form a debt owing to a member. Here all declared dividends had been paid, and no debt was owing;
- In relation to redemption rights, York could only redeem the shares out of profits or the proceeds of the new issue of shares made for the purposes of the redemption. Further, whilst the prospectus referred to an alternative of a selective buy back of the shares, this was, from York's perspective, optional;
- Therefore the obligation to redeem, as comprised in the constitution and prospectus as between York and the CPRPS shareholders, was not absolute. It was expressed to be subject to the requirements of the Act, and profits being available. Therefore, consistent with an earlier decision of the Full Federal Court, Federal Commissioner of Taxation v Coppleson (1981) 39 ALR 30, York was not in breach of contract by its failure to redeem on the relevant dates;
- There may be some contracts between shareholder and company which impose an "absolute obligation to redeem" (or pay specified dividends), in which case even if that failure was due to an unavailability of a fund for the payment to be made, a breach of contract would occur. However, this was not the case here.
The Court also suggested a member unable to redeem shares on the due date could possibly seek a just and equitable winding up. The Court also noted 588G(1A) of the Act was a deeming provision purely for the purposes of director liability under section 588G. It did not alter the position of the CPRPS shareholders as against the company.
The decision provides useful guidance to insolvency practitioners assessing proofs of debt lodged by redeemable preference shareholders. As in Heesh v Baker, many of those shareholders may believe they are creditors of the company, and lodge proofs of debt claiming the right to return of monies and unpaid dividends. Whether those shareholders are creditors of the company will depend on the shareholding contract. If that contract makes the right to redeem and dividends conditional on the company earning sufficient profits (consistent with the Corporations Act), the company would not be in breach of contract to the shareholder.
The decision is also relevant to directors of companies unable to meet redemption and dividend obligations. Under Heesh v Baker, provided the dividend/redemption rights are expressly subject to the Corporations Act restrictions above, the company will probably not be in breach of contract with its members by failing to redeem/declare dividends if profits are not available.
From a policy perspective this approach is consistent with the fact that redeemable preference shareholders are obtaining equity in a company and whilst making an investment, do so as shareholders, not lenders. In practice, however, many such shareholders will not appreciate the risk of the company being unable to meet dividends/redemptions when due, and will instead believe their investment provides a fixed and certain income stream. It is therefore imperative that any prospectus or other advertising material makes the position absolutely clear.
Based on the Court's discussion in Heesh v Baker, shareholders in this situation may still have rights also to seek to wind up the company (on a just and equitable ground). Directors also need to be aware of their liability under section 588G of the Corporations Act. Under this provision, for the purpose of any insolvent trading action against directors (applicable only once a company is wound up), a debt will be deemed to be incurred at the time the shares are issued (in the case of redeemable shares which are redeemable at a fixed time, or at the investor's option).
These are all matters to be taken into account for companies considering issuing redeemable preference shares as a means of raising funds.
[Addisons acted for the administrators in the above decisions]
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.