'What's in a name' - channeling Shakespeare, we looked at the changes in the Companies Act, 2013 ("2013 Act") with respect to preference and equity shares.

The scheme of erstwhile Companies Act 1956 ('1956 Act') under Part IV - titled 'Kinds of Share Capital', was two-fold. Firstly, that there would be only two kinds of share capital - preference and equity. 'Preference share capital' was defined as that part of the share capital of the company which provided preference to the holder at the time of payment of dividend and liquidation. 'Equity share capital' was defined as all share capital which was not preference share capital. Secondly, that (a) there would be no inequality of voting rights as between members holding equity share capital in a company; and (b) voting rights of a preference shareholder, broadly speaking, would be in the same proportion as the total paid up capital in respect of the preference share bears to the total paid-up equity share capital. To avoid complication, an exemption from these restrictions was granted to private companies which were not a subsidiary of a public company.

As a result of the exemption granted under Section 90 of the 1956 Act, investors preferred preference shares to equity. The instrument investors subscribed to would inherently have preferential rights required by them, such as that (a) cumulative or non-cumulative dividends; (b) convertible, redeemable, irredeemable or participating preference shares; (c) preference shares with differential voting rights; or (d) redemption at par or at premium. Such customization helped them safeguard their investment with minimal functional involvement in the company's day-to-day activities.

The 2013 Act, however, has no provision equivalent to the Section 90 of the 1956 Act. So what have we lost? Under the 2013 Act, both public and private company, need classify their share capital into either equity or preference. The option earlier available, and indeed preferred by the investors, of subscribing to preference shares with bespoke rights has vanished. An investor can no longer participate in the meetings of a company on the basis of its preference shareholdings. The number of votes it will be entitled to cast, on the basis of its preference shareholding, are also limited.

Historically, preference shares were not defined under the Companies Act, 1913 ('1913 Act')1. The 1913 Act permitted a company to divide its capital into two or more classes. These classes were distinguished from the descriptions provided. Though there were no uniformly applicable meanings or definitions to such descriptions. This resulted in the rights attached to such classes not being consistent with the descriptions. The 1913 Act appeared to subscribe to the view – 'What's in a name?' The actual rights attached to a share during the regime of the 1913 Act were required to be ascertained from the memorandum and articles of the company. This clearly left scope for considerable mischief. A company could make any provision in its articles regarding voting rights in respect of any class of shares in its share capital. There was nothing in law that required any particular voting rights to be attached to any particular class of shares.

Part IV of the 1956 Act had been brought into force for the purpose of managing this mischief. The 1956 Act insisted on all the share capital of a company being classified into either equity or preference. There was no scope of a third kind, except in the case of a private company. Private companies were permitted the flexibility to continue attaching any bespoke rights to shares. The effect of the exemption of private companies from the provisions of Sections 85 to 89 of the 1956 Act, therefore, was that such companies were permitted to issue shares with disproportionate rights including disproportionate rights with regard to dividend, voting, participation in extra profits and/or surplus on liquidation etc. This made the option of subscribing to the preference shares of a private company more attractive. An investor had the option of subscribing to customized preference shares and nominal equity shares, to cater to its specific needs relating to voting, dividend and liquidation preference, specifically.

In the absence of a provision equivalent to Section 90 of the 1956 Act, however, investors will have to ensure that their rights are protected contractually under the transaction documents. During the currency of 1956 Act, investors preferred to subscribe to preference shares and retain a nominal number of equity shares to best protect their interest. The major advantage of holding preference shares with differential rights for the investor was that (a) the investor had down round protection which is extremely hard to achieve without further investment if investment is in equity; and (b) the investor could not exercise voting rights on an as-if-converted basis on all matters of the target. Thus, now deal counsels will have to ensure that that the investors' right is protected contractually under the transaction documents without exposing them to the responsibility of micro managing the business on a daily basis. For this purpose the affirmative vote matters in the transaction documents will have to be made comprehensive and robust. Investors' will have to take a business call on the extent to which they would like to get involved in the business management of the target, in order to ensure that they enjoy the benefits which were previously being afforded by Section 90 of the 1956 Act.

In the 57th report of the Standing Committee on Finance (2011-2012) issued in July 2012, the committee had suggested that a provision similar to Section 90 of the Companies Act, 1956 be introduced. In exempting private companies from the restrictions imposed as regards the types of share capital and voting to provide flexibility to private companies in these matters. The Ministry of Corporate Affairs had then responded that such exemption could be provided at a later point of time through notification. The Ministry of Corporate Affairs has since circulated a draft notification under which private companies are proposed to be except from the purview of Section 43 and Section 47 of the 2013 Act. This draft notification has been tabled before the Lok Sabha in July 2014 and is still pending approval. Therefore, now it's a wait and watch game.


1. Juvansinhji Balusinhji and Ors. V. Balbhadrasinhji Indrasinhji and Ors. [1962] 32CompCas1162(Guj).

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