The Ambiguity with Preferential voting rights

Source :SIFY
Last Updated: Thu, Aug 29th, 2019, 15:46:40hrs
The Ambiguity with Preferential voting rights
Preference shareholders are entitled to number of benefits as opposed to ordinary shareholders due to their position in the company. The foremost benefit being that they will be paid first when the company makes a decision of the payment of dividends. They are not entitled to voting rights, which is enjoyed by the ordinary shareholders because the preference shareholders are not in a perilous position.

In fact, this is a bargain made in return for an assured income.

Section 43 of the Companies throws light on one of the privilege of the preference shareholders. It provides that on winding up of the company preference, the amount paid up on preference shares must be paid back before anything is paid to the ordinary shareholders. Thus, the first preference is to be given to the preference shareholders as regards the payment of shares. It could be seen that they are given preference even on the winding up of the company and their chances of being wiped out is extremely low, therefore they should not be given voting rights if dividend is not paid for 2 years.

The trouble, however, lies in the details of the Companies Act, 2013. Section 47(2) gives the same voting rights to the Preference shareholders as to ordinary shareholders. The provisions of voting rights are extremely useful and it is necessary that the limitations and disadvantages are given due treatment.

The second proviso to Section 47(2) is equivocal. It states that preference shareholders have the voting rights on failure to pay dividends for two years. It offers no clarification as regards the meaning of ‘two years’ (whether consecutively or any two years). Further, it is also not clear whether the voting rights of preference share holders on the aforesaid default will be temporary or permanent.

Clause (2) of Section 47 delineates that preference shareholders shall have a right to vote on those resolutions which affects the rights directly attached. Rights granted within this section to preference shareholders would definitely require the interpretation of whether the rights are directly attached to the preference shares or they are ancillary to it.

These would also include questions such as whether preference shares are cumulative or non- cumulative, redeemable or non-redeemable, participating or non- participating preference shares... All these may be considered as matters affecting the preference shares. But then, this hardly leaves any matter from the purview of preference shareholders and they technically have voting on all their matters. Therefore, such a provision is likely to lead to litigation.

One way of looking at this is that the ordinary shareholders remain true representatives of the company and hence their position should be shown deference. The giving of equal treatment to the preference shareholders as regards voting rights would defeat the purpose of classification. Giving additional voting rights would be prejudicial to the interests of the class of the preference shareholders who have been duly paid dividend and thereby not given voting rights, especially when the ordinary shareholders have also not been paid the dividend. Alike should be treated alike!

The preference shareholders are called so because they get paid first, they are preferred over ordinary shareholders. Thus, the phrase ‘Once a King, always a King’ doesn’t hold good for the preference shareholders. Therefore, if they are prioritized in the payment of dividend, it would not be just if they have the same voting rights in the decision making of the company. Finally, the purpose of issuance of preference shares is to ensure that ownership is not diluted. Voting provisions will enable the preference shareholders to extort control from the ordinary shareholders.

Providing voting rights to the Preference shareholders would sometimes have disastrous consequences when corporate battles between Board and shareholders arise. For example, in the case of the Tata group, the feud between the promoter (Ratan Tata) and Former Chairman of Tata Sons (Cyrus Mistry) was evident. Tata Sons sought shareholder’s approval to amend its AOA (articles of association) to give voting rights to the holders of company’s preference shares if it didn’t pay dividend for two years or more. This would dilute the hold of the ordinary shareholders. The said amendment is a part of bigger move to make it a board-controlled company in which most of the decisions taken will no longer need shareholder’s approval. Preference shares may gain an edge and be at par with the ordinary shares and would give them an equal seat at the table. Mr. Tata who has majority of the preference shares, if given voting rights would defeat most of Mr. Mistry’s resolutions because of their tussle. Thus, these can be used by them to their personal advantage.

A similar case reported at Infosys involved a tussle between Vishal Sikka and NR Narayan Murthy. Murthy was trying to garner shareholders to vote for removal of the board. Here too, voting rights for preference shareholders would make a difference in the meetings. It can be said here as well that rights of preference shareholders are directly affected because of the board's performance.

An illustration would be if one group of shareholders wanted the company to take decision pertaining to their interests, opposed by a rival shareholder group… The voting rights given to preference shareholders would assume great importance. When one group is in favour of acquiring another company or one is in favour of a particular future company strategy opposed by other, preference shareholders would play an important role. They will tilt the balance in favour of either of them.

The preference shareholders are given preferential treatment in the payment of dividend only in consideration of their contribution to the capital. The use of voting provisions for preferential shareholders brings into limelight the larger and important issue of balancing the freedom to vote against the safeguards necessary to protect the interests of ordinary shareholders that is beneficial to the company as a whole. The picture of the corporate affairs would be dramatically affected, if the preferential treatment were extended to voting rights. Hence, such voting rights should be discouraged.

The author, Disha Jain, is a 5th year student with Jindal Global Law School and can be contacted on Views and opinions expressed are solely that of the author and may not necessarily correspond with the official opinion of this publication.