According to the Australian Securities and Investments Commission (ASIC) preference shares are shares that give holders some right or preference.
What are Redeemable Preference Shares?
According to section 9 of the Corporations Act 2001 (Cth) (Act) a Redeemable Preference Shares is
"a preference share in a body corporate that is, or at the body's option is to be, liable to be redeemed".
It is generally considered that Redeemable Preference Shares (REDP) are hybrid securities because they have characteristics akin to both debt and equity. REDP are also known as Convertible Preference Shares.
Standard share codes
ASIC lists "REDP" as the standard share code for Redeemable Preference Shares in addition to defining a range of other Standard Share Codes which can be used to describe the various different classes of shares.
What is important to understand is that the rights and entitlements associated with those shares are not generic, but can be defined by the members passing a special resolution of the Company or by amending the Constitution to include the rights and obligations associated with those shares. Therefore the codes may be standard, but the rights and obligations may not be.
Power to issue
Section 254A of the Act provides for the issue of bonus, partly paid, preference and Redeemable Preference Shares.
In particular section 254A(3) provides that:
"Redeemable preference shares are preference shares that are issued on the terms that they are liable to be redeemed. They may be redeemable
- at a fixed time or on the happening of a particular event; or
- at the company's option; or
- at the shareholders option".
General requirements for issue and redemption
Further requirements for Redeemable Preference Shares are provided in sections 254J – 254L of the Act.
- the redemption of shares can only be in accordance with the terms of their issue – s254J;
- a company can only redeem Redeemable Preference Shares if the shares are fully paid up and out of profits of the proceeds of a new issue of shares made for the purpose of redemption – s254K;
- section 254L describes the consequences of contravening the provisions dealing with Redeemable Preference Shares.
Process for issuance
For a proprietary company to issue preference shares, a special resolution must be passed by the members or the terms in relation to the shares be described in the Company's constitution pursuant to section 254A(3).
ASIC requires the following forms to be lodged:
- Form 205 Notification of resolutions regarding shares; and
- Form 210 Notification of statement or special rights carried by shares within 14 days after the rights are made created.
Case law
The question of what is a redeemable preference share was considered by the High Court in the case of Weinstock v Beck [2013] HCA 14, which was on appeal from the New South Wales Court of Appeal. One of the issues to be determined in the initial proceedings in Beck v Weinstock [2010] NSWSC 1068 Hamilton AJ, was whether the redemption by the directors of the of the preference shares was valid because the purported C Class Shares were not preference shares and were therefore not "redeemable". The issue being that to be a preference share the rights and obligations associated with the class of shares need to afford some kind of absolute preference over issued shares and not unissued shares.
The take a ways from Weinstock v Beck [2013] HCA 14 are as follows:
- there must be at the time the preference shares are issued other shares which the preference shares have some advantage;
- preference shares can be given preference as to the repayment of capital or dividends not both.
In Capel Finance [2005] NSWSC 286 it was said that it was an essential requirement of Redeemable Preference Shares is that they have some preference over another class of shares. Therefore it would seem plain that Preference Shares cannot be the only class of share on issue in the capital of a company.
Benefits of Redeemable Preference Shares
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Cancellation
One of the key benefits is that on redemption, the Redeemable Preference Shares are cancelled. This can have a negative dilutive effect for founders who wish to have access to capital for short term and guarantee a return for a shareholder on the occurrence of a particular event. The terms of issue can be wide and varied as the terms of 254A(3) provide for much latitude.
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Flexibility
REDP provides for considerable flexibility in creating alternative hybrid securities and may further allow for flexibility in the capital raising process.
Taxation issues
Because of the flexibility REDP, care must be taken to ensure that there are no adverse taxation issues for the shareholder of the issuer of the shares.
The Australian Taxation Office provides that pursuant to Division 974 (the debt and equity tests) of the Income Tax Assessment Act 1997 (Cth) some REDP are classified as not equity and as a result are treated as unfranked distributions for imputation purposes.
The ATO guide on debt and equity tests provides guidance to determine whether RFS is an equity interest or a debt interest. Whilst it is possible for REDP to be hybrid debt and equity interest care must be taken to ensure that they are adequately classified.
Links and references
Legislation
Australian Taxation Office, Guide to debt and equity tests in Division 974.
Cases
Capel Finance Ltd [2005] NSWSC 286 (4 April 2005)
Weinstock v Beck [2013] HCA 14 (1 May 2013)
Beck v Weinstock [2010] NSWSC 1068
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.
