CORPORATE ALERT: PREFERENCE SHARES WHERE NO PREFERENCE EXISTS

In summary:

  • The High Court confirmed that a company registered under the Corporations Act 2001 (Cth) (Corporations Act) can have members who hold preference shares constituting one hundred percent (100%) of its issued shares. There is no requirement under the Corporations Act that ordinary shares need to be on issue in order for redeemable preference shares to be issued.
  • The High Court has reminded directors of their duties when approving and redeeming preferences shares under the Corporations Act.

 
The recent case of Beck v Weinstock [2013] HCA 15 dealt with the question of whether preference shares could be validly issued by a company that had not issued ordinary shares. The High Court clarified its position on preference shares and held that they could be issued or continue to exist even if there are no ordinary shares on issue.

What is a preference share?

A ‘preference share’ is a class of share that takes a preference over another class of share. Section 9 of the Corporations Act does define a ‘redeemable preference share’ as a preference share in a body corporate that is liable to be redeemed. Section 254A(2) of the Corporations Act provides that a company can issue ‘preference shares’ only if the rights attached to the preference shares are set out in the company‘s constitution or if such rights have been otherwise approved by special resolution of the company’s members. 

Background

LW Furniture Consolidated Pty Ltd (Company) was incorporated in 1971. Its articles of association (Articles) provided that 20,000 shares could be issued at $1 which were separated into a number of classes. The Articles provided for four (4) classes of shares, designated “A” to “D”, which were described as “preference shares” and ten (10) classes of shares, designated “E” to “N”, which were described as “ordinary shares”.

In 1971, when the Company was incorporated, the Company issued the following shares:

  • Five (5) “A” class shares, described in the articles as “convertible preference shares”. These shares had no voting rights and carried preference over share classes “B”,”C” and “D”;
  • Ten (10) “C” class shares, described in the articles as “redeemable preference shares”. These shares had no voting rights and ranked equally with “D” class shares, enjoying priority over all other shares that could be issued by the Company, other than “A” class shares;
  • Two (2) “D” class shares, also described in the articles as “redeemable preference shares”  These shares had no voting rights and ranked equally with “C” class shares enjoying priority over all other shares that could be issued by the Company, other than “A” class shares; and
  • The company never issued any ordinary shares.

 
Eight (8) of the “C” class shares were issued to Mrs Hedy Weinstock. When Mrs Weinstock died in 2004, the Company sought to redeem the “C” class shares. As executor of the estate of Mrs Weinstock, Mrs Beck claimed that the “C” class shares were not redeemable because they were not preference shares.

Decision in the Supreme Court of NSW and NSW Court of Appeal

In the Supreme Court of NSW, Hamilton AJ held that the “C” class shares were not validly issued as preference shares (and could not be redeemable preference shares), within the meaning of the Companies Act 1961 (NSW) (Companies Act) nor the Corporations Act. This was because it is an essential quality of a preference share that it confers some form of advantage over another class of shares.[1] Since no ordinary shares or other shares with lesser rights were issued (only “A’ class shares in the Company were ever issued) “C” and “D” class shares enjoyed no priority, and the redemption of the preference would then be void.[2]

On appeal his Honours Handley and Giles held that the “C” class shares were preference shares and had been validly redeemed (Young JA dissented and followed the reasoning of the primary judge in the first instance). By special leave, Mrs Beck appealed to the High Court. 

High Court Decision 

The High Court unanimously dismissed the appeal and rejected Mrs Beck’s argument, finding that the “C” class shares were preference shares (and could be redeemable preference shares) even where no ordinary shares were issued by the Company.

French CJ

 French CJ formed his view on the following basis:

  • The evolving characteristic of preference shares from ‘a device for emergency finance”[3] in the 18th and 19th century to an instrument issued that confers priorities in relation to dividend, capital and voting rights,[4] supports the argument that preference shares with a variety of rights and purposes could be issued in the absence of ordinary shares.
  • The Companies Act (the applicable corporate legislation at the time the “C” class shares were issued) and the Corporations Act both do not require a preference share to enjoy priority over some other issued share.[5]
  • He also rejected the argument that redeemable preference shares issued in advance of ordinary shares were inconsistent with the principle of maintenance of capital. French CJ stated that the protections afforded to company capital which are attached to the redemption of redeemable preference shares do not require that ordinary shares be first brought into existence and is not affected by the existence of only preference shares.

 
Hayne, Crennan and Kiefel JJ

In a joint judgment, Hayne, Crennan and Kiefel JJ examined only the relevance of the Companies Act.  Their Honours, pursuant to rules of the Companies Act, found that where a Company’s constitution authorised the issue of shares that carried a preference right, that share was a preference share. Their Honours went on to say:

“…it is necessary to distinguish between the rights attached to a share and the enjoyment of those rights. The holder of a share has whatever rights the memorandum and articles of association attached to that share. If, after the share was issued and allotted, there were to arise some question about the order in which shareholders would be repaid capital, participate in surplus assets or profits, receive or accumulate an entitlement to dividends, vote, or obtain payment of capital or dividend, that question would be resolved according to the rights attaching to the respective shares. A share which had one or more preferential rights was properly described as a “preference share” not only at the time the immediate question about employment or exercise of rights fell for consideration but also at the time of issue.” [6]

Their Honours considered the issue that the Company could possibly be left without any members if all the redeemable preference shares were redeemed by the company. They concluded however that it was doubtful that “the directors of the company would, or consistently with their duties” permit such a result.[7] They also noted the removal of all members would also be grounds to wind up the company under the Corporations Act.[8]

Gageler J

Gageler J adopted the view that the preference shares were redeemed and cancelled in 2004, therefore the issues relating to them should be dealt with under the Corporations Act. Gageler J noted the following:

  • The underlying concept of a preference share is that their rights are differentiated from ordinary shares. In order to differentiate, it is not necessary that ordinary shares be on issue.[9]
  • The Corporations Act neither requires nor assumes that shares cannot be preference shares or redeemable shares unless ordinary shares are issued by the Company.[10]
  • Shares that attached priority rights referred to in s.254(2)(a) of the Corporations Act remain preference shares, unless converted or redeemed, irrespective of whether or not ordinary shares are on issue.
  • The maintenance of capital argument was rejected; noting that s.254K of the Corporations Act requires the redemption of preference shares only out of profits or the proceeds of a new issue of shares made for the purpose of redemption.[11]

 
 Conclusion:

  • Private companies are not required to have ordinary shares on issue to issue preference shares; and
  • The redemption of redeemable preference shares, should be completed by companies in a manner that is consistent with the directors duties outlined in the Corporations Act and the requirements of s. 254K of the Corporations Act .

 
For further information, or if you have any queries relating to this area, please contact Michael Bishop or Phillip Grundy of our office on 03 9614 7707.

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