Voting Rights on Preference Shares: An Unclear Provision?

[The
following guest post is contributed by Vignesh Iyer of Vinod Kothari & Co.
The author can be contacted at [email protected]]
The enactment of the Companies Act,
2013 (Act, 2013) has given rise to various issues with regard to compliance and
interpretations of several statutory provisions. One such issue is the subject
matter of this post.
Section 47 of Act, 2013 – Voting
rights
Section 47 of Act, 2013 provides
for voting rights of the shareholders. The same corresponds to Section 87 of
the Companies Act, 1956 (Act, 1956). Section 87 of Act, 1956 clearly demarcated
the rights of cumulative and non-cumulative preference shareholders in case of
default in payment of dividend, whereas Section 47 of Act, 2013 does not
provide for the same.
The second
proviso to Section 47(2) of Act, 2013 provides:
“Provided
further that where the dividend in respect of a class of preference shares has
not been paid for a period of two years or more, such class of preference
shareholders shall have a right to vote on all the resolutions placed before
the company.”
It is evident
that the above proviso has been muddled, which leads to several queries viz.:
– Does it mean a period of two consecutive years or any two years?
– If dividend is paid in such two years, will it extinguish the voting
rights of the preference shareholders or will it be a permanent right?
– Whether subsequent payment considered as remedial?
– If remedial, how will it stand good in case of non-cumulative
preference shares?
In the case of Suryakant Gupta vs Rajaram Corn
Products (Punjab)
[1] it
was held that if dividend to preference shareholders is in default for a long
time, they became entitled under Section 87 of Act, 1956 for exercise voting
rights on preference share.
Section 87(2)(b)
of Act, 1956 provided:
“Subject as aforesaid, every member of a company limited by shares and
holding any preference share capital therein shall, in respect of such capital,
be entitled to vote on every resolution placed before the company at any
meeting if the dividend due on such capital or any part of such dividend has
remained unpaid-
i.          in the case of cumulative preference
shares, in respect of aggregate period of not less than two years preceding the
date of commencement of meeting; and
ii.         in the case of non-cumulative
preference shares, either in respect of a period not less than two years ending
with the expiry of the financial year immediately preceding the commencement of
the meeting or in respect of an aggregate period of not less than three years
comprised in the six years ending with the expiry of the financial year
aforesaid ”
Section 47 of
Act, 2013 acts almost as a red alert for the defaulters as there is no clear
line of distinction made with regard to the applicability of the section to
cumulative and non-cumulative preference shares. Additionally, whether the
right is of permanent nature or not has not been clarified too.
Accounting
treatment
By virtue of
attainment of voting rights on all matters of corporate affairs, the said
preference holders will also acquire control. Thus, this will also result in
consolidation of financial statements in the books of such preference
shareholder. The obvious thought that would arise is whether such preference
shareholder will have a right in the excess profits on the company? How will
the minority interest be determined? Let us discuss an illustration:
Company X holds
75% equity in Company Y (a listed entity). Remaining 25% equity is held by
public shareholders. Company X also holds 100% of non-cumulative preference
shares in Company Y. Company Y has not distributed any dividend for last 3
years, pursuant to which Company X has acquired voting rights. The voting
rights by being an equity and preference shareholder aggregates to 96% of paid
up capital of Company Y.
Standard 5.1(a)
& 8 of Accounting Standard 21[2]
which deals with ‘Consolidated Financial Statements’ provides for the
definition of the term ‘Control’ and presentation of Consolidated Financial
Statements respectively.
Standard 5.1(a) reads:
“Control:
(a) the
ownership, directly or indirectly through subsidiary(ies), of more than one-half
of the voting power of an enterprise;”
Primarily,
voting power is said to be vested in the equity shareholders of a company as
they are empowered to vote on all resolutions laid before the company. In the
present case, Company X holds 75% of the equity share capital and 100% of the
non-cumulative preference share capital which implies that Company X holds 75%
of the voting power. Thus, Company X holds more than 50% of the voting rights
in Company Y and consequentially Company Y is a subsidiary of Company X by
virtue of Standard 5.1(a) of Accounting Standard 21.
While
consolidation of financial statements is done 100%, calculation of minority
interest will be done based on the share of net assets owned by the holding
company. So in the present case, though there is an enhancement of voting
rights of Company X from 75% to 96%, calculation of minority interest shall be
done on the basis of Company X’s holding of 75% and not 96%. In case of
non-cumulative preference shares, the calculation of net income shall exclude
preference dividend unless it is declared.
Minority Interest = (Net Worth-
Preference share capital) * 25%
 Para 5.7 of Accounting Standard-21 reads:
“Minority
interest is that part of the net results of operations and of the net assets of
a subsidiary attributable to interests which are not owned, directly or
indirectly through subsidiary(ies), by the parent.”
Conclusion
Going by the
language of Section 47(2) of Act, 2013, in our view, the period of two years
mentioned shall be any two years from the issue and need not be
consecutive. In case of cumulative preference shares, payment of dividend in
the subsequent years after defaults may be taken as a remedial step but in case
of non-cumulative preference shares the question of subsequent payment being a
remedial step for past defaults is not practical. However, the question
persists whether the rights get extinguished by such remedial step or will it
remain permanent.
– Vignesh Iyer

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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