An Analysis of Redeemable Preference Shares under Indian Company Law

A Comprehensive Legal Analysis of Redeemable Preference Shares in India

Introduction

Redeemable Preference Shares (RPS) constitute a significant and distinct category of share capital within the Indian corporate legal framework. They represent a hybrid financial instrument, embodying characteristics of both equity and debt, yet legally classified as shares. This article provides a scholarly analysis of redeemable preference shares under Indian law, examining their statutory basis, nature, issuance, redemption, the legal status of their holders, and the consequences of non-redemption. The analysis draws significantly from the Companies Act, 2013, its predecessor the Companies Act, 1956, and judicial pronouncements that have shaped the understanding and regulation of these instruments.

The legal architecture surrounding RPS aims to balance the company's need for flexible capital raising with the protection of shareholder and creditor interests. Understanding the nuances of RPS is crucial for corporate structuring, investment decisions, and dispute resolution. As noted in an order by the Securities and Exchange Board of India (SEBI), "a share means share in the sharecapital of a company... According to section 86 of the Companies Act, the share capital of a company limited by shares shall be of two kinds only - equity share capital and (ii) preference share capital. Therefore, it can be seen that the share capital of a company limited by shares, comprises of equity shares and preference shares issued, if any. From the foregoing, it is easy to comprehend that shares dened under section 2(46) of the Companies Act would include preference shares" (Order in the matter of M/s. Prayag Infotech Hi-rise Ltd, SEBI, 2013).

Statutory Framework for Redeemable Preference Shares in India

The issuance and redemption of preference shares in India are primarily governed by the Companies Act, 2013, and prior to its enactment, by the Companies Act, 1956.

The Companies Act, 2013: Section 55

Section 55 of the Companies Act, 2013, is the principal provision governing the issue and redemption of preference shares. Key stipulations include:

  • A company limited by shares may, if so authorised by its articles, issue preference shares which are liable to be redeemed within a period not exceeding twenty years from the date of their issue (Companies Act, 2013, S. 55(1)).
  • No company can issue irredeemable preference shares (Companies Act, 2013, S. 55(1)).
  • Preference shares can be redeemed only out of the profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of such redemption (Companies Act, 2013, S. 55(2)(a)).
  • No such shares shall be redeemed unless they are fully paid (Companies Act, 2013, S. 55(2)(b)).
  • Where shares are proposed to be redeemed out of the profits of the company, a sum equal to the nominal amount of the shares to be redeemed must be transferred to a Capital Redemption Reserve Account (CRRA) (Companies Act, 2013, S. 55(2)(c)). The CRRA can be applied by the company in paying up unissued shares of the company to be issued to members as fully paid bonus shares.
  • If a company is unable to redeem any preference shares or to pay dividend, if any, on such shares, it may, with the consent of the holders of three-fourths in value of such preference shares and with the approval of the National Company Law Tribunal (NCLT) on a petition made by it, issue further redeemable preference shares equal to the amount due, including the dividend thereon, in respect of the unredeemed preference shares. On the issue of such further redeemable preference shares, the unredeemed preference shares shall be deemed to have been redeemed (Companies Act, 2013, S. 55(3)). This provision mirrors the intent previously found in Section 80A of the Companies Act, 1956. The NCLT in SHREE RAMA MULTI-TECH LIMITED v. NA (2023) approved such an issuance of further RPS.

The Companies Act, 1956: Sections 80 and 80A

Prior to the 2013 Act, Section 80 of the Companies Act, 1956, governed the power to issue redeemable preference shares and specified similar conditions for redemption, primarily that redemption must be out of profits otherwise available for dividend or out of the proceeds of a fresh issue of shares (Birla Global Finance Limited v. Nr, Bombay High Court, 2003; N.A. v. In The Matter Of Section 80 Read With Sections 100 To 104 Of The Companies Act, 1956, Bombay High Court, 2003).

Section 80A of the Companies Act, 1956, introduced by the Companies (Amendment) Act, 1988, mandated the redemption of existing irredeemable preference shares and provided a mechanism for companies unable to redeem preference shares within the stipulated time to issue further redeemable preference shares with the consent of the Company Law Board (CLB), now NCLT (K.K. Jindal v. Rajaram Com Products (Pb) Pvt. Ltd., Company Law Board, 2013; Sahu Cylinders And Udyog P. Ltd. v. Registrar Of Companies, Madras High Court, 2006). The CLB in In The Matter Of Sections 80/80A & 634A Of The Companies Act, 1956 (2013) noted that once further RPS are issued under Section 80A, the unredeemed shares are deemed to have been redeemed.

Nature and Characteristics of Redeemable Preference Shares

Hybrid Nature: Shareholder Rights with Redemption Feature

Redeemable preference shares possess a hybrid character. Financially, they may resemble debentures due to the fixed return (dividend) and eventual repayment of principal (redemption). However, legally, they are unequivocally shares. The Calcutta High Court in Hindustan Gas And Industries Ltd. v. Commissioner Of Income-Tax, West Bengal-Ii (1978) observed, quoting Palmer's Company Law, that "though they share the disadvantages of debenture-holders they lack their advantages. They can only receive a return on their money if profits are earned and dividends declared, they rank after creditors on a winding up, and they have less effective remedies for enforcing their rights. Suspended midway between true creditors and true members they get the worst of both worlds."

The Gujarat High Court in Anarkali Sarabhai v. Commissioner Of Income Tax (1982) reinforced this, stating:

"From the financial point of view, redeemable preference shares are a hybrid form shares and debentures, incorporating features of both, and being closer to the latter than other preference shares, but from the legal point of view they are shares, and are treated as such." (quoting Palmer's Company Law, 22nd Edn., Vol. I, p. 356).

Distinction from Debentures

Despite some similarities, RPS are fundamentally different from debentures. Debenture holders are creditors of the company, whereas preference shareholders are members. This distinction has significant legal ramifications, particularly concerning rights in winding up and remedies for non-payment. The Bombay High Court in Commissioner Of Income Tax-4 v. Enam Securities Private Limited (2012) explicitly stated that "non-cumulative redeemable preference shares cannot be equated with debentures or bonds... A debenture is a loan taken by the Company. The Companies' Act, 1956 envisages two types of capital, equity share capital and preference share capital."

Terms of Issue

The terms of issue of RPS are typically set out in the company's Articles of Association and the resolution authorizing the issue. These terms include the rate of dividend (which may be fixed and cumulative or non-cumulative), the period of redemption, and any premium on redemption. For instance, in Tin Plate Dealers Association Pvt. Ltd. & Ors. (S) v. Satish Chandra Sanwalka & Ors. (S) (2016), the Supreme Court noted preference shares carrying a "fixed cumulative free of income tax dividend @ 6% per annum" and redeemable "at any time after a period of 5 or 10 years... at the option of Directors... or at the option of the holder thereof." The SEBI order in M/s. Prayag Infotech Hi-rise Ltd (2013) also referred to terms where "the principal and redemption premium shall be paid on maturity on surrender of preference share certificates."

Redemption of Preference Shares

Sources of Funds for Redemption

As mandated by Section 55(2) of the Companies Act, 2013 (and previously Section 80 of the 1956 Act), redeemable preference shares can only be redeemed out of:

  • Profits of the company which would otherwise be available for dividend; or
  • The proceeds of a fresh issue of shares made for the purposes of such redemption.

This was unequivocally affirmed by the Bombay High Court in Birla Global Finance Limited v. Nr (2003) and N.A. v. In The Matter Of Section 80 Read With Sections 100 To 104 Of The Companies Act, 1956 (2003), which addressed the question: "Whether the preference shares can be redeemed otherwise than out of the profits of the Company which would otherwise be available for dividends or out of the proceeds of the fresh issue of shares made for the purpose of redemption?" The answer being in the negative. This restriction is crucial for protecting the company's capital and the interests of its creditors.

Creation of Capital Redemption Reserve Account (CRRA)

When redemption is effected out of profits, an amount equal to the nominal value of the shares redeemed must be transferred to the CRRA (Companies Act, 2013, S. 55(2)(c)). The Calcutta High Court in Commissioner Of Income-Tax, West Bengal-Iv, Calcutta v. Placid Limited (1984), while discussing the nature of such reserves under the earlier Act, noted that the "capital redemption reserve account may... be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares."

Prohibition on Redemption otherwise than from Prescribed Sources

The statutory limitation on the sources for redemption is strict. Any redemption not adhering to these provisions would be invalid and could be construed as an unauthorized reduction of share capital.

Redemption at the Option of Company/Holder

The terms of issue may provide for redemption at the option of the company or the shareholder, or upon the expiry of a stipulated period (Tin Plate Dealers Association Pvt. Ltd. & Ors. (S) v. Satish Chandra Sanwalka & Ors. (S), 2016). However, the Calcutta High Court in Placid Limited (1984) observed that generally, "the redemption of redeemable preference shares is a right conferred on the company and not on the holders of such shares who cannot call upon the company for redemption," unless the terms specify otherwise.

Legal Status of Redeemable Preference Shareholders

Shareholders, Not Creditors

A fundamental principle is that holders of redeemable preference shares are shareholders (members) of the company and not creditors, even when their shares become due for redemption. The Andhra Pradesh High Court in Lalchand Surana And Others v. M/S. Hyderabad Vanaspathy Ltd. (1988) explicitly held that preference shareholders "cannot style themselves as ‘creditors’." The court reasoned that their shares can be redeemed only out of profits or a fresh issue of shares, a limitation not applicable to ordinary creditors.

This was also affirmed by the Gujarat High Court in Anarkali Sarabhai v. Commissioner Of Income Tax (1982): "We are unable to accede to the submission that the holder of a redeemable preference share is in a position of creditor once the company decides to redeem the shares... if redemption would make the company insolvent, the company may not be allowed to redeem preference shares because repayment of preference capital would be a fraud upon its creditors. This would clearly indicate that the holder of preference shares is not in the same position as that of a creditor."

Implications for Winding-Up Petitions

Consequently, a preference shareholder whose shares are due for redemption but remain unredeemed generally cannot petition for the winding up of the company as a creditor on the ground of inability to pay debts. In Lalchand Surana (1988), the court held that such shareholders "do not become creditor and cannot, therefore, apply for winding-up of the company" under the provisions applicable to creditors. Similarly, in Aditya Prakash Entertainment Pvt. Ltd. Petitioner v. Magikwand Media Pvt. Ltd. (2018), a winding-up petition was filed by a preference shareholder for non-redemption, though the arguments also touched upon the company's eroded net worth, a ground available to contributories.

Exceptions: Financial Assistance Agreements

An important distinction was drawn by the Debts Recovery Appellate Tribunal in Invent Assets Securitisation & Reconstruction Pvt. Ltd.… v. Emtex Industries (I) Ltd. & Ors.… (2014). While reiterating the general principle from Lalchand Surana that simple subscription to RPS makes one a shareholder, the Tribunal found that if the subscription is part of a larger "financial assistance" arrangement, accompanied by agreements like guarantees or mortgages for repayment, the character of the transaction might change. In such specific contexts, the amount payable on maturity of RPS could be treated as a 'debt' for the purposes of recovery, distinguishing it from a mere shareholding relationship.

Consequences of Failure to Redeem and Remedies

Issue of Further Preference Shares

As per Section 55(3) of the Companies Act, 2013 (and its precursor Section 80A of the Companies Act, 1956), if a company is unable to redeem its preference shares or pay dividends thereon, it can, with the consent of three-fourths of the preference shareholders and NCLT approval, issue further RPS to the extent of the amount due (including arrears of dividend). Upon such an issue, the original unredeemed RPS are deemed to be redeemed. This was the mechanism applied in SHREE RAMA MULTI-TECH LIMITED v. NA (2023) by the NCLT and discussed in K.K. Jindal (2013) and In The Matter Of Sections 80/80A (2013) by the CLB.

Enforcement through NCLT/CLB

Preference shareholders may approach the NCLT (formerly CLB) for enforcement of redemption obligations or for orders under provisions like Section 55(3). The CLB in In The Matter Of Sections 80/80A (2013) considered the enforcement of its earlier orders related to RPS redemption.

Limited Scope for Winding Up

As discussed, the right of a preference shareholder to seek winding up as a creditor is severely restricted. However, they may petition as a contributory if grounds under Section 271 of the Companies Act, 2013 (e.g., just and equitable grounds) are met, which might include persistent failure to redeem coupled with financial mismanagement or erosion of substratum.

Regulatory Oversight and Public Issues

SEBI's Role in Public Issues of RPS

If redeemable preference shares are issued to the public, compliance with SEBI regulations is mandatory. SEBI has investigated companies for fund-raising activities involving the issue of RPS without adhering to public issue norms (Express Cultivation Limited, SEBI, 2016).

The Supreme Court's decision in IFB Agro Industries Limited v. SICGIL India Limited (2023), while primarily concerning jurisdictional boundaries between NCLT and SEBI for violations of SAST and PIT Regulations, reinforces SEBI's exclusive jurisdiction in matters of securities market regulatory violations. This principle would extend to violations related to public issues of RPS.

Compliance with Public Issue Norms

The issuance of RPS to more than a prescribed number of persons (e.g., 49 or 50, depending on the applicable statutory threshold at the time) without following public issue norms constitutes a violation of the Companies Act and SEBI regulations. This was highlighted by the Securities Appellate Tribunal in cases like Mr. Basir Uddin Khan v. (2017) and Suvidha Land Developers India Ltd. and Anr. v. (2017), both referencing the Supreme Court's judgment in Sahara India Real Estate v. SEBI (2013) 1 SCC 1.

Taxation Aspects

Deductibility of Expenses on Issue of RPS

Expenditure incurred in connection with the issue of redeemable preference shares, such as legal charges for preparing a prospectus, underwriting commission, and brokerage, has been a subject of tax litigation. The Calcutta High Court in Hindustan Gas And Industries Ltd. v. Commissioner Of Income-Tax, West Bengal-Ii (1978 SCC ONLINE CAL 410) held such expenses to be of a capital nature, not revenue expenditure. This case was referenced in Commissioner Of Income-Tax Bombay City-I, Bombay v. M/S. National Rayon Corporation Ltd. (1984), where the court discussed deductibility of various business expenses. The reasoning often analogizes the raising of preference share capital to an expansion of the capital base of the company.

Redemption as a "Transfer" for Capital Gains

The redemption of preference shares has been held to constitute a "transfer" within the meaning of Section 2(47) of the Income Tax Act, 1961. Consequently, any gains arising from such redemption may be subject to capital gains tax in the hands of the shareholder. The Bombay High Court in Commissioner Of Income Tax-4 v. Enam Securities Private Limited (2012), following the Supreme Court in Anarkali Sarabhai v. CIT (1997) 224 ITR 422 (SC) (which is a different Anarkali Sarabhai case from the 1982 Gujarat HC one cited earlier, and should be noted for clarity, though not directly provided as a reference material, its principle is cited by Enam Securities), affirmed this position.

Conclusion

Redeemable preference shares occupy a unique position in Indian corporate finance and law. Governed primarily by Section 55 of the Companies Act, 2013, their issuance and redemption are subject to stringent conditions designed to protect capital integrity and stakeholder interests. Legally, holders of RPS are shareholders, not creditors, a distinction that critically impacts their rights and remedies, particularly in scenarios of non-redemption or corporate insolvency. While offering companies a flexible means of raising capital, the framework ensures that redemption occurs only from permissible sources (distributable profits or fresh issue of shares) or through a structured process of issuing further shares with requisite approvals. Judicial interpretations have consistently reinforced their status as equity, clarified their distinction from debt, and delineated the scope of regulatory oversight, especially concerning public issues. A thorough understanding of this legal landscape is indispensable for corporates, investors, and legal practitioners navigating the complexities of share capital in India.