Redeemable Preference Shares: What You Need to Know

There is a range of different shares that Australian companies are able to offer investors, one of which is preference shares. Investors considering investing in a company may pursue preference shares if they are unsure of the future success of the company.

Preference shares can be complex — this article will answer the most commonly asked questions regarding preference shares.

Australian companies are regulated by the Corporations Act 2001 (the Act). Chapter 2H in volume 1 of the Act determines the kind of shares a company may issue, and how they are issued. Preference shares are one of the types of shares that can be issued by a company.

Preference shares, in simple terms, are shares that provide shareholders with preference, or priority, over ordinary shareholders with regards to dividends or company assets in liquidation. A redeemable preference share is a share that can possibly be redeemed, or reclaimed, by the issuing company.

Redeemable preference shares provide the company with the option to buy back the share at a later date. After redemption, the share is cancelled.

The Corporations Act 2001 provides that a company possesses the power to issue shares, including redeemable preference shares. There are, however, specific terms for redeemable preference shares that govern factors such as when a company can redeem them.

These terms must be either approved by a special resolution of shareholders or set out in the company constitution.

The most important term of any redeemable preference share is that the company that issues them may be obligated to redeem them, or repurchase them, at some point. The company that issues the shares must, when issuing them, include the specific circumstances in which the shares either must or can be redeemed.

Common examples of circumstances in which redeemable preference shares can be redeemed include:

● At the company’s option
● At the shareholder’s option
● At a fixed time, or when a specific event occurs

Special resolutions either agreed upon by shareholders or defined in the company’s constitution dictate the key terms of redeemable preference shares. These key terms can include:

● Terms that define when shareholders have the right to the company’s assets and profits
● Terms that define when a company will repay shareholders the initial price of the shares issued

Other key terms of redeemable preference shares can define the following:

● Whether shareholders have the right to vote or participate in governance
● Whether shareholders are entitled to either cumulative or non-cumulative dividends
● Have the right to be paid in priority compared to shareholders that hold ordinary shares or shares of a different class

When issuing redeemable preference shares, a company is obligated to lodge with the Australian Securities and Investment Commission (ASIC) within 14 days of the share issue. The following forms must be lodged:

● Form 2205, notification of resolutions regarding shares
● Form 210, notification of statement or special rights carried by shares

It’s important to note that ASIC classifies redeemable preference shares under the share class code “REDP.”

Companies that issuer redeemable preference shares may only redeem them following terms established in the company constitution. Terms must be included for any redeemable preference share — such as terms that dictate that the company is unable to redeem shares unless they are fully paid up.

The redemption payment made to redeem shares must be made with the profit of the company or paid with the proceeds of a new issue of shares for the purpose of redemption. These restrictions prevent the redemption of shares potentially disadvantaging creditors by reducing the capital of a company.

If a company redeems shares without meeting these requirements, it won’t be guilty of an offense — while the transaction itself will remain valid, any individual involved in the infringement may face penalties, such as a director.

Shareholder approval is not necessary to approve the redemption of shares, but the shares redeemed by a company must be done so on the terms outlined in the constitution. The amount paid to shareholders is determined in accordance with the share price defined in the terms for redeemable preference shares. The company pays shareholders subsequent to the redemption of shares.

After shares are redeemed, redeemable preference shares are canceled. It’s important to note that by redeeming shares, a company eliminates any dividend rights attached to the shares. Some exceptions apply to this scenario, such as when the terms of issue defined in the company constitution specify otherwise.

Terms may, for example, specify that shareholders receive a dividend payment from any profits the company has generated on completion of share redemption.

It’s also possible for companies to redeem and cancel shares. A special resolution of redeemable preference shareholders and a company resolution in a general meeting can allow a company to redeem and cancel shares in a selective reduction of capital.

Selective buy-back terms may allow a company to redeem shares under terms different than original share terms. This process requires approval from any shareholders that will have their shares bought back — redeemable shareholders will need to accept the buy-back terms.

If a company chooses to buy back shares with this process, the funds used to buy them do not need to be paid from company profits. Under buy-back rules, however, the redemption of shares must not materially prejudice the ability of the company to pay any of its creditors.

ASIC must be notified of a completed redemption of redeemable preference shares via Form 484. The redeeming company must lodge this form within a month of the date the redeemed shares were cancelled on.

Details covered in Form 484 include the total number of shares cancelled, any amount paid by the company in cash or otherwise upon the cancellation of redeemed shares, and the classification of the shares that were redeemed.

The same requirements are applied to any buy-back, including through capital reduction or through a special resolution.

The Australian Taxation Office (ATO) treats redeemable preference shares differently depending on their terms — under ATO rules, redeemable preference shares may be classified as a debt interest or an equity interest. The hybrid nature of redeemable preference shares means that they combine both debt and equity.

Company directors should note that a company will incur a debt regarding these shares with regards to the insolvent trading provisions of the Corporations Act. Debt is incurred by companies in this manner when a company exercises its option to redeem shares, or issues redeemable preference shares that are redeemable under terms otherwise than solely at the option of the company.

Redeemable preference shares provide companies with the ability to issue shares to shareholders then later redeem them on predetermined terms that shareholders agree to. Companies that issue redeemable preference shares possess the right to buy back shares when specific events occur, at a fixed time, or at the option of either the shareholder or the company.