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 rightsSection 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; andii.         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 treatmentBy 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-halfof 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.”ConclusionGoing 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 [1](2008) 142 CompCas 416 (CLB) [2]

Source: Corporate

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