Redemption of Preference Shares

The process or requirement of repaying the capital of preference shares to the shareholders is referred to as redemption of preference shares. A firm can only redeem its preference shares according to the terms that were stated at the time of issuance or as amended once the shareholders of those preference shares have given their assent. The terms of the issue of these shares provide that the firm would refund the amount invested by the shareholders in the company at a later period, as well as pay a set amount in the form of interest on a regular basis over the contract's term.

The date of redemption is the maturity date that is given in the preference share certificate. Redemption of preference shares helps the company in adjusting the financial structure. The redemption of these shares takes place:

• At a fixed time or on the happening or completion of an event,
• Any time when the issuance company wants, or
• Any time when the shareholders want.

Why Do Companies Issue Redeemable Preference Shares?

There are certain reasons because of why a company may issue redeemable preference shares. They include the followings:

• It is an efficient way for a company to raise funds or to attract investors in a dull primary market.
• There can be difficulty arising for a company in raising the funds if its shares are not traded on the stock exchange. In such a case, the potential customers may feel hesitant in investing money in the shares of that company due to the high risk as the shares cannot easily be sold. Redeemable preference shares can be a better option to tackle this problem and encourage investors.
• The company can redeem the preference shares only when there is a surplus of capital in the company and this surplus can't be used by the company for the profitable purpose of the business. So the companies issue redeemable preference shares to get this benefit also.

In our country, Section 55 of the Companies Act, 2013 governs the issue and redemption of preference shares.

Conditions for Redemption of Preference Shares

• Preference shares can be redeemed either on par or at a premium. The preferred shares cannot be redeemed at a discount by any company.
• Only earnings available for dividends or funds from a new issue of shares (either equity or preference shares, but not debentures) made for the same purpose can be used to redeem preference shares.
• The premium amount on redemption of preference shares (if any) will be paid out of earnings available for dividend or out of securities premium or debenture premium account if any is generated.
• The shares must be fully paid up for their redemption.
• The redemption of such shares does not result in a diminution in the company's share capital.
• Only when the shares are redeemed out of undistributed earnings will a sum equivalent to the nominal value of the redeemable shares be transferred from such profits to the Capital Redemption Reserve Account.

Procedure for Redemption of Preference Shares

1. Prior Notice of the Meeting of the Board of Directors

Companies with non-convertible preference shares listed on an exchange must notify the Board of Directors in advance of the meeting. This information should be given at least 11 working days prior to the day when the company will begin paying the redemption amount.

2. Call and Convene a Board Meeting

There are several sub-steps included in this step:

• First of all, send a notice to all the members of the board regarding the meeting. The notice should be sent at least 7 days before the meeting. However, short notice can also be sent in case of urgency.
• Along with the notice, send Agenda, Notes to the agenda, and Draft Resolution.
• Now, the meeting can be convened to pass the required Board Resolution:

• To approve the redemption of preference shares in any of the following ways.
• To authorize redemption from the company's profits or by issuing new shares.
• To authorize the deposit of funds into the capital redemption account. This amount will be equal to the nominal amount of redeemable preference shares.
• To authorize the issuance of new shares up to the nominal value of the redeemable preference shares, but exclusively for redemption.
• If the company's non-convertible preference shares are listed on an exchange, determine the record date in accordance with Regulation 60 of the SEBI (LODR) 2015.
• To authorize the company's CS, CFO, or any director to file the redemption notice with the ROC.
• If the company's non-convertible preference shares are listed on the exchange then it has to give prompt information to the exchange related to any action taken for redemption of these shares. Other than this, such a company has to give advance notice to the stock exchange of a minimum of 7 working days excluding the date of intimation and record date.
• Draft minutes should be prepared and circulated within 15 days from the conclusion of BoD's Meeting, by using any of the means of transport to all the Directors to get their comments.

3. Payment of Redemption Amount

The corporation will pay the redemption amount and the premium amount (if any) to the redeemable preference shares after the second stage is completed.

4. Relevant Entries in the Register of Members

Now, the company will make the relevant entries in the Register of Members in Form MGT-1. This work should be done within 7 days from the date on which the BoD's meeting was conducted to get approval for the redemption of preference shares.

5. Corporate Actions

After making the entries, the company is required to file the necessary corporate action so that the preference shares can be debited from the account of the shareholders. The company can do this work after allotting the redeemable preference shares in Demat format.

6. File Notice

The corporation will file a notice of redemption of preference shares with the ROC in Form SG-7 at this point. This notice must be submitted within 30 days of the redemption date. The paperwork should be accompanied by a copy of the Board Resolution allowing the redemption of such shares.

7. Transfer of Amount to Capital Redemption Reserve Account

Finally, the corporation will send to the Capital Redemption Reserve Account an amount equivalent to the nominal value of redeemed preference shares. This step can be completed if the corporation has redeemed preference shares with profits from the business.

Methods of Redemption

1. For Fully Paid-up Preference Shares

As per the Companies Act 2013, the company must redeem the preference shares within the maximum period, i.e., 20 years allowed under the Act. Thus, a company does not have the right to issue irredeemable preference shares. Sector 55 of the Companies Act, 2013, deals with the issue related to the redemption of preference shares. It makes sure the redemption does not cause any reduction in the shareholders' funds and thus the interest of the external parties remains unaffected. For this, it is needed that the redemption is done by the fresh issue of shares and/or undistributed profits which are transferred to the 'Capital Redemption Reserve Account'.

To protect the interest of the outsiders, Section 55 provides for the redemption of only fully paid-up preference shares. The 'gap' generated in the capital of the company due to redemption much be filled in in the following ways:

1.1. Redemption by Fresh Issue of Shares

The proceeds of a new share offering are one of the most typical mechanisms for the redemption of preference shares. A company is free to use new equity or preference shares and the proceeds from them can be used for redemption purposes. The company can prefer this method under the following conditions:

• When the corporation realizes that the capital is necessary indefinitely, issuing equity shares makes it more logical.
• When the company has an insufficient balance remaining from the profit after the distribution of dividends.
• When the company's liquidity position is not good enough.

Advantages

• It does not cause any outflow of cash from the company's fund.
• The company can value the new equity shares at a premium.
• The equity interest is retained by the shareholders.

Disadvantages

• The company can face the problem of dilution of future earnings.
• The changes occur in the shareholdings of the company.

1.2. Redemption by Capitalization of Undistributed Profits

A corporation can also use its undistributed earnings to redeem preference shares, according to the Companies Act of 2013. When utilizing this technique, the corporation must debit the amount of distributable profit and transfer an amount equivalent to the face value of the shares to the Capital Redemption Reserve Account. In other terms, the company keeps some part of the distributable profit to make sure that the amount will not be distributed as a dividend. This newly formed account's balance can be used for fully paid bonus shares, which ultimately convert the retained profits into share capital.

Advantages

• The company can utilize its surplus funds.
• It does not affect the percentage of the equity shareholding of the company.

Disadvantages

• The only negative of redemption of preference shares by the capitalization of undistributed profits is that it may reduce the liquidity of the company.

1.3. Redemption by Combination of Fresh Issue and Capitalization of Undistributed Profits

A company can also use the combination of both, i.e., partly from fresh issues and partly from capitalization of undistributed profits for the redemption of preference shares. In order to fill the 'gap' between the face value of redeemed shares and the revenues from the new issue, the firm must make a transfer from distributed profits to Capital Redemption Reserve. This approach employs the following formulae:

• Amount to be Transferred to Capital Redemption Reserve

• Proceeds to be Collected from New Issue

Sale of Investments

The companies can also sell their investments in the market to arrange sufficient funds for the redemption of preference shares.

2. For Partly Called-up Preference Shares

In such a case it is assumed that the final call on the redeemable preference shares is demanded and received before proceeding with redemption. This is done because of a condition of redemption which is that the company can redeem only fully paid-up preference shares. If the company has the information about both partly and fully paid-up preference shares then it will redeem only fully paid shares.

3. For Fully Called but Partly Paid-up Preference Shares

In this case, the redemption of shares can be divided into the following two categories:

3.1. When the company has received Calls-in-Arrears

If the company has collected the number of unpaid calls before redemption then the following entry is passed:

Bank A/c Dr.

To Calls-in-Arrears A/c

Once the company receives call-in-arrears the shares got converted into fully paid-up and then the procedure of redemption can be continued in the normal course.

3.2. When the Shares are Forfeited

If shareholders fail to pay for unpaid calls despite receiving adequate notice from the corporation, the Board of Directors may forfeit the shares and cancel them rather than reissuing them. This is due to the fact that these shares are due to be redeemed immediately or in the near future. In this situation, the corporation will proceed with the forfeiture entries as usual.