Legal Issues Relating to RCPS Issuance under the Companies Act 2016

Introduction

A preference share, when issued, will form a part of the issued share capital of a company. In practice, a preference share confers upon the holder a preference or priority over a holder of ordinary shares, usually in respect of fixed dividends and return of capital upon a winding-up. However, it generally does not entitle the holder to the right to vote on a resolution or to any right to participate beyond a specified amount in any distribution whether by way of dividend, or on redemption, in a winding up, or otherwise.

In addition to the preferential feature, preference shares may also have a redeemable feature, which make them liable to being redeemed in the future, and also a convertible feature, which grants an option for the preference shares to be converted into ordinary shares.

A company’s power to issue preference shares is subject to the Companies Act 2016 (“2016 Act”) and shall also be in accordance with the company’s constitution. In this regard, any issuance by a company of redeemable convertible preference shares (“RCPS”) and rights attached thereto are subject to the requirements and restrictions of the 2016 Act, which the issuing company and its directors need to consider before the issuance. A subscriber of RCPS will also need to consider the legal considerations under the 2016 Act prior to subscribing to RCPS, so that both the issuer and the subscriber may benefit from the features of the RCPS.

A recent example of the issuance of RCPS is the issuance by Proton Holdings Berhad of redeemable convertible cumulative preference shares worth RM1.25 billion and RM250 million in 2016 and 2017 respectively to GOVCO Holdings Berhad, which is 99.99% owned by the Ministry of Finance (MOF), as part of its capital raising exercise.

Under the 2016 Act, a company having a share capital may issue preference shares if so authorised by its constitution¹. This requirement indirectly means that a company that proposes to issue RCPS is required to have a constitution.

A company which does not have the enabling provisions in its constitution will also need to make the necessary amendments to allow the issuance of RCPS. A company is also restricted from converting any issued shares into preference shares unless so authorised by its constitution².

In this regard, prior to the issuance of RCPS, an issuing company is required to have or amend its constitution to expressly set out the rights of the company to issue the RCPS and the rights of the holders of preference shares, which shall include repayment of capital, participation in surplus assets and profits, cumulative or noncumulative dividends, voting and priority of payment of capital and dividend in relation to other shares or other classes of preference shares³.

As a company’s constitution is a contract between the company and its members, specifying the rights attached to preference shares ensures that the preference shares holders rights are entrenched and cannot be disputed by the other members. Further, any prospective investor may also investigate the rights attached to preference shares as a company’s constitution is required to be lodged with the Registrar of Companies⁴, and hence become a document accessible by the public.

It is also noteworthy to highlight that where a company issues shares with different rights, it must also be provided in the company’s constitution that the company has different classes of shares and the rights of each class of shares⁵.

Redemption

Subject to the 2016 Act and the company’s constitution, a company may issue preference shares which are liable or at the option of the company liable to be redeemed, in accordance with its constitution⁶.

The redemption of preference shares is however, not to be taken as a reduction of the share capital of the company⁷.

Notwithstanding the right of redemption, preference shares may only be redeemed if the shares are fully paid up and the redemption is made out of either:

(a) profits;

(b) a fresh issue of shares; or

(c) the capital of the company⁸.

In Arah Cipta Sdn Bhd v. Piala Gagasan (M) Sdn Bhd & Anor⁹, the High Court held that notwithstanding the contractual obligations on the issuer to redeem the preference shares, it could only be redeemed through profits or out of proceeds of a fresh issue of shares as required under the previous Companies Act 1965 (“1965 Act”).

The court had referred to the Australian Federal Court case of Commissioner of Taxation v. Coppleson¹⁰ where the learned judge held that the parties contracted on the basis of the law and part of that law is section 61(3) of the Act, as such, the parties cannot be presumed to have assumed obligations which it is unlawful for one of the parties to fulfil. Where redemption is made from the profits or the capital of the company, the company is required to transfer an amount equal to the amount of shares redeemed into the share capital of the company from its profits¹¹.

The 2016 Act provides an additional avenue for redemption through the capital of the company. In order to redeem from the capital of the company, the company must satisfy the solvency test. All directors of the company are required to make and sign a solvency statement in relation to the redemption to be supported by a declaration to the effect that the directors have made an inquiry into the affairs of the company¹² and have formed the opinion that the company is able to pay its debts immediately after the redemption¹³.

The company is then required to lodge a copy of the solvency statement with the Registrar of Companies¹⁴. As the 2016 Act provides that redemption may be liable to be redeemed at the option of the company, or as specified in its constitution, a company is to consider the appropriate circumstances of the redemption (e.g. fixed period, occurrence of a specific event, etc.), taking into account the company’s ability to redeem the RCPS when so liable to be redeemed.

In this regard, the redemption needs not necessarily be at the option of the issuer, and may be at the option of the holder, if so specified in the issuer’s constitution. The detailed mechanism for the redemption may also be spelt out in the constitution, e.g. redemption price, any other approvals (internal and external, if any) required to be obtained by the company prior to such redemption.

Conversion

RCPS with convertible feature grants an option for the RCPS to be converted into ordinary shares of a company. In having the convertible feature, a company is to consider at whose option the RCPS are to be converted, being mindful of the debt and equity classification as mentioned below.

Notwithstanding that the conversion is provided at the option of the holder, the company may still consider spelling out the circumstances or conditions for the conversion of the RCPS, e.g. that the conversion can only happen after certain point of time or event or of within certain period of time only. Pending completion of conversion process of the RCPS into ordinary shares, the RCPS holder should continue to enjoy the rights under the RCPS up to immediately prior to the conversion into the ordinary shares.

Dividends

Preference shareholders receive their dividends first in priority to ordinary shareholders. It may also be specified in the constitution that the RCPS holder is to have first priority in receiving dividends as against other classes of shares and other classes of preference shares.

It is to note that under the 2016 Act, distribution out of profits to shareholders may only be done upon the company satisfying the solvency test¹⁵ whereby all the directors of the company make a statement that the company will be solvent after the distribution out of profits.

A company is to consider whether dividends shall be cumulative or non-cumulative. A cumulative right to dividends entitles the RCPS holder to accumulate unpaid dividends of the previous years, (e.g. if the company did not declare dividends in year 2017 due to unavailable profits, the RCPS holder will be owed the dividend for 2017 in the following year 2018, to be paid when the company has sufficient profits).

As the RCPS will rank in priority over ordinary shares, all accumulated dividends must be paid to preference shareholders before any dividend for ordinary shareholders is Paid¹⁶.

In contrast, a non-cumulative right provides no accumulation of dividends from previous years when dividends are unpaid.

Rights to Vote

As RCPS is a preference share, the 2016 Act does not provide a RCPS holder with the following voting rights:

1. to attend, participate and speak at a general meeting;
2. to vote on a show of hands on any resolution of the company;
3. the right to one vote for each share on a poll on any resolution of the company.

However, a RCPS holder has the right to vote on a variation of his class rights¹⁷.

Notwithstanding a preference shareholder having limited voting rights, the 1965 Act provides the memorandum and article of a company may allow preference shareholders to attend and vote in a general meeting of the company under the following circumstances:

1. when their dividends are in arrears and unpaid;
2. upon any resolution which varies the rights attached to such shares; or
3. upon any resolution for the winding up of the company.

It is noteworthy that the 2016 Act has omitted a similar provision to allow preference shareholders the right to attend and vote at a general meeting upon the occurrence of the above events. In this regard, due to its exclusion under the 2016 Act, a RCPS holder will no longer enjoy this statutory right as was afforded under the 1965 Act.

However, a company may consider including such voting rights expressly in its constitution to the effect that the company shall have the rights to attend and vote at general meeting in the event of the above-mentioned circumstances having occurred and is occurring. Alternatively, a subscriber of RCPS may consider providing the rights to attend general meetings as an observer.

Debt vs. Equity

A company is to consider the manner the preference shares are to be treated in its account as under the accounting treatment, preference shares may either be a debt or equity instrument depending on the various rights attached to it. In determining whether a preference share is a financial liability or an equity instrument, an issuer should assess the particular rights attaching to the share to determine whether it exhibits the fundamental characteristic of a financial liability or equity instrument.

Conclusion

The issuance of RCPS is subject to the requirements of the 2016 Act as well as the constitution of the issuing company. As such, a company intending to issue or to subscribe RCPS will need to consider the features of the RCPS and the legal considerations to be negotiated and spelled out to govern such issuance and subscription, so that both parties may be protected and enjoy the features and benefits of the RCPS.

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1. Section 72(1)
2. Section 90(4)
3. Section 90(4)
4. Chan Wai Meng, (2017). Essential Company Law in Malaysia: Navigating the Companies Act 2016. Kuala Lumpur, Sweet & Maxwell
5. Section 90(1)
6. Section 72(2)
7. Section 72(3)
8. Section 72(4)
9. [2010] 9 CLJ 964
10. ALR Volume 6 1981-1982 p. 428
11. Section 72(5)
12. Section 113(1)
13. Section 112
14. Section 72(6)
15. Section 132
16. Mosgiel Ltd v. Mutual Life and Citizens Assurance Co Ltd (1992) 6 NZCLC 67,784, 67,803
17. Section 91-96

Written by:

Sharizan Sarif (Partner) sharizan@azmilaw.com

Ahmad Danial Abdul Rahim (general@azmilaw.com)