Redemption of Preference Shares

A company cannot return its share capital to its shareholders during its life time without the permission of the Court (Sec. 100). However, a Company limited by shares may, if so authorised by its Articles, issue a special class termed as Redeemable Preference Shares, which can be redeemed during its life time as per the provisions of Sec. 80. of the Companies Act, 1956.

The Redeemable Preference Shares are those, the amount of which can be paid back to the holders of such shares. That is, the capital raised through the issue of Redeemable Preference Shares can be paid back by the Company to such shares. The paying back of capital is called the Redemption.

The redemption of redeemable preference shares does not reduce the Company’s authorised capital. From the Creditors’ point of view the capital remains intact because the share capital redeemed is simply replaced by the nominal value of the new shares issued for the purpose of redemption or by a Capital Redemption Reserve Account, for practical purposes, is equal to the paid up capital of the company.

Companies (Amendment) Act 1988 and 1996

By virtue of Section 5 A of Sec. 80 of the companies (Amendment) Act 1996, no company limited by shares can issue irredeemable preference shares. Further, by the insertion of Section 80 A in the Amended Act of 1988, companies which had issued irredeemable preference shares prior to the commencement of the Amendment Act 1988 were required to redeem such shares within a period of 5 years from 15th June 1988, regardless of the terms of issue.

In the case of redeemable preference shares issued prior to 15th June 1988, redemption had to be effected on the due date as per the terms of issue, or within a period of 10 years from the date of commencement of the Amendment Act, 1988.

Where a company was not in a position to redeem its preference shares within 10 years or to pay dividend, if any due on them, it was permitted to issue fresh redeemable preference shares equal to the amounts due on the unredeemed preference shares with the consent of the National Company Law Tribunal. On such an issue, the unredeemed preference shares were deemed to have been redeemed.

Sec. 80 of the Companies Act authorizes only the fresh issue of redeemable preference shares. No company is permitted to convert the existing preference shares into redeemable preference shares. Further by the Amendment Act 1996, no company limited by shares can issue preference shares which is irredeemable or redeemable after the expiry of a period of 20 years from the date of their issue. Thus, the maximum period of redemption is 20 years.

The above discussion makes clear the following points:

“To redeem” means “to pay back or return”.

Redemption of Preference shares means repayment of money paid by the holders of redeemable preference shares, against the issue of such shares.

Preference shares can be redeemed only if they are fully paid up. That is, partly paid up preference shares cannot be redeemed.

The sources for redemption come from two sources – Fresh issue of shares and Profit of the Company.

When redemption is out of fresh issue, the amount received on fresh issue is utilised for the redemption of preference shares. Thus new shares take the place of redeemed shares.

When redemption is out of profits, the required amount is transferred from profit to a special account called “Capital Redemption Reserve Account”. Then preference shares are redeemed. The Capital Redemption Reserve Account takes the place of redeemed shares.

Sources of Redemption

One of the conditions of redemption of preference shares lays down that where redemption is to be effected at a premium, the same is to be provided for out of the profits of the company, or out of the company’s Securities Premium Account.

This condition implicitly permits a company to redeem its preference shares at a premium. Accordingly one of the sources of redemption at a premium is the company’s retained earnings in the absence of Securities Premium Account or the Securities Premium Account itself.

The following are the some examples of profits which are available for dividends and which may be utilised for the purpose of creating a Capital Redemption Reserve Account:

Proceeds of Fresh Issue

Fresh issue of shares can be made only by Equity Shares or by Preference Shares. It is to be remembered that the proceeds of borrowings (e.g. by the issue of Debentures or loans) or the proceeds by selling fixed assets/Investments, may not be utilised for the purpose. It is also to be remembered that reduction of Preference Shares shall not be considered as a reduction of its authorised Share Capital.

The word “proceeds” implies the amount received excluding the amount of Securities Premium on the new issue of shares. Similarly, when the new issue is at par or at a discount, the net amount received from the issue should be deemed as “proceeds”.