The Hindu Business Line : Preference in conversion

T. V. Narayanaswamy on the applicability of Takeover Regulations to the conversion into equity shares of preference shares which carry voting rights

TAKE the case of a company (the target company) which issued redeemable cumulative preference shares a few years back and did not pay dividend thereon at the agreed rate since the issue of the said shares, and consequently the dividend on the preference shares, is in arrears. The company now desires to covert these preference shares into equity after complying with the requisite formalities provided in the Companies Act, 1956.

In this background, the following question arises: Does this conversion require compliance with the requirements of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (Takeover Regulations) by the holders of the preference shares?

Proposed conversion and preferential issue?

Before examining this, it would be useful to consider whether the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000 would apply to such an issue. As the shares on conversion would be offered only to the holders of preference shares, a question would arise whether it amounts to preferential issue, which is governed by Chapter XIII of the Guidelines.

Passing of necessary resolution: As regards issue of equity shares on conversion of preference shares, resolution under sub-section (1A) of Section 81 of the Act will have to be passed. Such an issue cannot be called a private placement, as the conversion will take place in respect of all the holders of preference shares. It may be more than or less than 50 members depending on the number of holders of preference shares in the company embarking on conversion.

This, in effect, is an offer to a section of the public and thus would be deemed to be a public issue under Section 67 of the Act. As such Chapter XIII of the Guideline would not be applicable to such an issue. But, as seen earlier, it is a public issue, even though specifically the Guidelines do not deal with such issues, a prospectus has to be filed with SEBI/Registrar of Companies in connection with such an issue. In this connection, it is suggested that a comprehensive document such as the Guidelines should cover this situation also by making suitable amendments thereto.

Pre- and post-acquisition obligation under the Takeover Regulations: The requirements to be complied with in regard to acquisition of shares or voting rights under the Takeover Regulations relate to both pre- and post-acquisition. Under Regulation 7 of the Takeover Regulations, intimation has to be given by the acquirer to the company and to the stock exchanges in which the shares in the target company are traded within two days of the acquisition/allotment on conversion.

Obligation as to public announcement to acquire shares: In terms of the provisions of amendments made to the Regulations on December 30, 2004, no person can acquire shares or voting rights in a target company by market purchases or preferential allotment if his voting right consequent to the acquisition exceeds 55 per cent of the voting rights in the target company unless he makes a public announcement to acquire shares or voting rights in accordance with the Takeover Regulations vide Regulation 10 read with Regulation 11.

Definition of `share' in Takeover Regulations: The term `share' has been defined in the Takeover Regulations to mean "shares in the share capital of a company carrying voting rights and includes any security which would entitle the holder to receive shares with voting rights but shall not include preference shares". While referring to pre-acquisition holding, the phrase used is `shares or voting rights'when a prohibition or restriction is imposed on acquisition of shares or voting rights without making a public announcement, the reference is to voting rights only. Scope of restriction or prohibition and obligation to make a public announcement: The restriction or prohibition does not make any reference to nature or volume of shares after acquisition. The shares may be equity or preference. Likewise, the volume may be anything. But the prohibition or obligation to make a public announcement would arise only if there is any augmentation of the voting right beyond 5 per cent of the total increased voting rights in the company concerned.

In the example looked at earlier, the company has not paid any dividend on the preference shares for a continuous period of more than two years. A company can hold its annual general meeting (AGM) for consideration of accounts up to six months of the close of the financial year and if dividend is declared at the AGM, then under Section 205A of the Act, the dividend has to be distributed within 30 days.

Under the circumstances, the holders of preference shares on which dividend has not been paid for many years would become entitled to voting rights under sub-clause (i) of clause (b) of sub-section (2) of Section 87 of the Act on all resolutions placed before the general meeting of members, from the expiry of 30 days from the last date by which the target company is required to hold its AGM in respect of the second financial after the issue of preference shares.

For convenience, it can be assumed that this day falls on May 1, 2005. Thus, with effect from May 1, even though the terms of issue of the preference shares do not confer on their holders or carry any voting rights, because of the legal fiction in sub-clause (i) of clause (b) of sub-section (2) of Section 87, the holders of the aforementioned preference shares are entitled to vote on all resolutions placed at any general meeting held on or after May 1.

By getting this voting right because of a legal fiction, it cannot be said that those persons who are the holders of the preference shares have acquired voting rights

(By arrangement with Corporate Law Adviser, New Delhi.)

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